Comparison of A-share and H-share Prices

IFM FALL 2005 FINAL PAPER

Peishee Seah, Jeremy Tan and Amy Hsiang

Why are the shares of People’s Republic of China (PRC)-domicile companies with cross listings in China’s stock exchanges priced

differently?

When companies that are incorporated in the PRC decide on public listing in China1, they have to make numerous decisions, including which stock exchange(s) to list on and what class(es) of shares to list. Currently, the choices in which stock exchanges to list on are Hong Kong Stock Exchange, Shanghai Stock Exchange and Shenzhen Stock Exchange 2 . These PRC-domicile companies also face the choice of whether they should list in only one class of share, namely A, B or H share; or have multiple listings across various share classes.

This paper provides a primer on the various share classes in Chinese stock exchanges today and aims to explore the drivers for differentials in stock pricing for those PRC-domicile companies that have multiple listings across different share classes.

There are three main sections: the first section introduces the different classes of shares and describes the characteristics of each share class; the second section discusses the reasons in pricing differentials for PRC-domicile companies with multiple share classes; the third section focuses on recent reforms in listing and share class regulations and resulting implications. I. Characteristics Of Each Type Of Share Class Since their establishment in the early 1990s, the Shanghai and Shenzhen stock exchanges in PRC have grown to a combined market capitalization of nearly USD400Bn3. On the other hand, the Hong Kong stock exchange was established in 1914 and has a current market capitalization of more than USD635Bn4. Currently, there are 2 classes of shares listed and traded in the PRC exchanges – A share and B share, and another 2 classes of shares in the Hong Kong exchange – H share and Red Chip share. The A, B and H share classes are structures set up for public listing of PRC-domiciled companies only. The Red Chip share class is a public listing structure for companies incorporated in Hong Kong but have their main business activity in PRC.

1 In this paper, our references to “China” include the People’s Republic of China where the Shanghai and Shenzhen stock exchanges are located, and the Hong Kong Special Administrative Region (SAR). We make the distinction of PRC-domicile companies and Hong Kong-domicile companies, as it is only the PRC-domicile companies that have multiple listings across different share classes in the Chinese stock exchanges. 2 Listing in overseas exchanges is also an option. This paper only focuses on listing option in China. 3 Bloomberg LP, accessed December/2005.

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4 Capital IQ, accessed December/2005.

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This section describes the characteristics of each class of share including the average volume traded, investor type and regulations and listing requirements, and explains the key differences among all these classes of shares.

I.I A-class shares5

Characteristics: The A-class shares are stocks listed locally in PRC. The prices of A-class shares are quoted in Renminbi and currently, only PRC citizens, permanent residents and selected foreign institutional investors are allowed to trade them. Most A-class share companies are partially privatized government companies; approximately two thirds of total A-class shares are held by the Chinese government. The market capitalization of tradable A-class share is around USD150Bn. Turnover is very robust in this market while management quality, disclosure, and shareholder protection tend not to be held in high regard. Listing Requirements: Listing requirements for A-class share in both Shanghai and Shenzhen stock exchanges are similar. The general requirements for listing6 include:

• IPO granted by the China Securities Regulatory Commission • Gross Capital stock of 50 million shares • A minimum three-year operating history • Positive earnings in each of the past three years • Public holdings of no less than 25% • Good credit records in the past three years

I.II B-class shares

Characteristics: The B-class shares are also stocks listed locally in PRC, but designated for foreign investors and PRC residents with appropriate foreign currency dealing accounts. The shares are denominated in Renminbi and payable in foreign currency. The B-class shares listed in the Shanghai Stock Exchange are quoted in US dollars, while those listed in the Shenzhen Stock Exchange are quoted in Hong Kong dollars. Listing requirements7: For PRC-domicile companies that seek to attract foreign investors, the B-class share market offers less stringent listing requirements and is a lower-cost listing alternative than the H-class share market (another type of share listed in Hong Kong that are available to foreign investors). Currently, the listing requirements for B-class share are similar to those of A-class share explained in the sub-section I.I above. Please refer to the section I.III for detailed information on listing requirements for the H-class shares.

