Chinese regulation and its capital markets
Yimin Huang | August 10th, 2022
Source: Mint
China is the world's most populous country, with more than 1.4 billion people and has the second-largest economy in the world at USD$17.73 trillion after the United States (World Bank Data). Hong Kong also acts as a gateway between China’s capital market and the world. Under the principle of one country, two systems, Hong Kong’s economy is characterized by low tax rates, free trade, and limited government interference. Hong Kong operates with its own judicial system and legislative branch, and a free enterprise system with its own policies on trade, customs and currency.
Even though diplomatic relations can sometimes be strained, the two localities are economically interdependent, closely connected by trade imports and exports. Their bilateral trade was valued at more than $560 billion in 2021. Mainland China is Hong Kong's largest trading partner and its second-largest source of inward direct investment, accounting for 27.1% of the total, according to Hong Kong's Trade and Industry Department.
China’s Stock Exchanges
The Shanghai Stock Exchange (SSE) is China's and Asia’s largest and world's 3rd largest stock exchange with a total market capitalization of USD$7.62 trillion as of July 2021. Most of the companies listed are large, state-owned companies like energy firms and most investors are financial institutions like pension funds and banks.
The Shenzhen Stock Exchange (SZSE) is a smaller exchange with a market capitalization of USD$3.9 trillion in July 2021. It trades the shares of smaller, more entrepreneurial and emerging-sector companies, including many tech companies, and most investors are individuals.
The Hong Kong Stock Exchange is the fourth largest in Asia and seventh largest in the world by market capitalization, at $5.4 trillion at the end of 2021. Slightly over 50% of the total number of listed companies on the exchange are mainland Chinese companies ("H-shares") whose rapid development has gone hand-in-hand with the enormous economic rise of the country.
Understanding the main types of Chinese shares
A-shares: RMB-denominated shares in mainland China-based companies listed on the Shanghai and the Shenzhen stock exchanges. A-shares have in the past been restricted to Chinese citizens but is now gradually being opened up to outside investors who meet the eligibility criteria through programs such as the Qualified Foreign Institutional Investors (QFII), Renminbi (RMB) Qualified Foreign Institutional Investors (RQFII) and Stock Connect programs. Electronics giant Media Group, and the Industrial and Commercial Bank of China (ICBC) have A-shares listed on domestic stock exchanges.
B-shares: Non RMB-denominated shares in mainland China-based companies listed on Chinese mainland stock exchanges. B-shares ownership is open to both foreign investors and domestic investors with foreign currency accounts. Examples of companies with B-shares include Hainan Airlines and the real estate giant Vanke, which are listed on the Shanghai and Shenzhen Stock Exchange respectively.
H-shares: HKD-denominated shares in Chinese companies which are listed in and trade on the Hong Kong Stock Exchange. Companies with H-shares include the likes of CITIC Securities, Tsingtao Brewery, and ZTE Corporation, all of which are incorporated in the Chinese mainland.
Other Chinese share classes include N-shares, Red Chips and P Chips, which are securities of companies incorporated and listed outside mainland China.
Source: Plus 500
Access to Capital and Investments in China and Hong Kong
The mainland Chinese stock markets are generally more restrictive and have high financial requirements, while Hong Kong's stock market has typically been more accessible and attractive to overseas investors for its advantages, as distilled by Tianlei Huang, research analyst at the Peterson Institute for International Economics: First, the registration-based IPO system enables a faster and smoother listing process compared to the mainland. Second, the absence of capital controls and greater international exposure allows Hong Kong to serve as an anchor point for global expansion. Third, Hong Kong’s sound financial infrastructure mitigates operational costs. Lastly, its regulatory framework which focuses on transparency and prudent minimum standards also makes it attractive to overseas investors.
For these reasons, the Hong Kong Stock Exchange has been seen as a gateway to China for those who are interested in doing business on the mainland or in accessing Chinese stocks or investments, and is also the preferred choice for many Chinese companies looking to raise capital.
However, markets in mainland China are also beginning to open up to foreign institutions. In 2014, a program titled "Shanghai-Hong Kong Stock Connect" was launched to allow investors in these regions to have access to and trade specified companies listed on each other’s stock exchange through their local securities firms via the cross-border channel. In 2016, a similar program titled "Shenzhen-Hong Kong Stock Connect" was launched as well.
Effects of Chinese regulation on Chinese businesses
Stock prices are determined by supply and demand which are affected by a number of factors, including fundamental factors such as the company's earnings and profitability, technical factors relate to a stock's price history in the market pertaining to chart patterns, momentum, and market sentiments.
In particular, diplomatic relations between mainland China and regions like Hong Kong also have effects on investor sentiments and therefore stock prices. For instance, Chinese President Xi Jinping’s first trip outside the mainland since the pandemic to Hong Kong in July 2022 to swear in Hong Kong’s new leader John Lee and celebrate 25 years of Chinese rule boosted Hong Kong stocks, with the Hang Seng China Enterprises Index gaining 16%. Meanwhile, heightened geopolitical tensions after United States House Speaker Nancy Pelosi’s visit to Taiwan on August 2, 2022 reflected losses in mainland China and Hong Kong markets, as the Shanghai Composite lost 2.26%, the Shenzhen Component shed 2.37%, and Hong Kong’s Hang Seng index fell 2.36%.
Tighter regulatory controls pose more serious impacts on businesses.
One of the more well-known cases is the sudden cancellation of a $34.5 billion IPO of Ant Group, financial affiliate of the Alibaba Group, in November 2020 citing regulatory concerns. If successful, it would have been the biggest IPO in history. Since then, new anti-monopoly regulations and rulings have been imposed on an array of internet platforms. Alibaba shares dropped 8% after Ant Group said it currently has no plans to revive an IPO, and a key regulator said it had not conducted an evaluation on a potential listing.
Ride hailing giant Didi Global had also come under scrutiny as the Chinese government tightened control of consumer data. Just days after it raised $4.4 billion in a New York IPO in 2021, Beijing launched a data-related cybersecurity investigation into the company, causing shares to plunge. The Cyberspace Administration of China alleged that Didi was illegally collecting users’ data and ordered its app removed from the local app store. In less than 6 months after its IPO, Didi announced that it will delist from the New York Stock Exchange and seek to list in Hong Kong instead. In July 2022, Didi was fined $1.2bn after the probe.
The country’s $120 billion private tutoring industry was also a target for crackdown. Under the policy change, classes on weekends and during summer and winter breaks are banned, approvals of new schools have been halted and foreign investment in the industry is restricted and education companies have been barred from raising capital through public listings. This move to turn all private tutoring companies to non-profit wiped out billions of dollars in value of listed Chinese firms, triggering a massive sellout and plummet of share prices.
Conclusion
China extends strong regulatory hold over its domestic markets, but as its homegrown firms grow, how it manages the relationship between the government and market will have to be seen. There seems to be indications that the clampdown is easing – just recently in May 2022, Chinese Vice Premier Liu He said the government will support the development of the technology sector, public listings for technology companies, and the healthy development of the platform economy. Even so, the series of mixed developments and regulatory signals, especially just following contracting industrial output and consumer spending, are factors of caution for investors.