Monday, March 12, 2007

The East Is 'Red'

HK's Financial Markets' Future

The Shanghai Stock Exchange has a market cap of nearly HK$7,400 billion (US$950 billion). In comparison, China companies listed on HKSE comes to a total market cap of HK$2,000 billion, which means roughly 21% of China listed assets is in HK. If you were to check the same figures 3 years ago, 6 years ago and 10 years ago as a percentage of total HKSE market cap, suffice to say that China stocks may be instrumental in revving up interest in HK stocks for the last 5 - 8 years.

China stocks listed in HK are known as red chips (H shares). Most are also dually listed in Shanghai. One trades in HKD while the other is in yuan. Shares on Shanghai Exchange or Shenzhen Exchange are known as "A shares". Foreign investors can only buy the A shares provided they have QFII quota. As at the end of November last year, there were 85 red chips.

Companies under HK rules generally come under more stringent financial reporting rules. Red chips trades in HKD which has more convertability. The rule of law in HK makes for a significant reduction in risk premium in terms of accountabity, securing shareholders' rights, etc... Hence you would expect the red chips to trade at a premium to the A shares. Unfortunately the reverse is true.

Both H and A shares have the same shareholders' rights but the HK listed red chips are at a discount to their Shanghai counterparts. For example Bank of China in Shanghai trades at more than 30% premium to its HK share price, while China Life in Shanghai is at a quite ridiculous 60% premium. Whether a stock is at a premium or a discount, its all valuation. Who is to say the Shanghai price is more correct than the HK price? Maybe the smarter valuation is in HK and not Shanghai??

Looking at the China prices, the premium is not one which is based on strong factors. Rather, it is based on weak factors such as the LACK of good listed China companies in Shanghai and Shenzhen exchanges. While that will push up premium on good stocks, it is not something that will or can last.

One of the biggest danger making its round in HK is the fear that a few red chips may be making its way back to list solely on the Shanghai Exchange, owing to the better valuation there. Better valuation means cheaper access to funds. It will also allow for borrowing in yuan as the bulk of most red chips business is out of China anyway.
Among those touted as being the first movers back to Shanghai include China Telecom and CNOOC. What about the views from party leadership? I am sure they would want Shanghai Exchange to flourish, hence moving these stocks back would be the right thing to do. However, they will end up with a dire lack of visibility among international investors. The bulk of foreign investors wanting a slice of China action will have to go via China funds. The restrictive QFII quota also means it will have to be looser and broader in the near future.

I doubt WTO and Hank Paulson will look upon this development positively. They can bring back companies to Shanghai but also needs to loosen up the QFII immediately. If not, the current crop of those with QFII quota will see their funds trade at a big premium due to scarcity.

What companies would lose out on if they leave HK? Access to multi-currency fund raising options. Better and more stringent financial regulatory processes, which bodes well if the company intends to compete in international markets or be in jvs with international partners. Access to human capital and launchpad for market visibility. How many international news bureau or international business channels do you see in Beijing or Shanghai (or Singapore for that matter)??!!

At the end of the day, if more and more red chips convert their H shares back to A shares, the premium would dissipate anyway. Don't tell me then the companies would want to relist their H shares in HK again? It is also a question of Shanghai or HK for the party leadership .... but I thought Shanghai and HK belonged to the same party leadership??

Red chips moving back won't hurt HK's financial future much, it would have been very nice but the depth and breadth of the markets in HK means losing the listing is not material. It would hurt the actual companies more for them to move back because of the reasons cited above.

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