5 Brad Aham, “China: An Update for Foreign Investors”, Global Active Equity. 6 Shanghai Stock Exchange, “Listing on SSE”, Shanghai Stock Exchange Web site, http://www.sse.com.cn/sseportal/en_us/ps/lc/lst_req.shtml, accessed December 2005.

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7 Shanghai Stock Exchange, “Listing on SSE”, Shanghai Stock Exchange Web site, http://www.sse.com.cn/sseportal/en_us/ps/lc/lst_req.shtml, accessed December 2005.

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http://www.sse.com.cn/sseportal/en_us/ps/lc/lst_req.shtml

I.III H-class shares Characteristics8: H-class shares are stocks for companies that are incorporated in PRC

but listed on the Hong Kong stock exchange. These shares are denominated in Hong Kong dollars. Most H-class share companies are former PRC State-Owned Enterprises (SOEs) that are in the process of privatization. Some of these companies with H-class shares also issue American Depository Receipts (ADRs) that are traded on the New York stock exchange. Listing Requirements9: As mentioned above, the listing requirements for H-class shares are more stringent than for those of A or B-class shares. The PRC-domicile companies that wish to list in the H-class share market must comply with the Hong Kong Stock Exchange listing regulations. The general requirements for listing on the main board include:

• The issuer must be incorporated in Hong Kong and comply with Hong Kong stock exchange regulations

• The Hong Kong exchange must view that the business and the issue is suitable for listing • The issuer must satisfy the profit test

- Demonstrate profitability in the last three years with most recent profit of at least USD2.8MM and minimum aggregate of USD4.2MM in the two preceding year

• The issuer must satisfy the market capitalization/revenue/cash flow test - Market capitalization of at least USD258MM at the time of listing - Revenue of at least USD65MM in the most recent edited financial - Positive cash flow in the most recent edited financial

Despite the more stringent listing requirements for H-class share, most companies, of which most are PRC SOEs, still prefer to seek listing in the Hong Kong stock exchange. This is due to the fact that the H-class share in the Hong Kong stock exchange is significantly more liquid than the B-class share in the PRC stock exchanges. From Jan 2002 to Dec 2005, the average daily trading volume for H-class share is 629MM compared to 28MM and 49MM trading volume for B-class share in the Shanghai and Shenzhen stock exchanges respectively 10 . Apart from the larger liquidity of H-class share market, foreign investors also prefer the larger degree of transparency that companies with H-class share listing typically provide. Having said that, overall, the PRC government still retains strong control over the selection of SOEs that are eligible to seek H-class share listing.

I.IV Red Chip shares

Characteristics: Red Chip companies are those which are incorporated in Hong Kong but have majority of their business activity in the PRC. Often, their parent companies are former PRC SOEs. In most cases, a provincial or municipal government in the PRC is the majority owner of the holding parent company. These Red Chip stocks are listed in the Hong Kong stock exchange and quoted in Hong Kong dollars.

8 Brad Aham, “China: An Update for Foreign Investors”, Global Active Equity. 9 Hong Kong Stock Exchange, “Issuer Services – Listing in Hong Kong,” Hong Kong Exchange and Clearing Limited website, http://www.hkex.com.hk/issuer/listhk/rules_reg.htm, accessed December 2005.

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10 Bloomberg LP, accessed December/2005.

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http://www.hkex.com.hk/issuer/listhk/rules_reg.htm

As Red Chip companies are Hong Kong-domiciled, they are not eligible to list in the stock exchanges in PRC. Hence, unlike their PRC-domiciled counterparts that may list in both PRC and Hong Kong, Red Chip companies do not have the right to cross-list in Hong Kong and Shanghai or Shenzhen. Listing Requirements: The general requirements for listing11 are:

• The issuer must be incorporated in Hong Kong and comply with Hong Kong stock exchange regulations

• The Hong Kong exchange must view that the business and the issue is suitable for listing • The issuer must satisfy the ownership test

- At least 30% of its shares held by PRC entities, with these entities being the largest shareholders in aggregate terms; or

- PRC entities have between 30% and 20% of share holdings and there is strong influential presence of PRC-linked individuals on the board of directors

