The brewer of China’s popular Tsingtao beer enjoys ample market access, having listings on both the Shanghai and Hong Kong stock exchanges. But Tsingtao Brewery Co.’s Shanghai-listed A shares trade at a whopping 30 percent discount to its H shares in Hong Kong.
The huge price difference for shares that have the same economic interest in Tsingtao is a reminder that the “one country, two systems” political relationship between China and the former British colony also applies, with a vengeance, to equities.
Big changes are expected this fall, though, with the launch of a long-awaited pilot project that aims to bridge that valuation gap. Under the program, mainland investors for the first time will be allowed to trade certain H shares on the Hong Kong stock exchange, whereas eligible Hong Kong account holders will gain direct access to the Shanghai market.
If the project succeeds, officials at the China Securities Regulatory Commission in Beijing and the Hong Kong Securities and Futures Commission are expected to use this cross-border trading initiative as a template for more bridge-building. Future projects could connect Hong Kong with China’s second big stock market, in Shenzhen. Analysts also speculate that the authorities might create a similar bridge between the two mainland exchanges and Singapore.
Valuations between mainland stocks and their H-share equivalents in Hong Kong have long varied, but over the past year A shares have been trading at a notable discount because of an influx of global liquidity into the Hong Kong market and a higher cost of capital in Shanghai and Shenzhen, according to a recent report by UBS.
The Hong Kong exchange’s market cap rose 18.6 percent over the latest 12-month period, to $3.29 billion, whereas the Shanghai Stock Exchange’s market cap grew by 13.6 percent in dollar terms, to $2.62 billion, according to the World Federation of Exchanges.
The opening of a trading bridge between Hong Kong and the mainland should narrow the A-share discount, says Chen Li, head of China equity research at UBS in Shanghai.
“I do believe the gap between A shares and H shares, especially for the dual-listed companies, will compress in the short term,” Chen tells Institutional Investor. “If you are a global fund manager, you will go for the less expensive [stock] in the same companies to maintain your position in China.”
Global fund managers are also being forced to weigh this new window to Shanghai stocks against their participation in the Chinese government’s 11-year-old Qualified Foreign Institutional Investor program. QFII has awarded about $50 billion in quotas to more than 200 entities, from the Ford Foundation and Pacific Investment Management Co. to the Qatar Investment Authority, the Gulf state’s sovereign wealth fund.
About three fourths of all QFII cash is in equities, including Shanghai and Shenzhen stocks. Chen expects some of that foreign money to shift into the new program, although QFII will still be a viable channel for fixed-income investment as well as mainland equities not covered by the new scheme.
Chinese investors, meanwhile, are chomping at the bit for a chance to play Hong Kong stocks, according to Xie Kaicong, an analyst at the Hong Kong office of China’s Guosen Securities. The official Securities Daily newspaper recently said investors had opened at least 30 new, Hong Kong exchange–eligible accounts with mainland brokers every day in the first half of this year.
Direct access to Hong Kong stocks is a dream come true for many mainlanders. Currently, retail investors can only buy overseas-listed shares through funds under the government’s Qualified Domestic Institutional Investor program. About 120 funds, most run by state banks and securities firms, have permission to invest about $86 billion in foreign equities.
“Hong Kong is a shopper’s paradise” for mainlanders on holiday, Xie notes. “But it’s also stock market heaven.”
When the two-way stock investment project’s first draft came off the drawing board seven years ago, mainland brokers excited about the prospect of fast-track access to the Hong Kong market dubbed the proposed link the “through train.” In the excitement, though, policymakers smelled risks and decided to shelve the plan.
Officials dusted off the idea last April and named it the Shanghai–Hong Kong Stock Connect program; it’s also commonly known as mutual market access (MMA). Officials have not set a launch date, but they hinted at early October by announcing April 10 that the start would come in “approximately six months.”
Today broker enthusiasm for MMA is still strong but tempered by restrictions that limit trading options and, regulators hope, mitigate risk.
Regulators have set an overall ceiling of $88.7 billion for the two-way investment flow under the program. They have further limited trading to a combined $2 billion a day flowing into Shanghai from non-Chinese investors and $1.6 billion per day into the Hong Kong market by Chinese investors. The expectation is that these quotas will rise over time.
So far, officials have named 568 Shanghai stocks and 266 Hong Kong stocks that will be eligible for two-way trading. These include many of the 170 mainland companies that already have listings at home and in Hong Kong. Altogether, about 1,600 companies are listed in Hong Kong, compared with some 1,000 in Shanghai.
The rule makers say all trading must be denominated in yuan, which fits China’s goal of increasing the international use of the country’s currency. And all but two participating securities firms — UBS and Goldman Sachs — will be Chinese. Regulators have also made clear that inbound investment will be subject to Beijing’s existing restrictions, which say a single foreign investor cannot hold more than 10 percent of any mainland company’s shares, and foreigners overall cannot own more than 30 percent of any company.
Analysts believe that MMA will attract a narrow range of investors, at least initially, because of the various rules. Chen argues that hedge funds will be among the most active early players, looking to take advantage of the possibilities for arbitrage between the A-share and H-share markets. Before diving in, he says, foreign investors should pay close attention to issues of corporate governance and financial reporting, for which standards are looser on the mainland than in Hong Kong. They also “need to understand the retail investors” who strongly influence mainland markets and who are “very sensitive to liquidity and policy” issues, Chen adds.
But over time, as price gaps narrow and two-way investment flows grow, MMA could be a stepping stone to bigger and more lucrative trading links that bring China and the rest of the world closer. The pilot project “is just a start for the opening of China’s capital market,” says Chen.