Table 1 below illustrates the differences among the 4 different classes of shares discussed above: Table 1 - Key characteristics of A, B, H and Red Chip shares

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A share B share H share Red Chip share

Number of listed companies

Companies’ country of domicile

Investor type

Stock exchanges with such shares

Average daily trading volume1

Average P/E3

Total market capitalization

Characteristic

PRC exchanges: Shanghai, Shenzhen


Hong Kong exchange

Hong Kong exchange

Shanghai: 55Shenzhen: 59

Shanghai: 824Shenzhen: 556 Hong Kong: 117 Hong Kong: 89

PRCPRC PRC Hong Kong

Foreign investors, PRC residents with foreign currency dealing accounts

Local PRC investors, selected foreign institutional investors

Foreign investors Foreign investors

Hong Kong: 629MM Hong Kong: 350MM2Shanghai: 28MMShenzhen: 49MM

Shanghai: 1,234MMShenzhen: 761MM

1 Average daily trading volume from Jan 2002 to Dec 20052 Average daily trading volume from May 2005 to Dec 2005

3 P/E as of 5 Dec 2005

USD7.59BnUSD383.75Bn USD78.0Bn USD183Bn

Hong Kong: 12.90 Hong Kong: 16.08Shanghai: 17.51Shenzhen: 8.86

Shanghai: 17.12Shenzhen: 24.04

A share B share H share Red Chip share

Number of listed companies

Companies’ country of domicile

Investor type

Stock exchanges with such shares

Average daily trading volume1

Average P/E3

Total market capitalization

Characteristic



Hong Kong exchange

Hong Kong exchange

Shanghai: 55Shenzhen: 59

Shanghai: 824Shenzhen: 556 Hong Kong: 117 Hong Kong: 89

PRCPRC PRC Hong Kong

Foreign investors, PRC residents with foreign currency dealing accounts

Local PRC investors, selected foreign institutional investors

Foreign investors Foreign investors

Hong Kong: 629MM Hong Kong: 350MM2Shanghai: 28MMShenzhen: 49MM

Shanghai: 1,234MMShenzhen: 761MM

1 Average daily trading volume from Jan 2002 to Dec 20052 Average daily trading volume from May 2005 to Dec 2005

P/E as of 5 Dec 2005

USD7.59BnUSD383.75Bn USD78.0Bn USD183Bn

Hong Kong: 12.90 Hong Kong: 16.08Shanghai: 17.51Shenzhen: 8.86

Shanghai: 17.12Shenzhen: 24.04

3

Source: Bloomberg; Capital IQ

11 Hong Kong Stock Exchange, “Listing Matters and Listed Companies,” Hong Kong Exchanges and Clearing Ltd website, http://www. Hkex.com.hk/listing/listing.htm, accessed December 2005.

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II. Reasons in pricing and trend differentials for companies with multiple share classes

In this paper, we will focus on investigating price differentials for companies with A and H share cross-listings only. The paper will not focus on companies with A and B share cross-listings because of the low liquidity of the B-share market (refer to Table 1: comparison of average daily trading volume across different types of shares). We will investigate price differentials for companies with A and H share cross-listings on an aggregate and a company-specific level. Our analysis of price differentials on a company-specific level will enhance the understanding of explaining this phenomenon on an industry level.

II.I Price differentials between A-class and H-class shares on an Industry Level

At the end of December 2004, there are 30 companies cross-listed on both A-class share and H-class share. 28 of these companies have A-shares trading at a premium over their H-class shares. These premiums ranged from 6% to 349%12 with a market capitalization weighted average of about 39%. In contrast, only 2 companies have A-class shares traded at a discount to its H-class shares, ranging from 0.1% to 8.9%3. Table 2 below shows the distribution of price premiums across these 30 companies. Table 2 - Price differentials between A-class and H-class shares (as at end of December 2004)13

Premium of A-shares over H-shares December 2004 0 - 50% 10 50 - 100% 4 100 - 200% 9 200 - 300% 4 +300% 1

Sub-total 28

Premium of H-shares over A-shares December 2004 0 - 25% 2

Sub-total 2

TOTAL 30 Source: SFC Research Based on our research, there are two main reasons driving the gap between A-class and H-class shares on an industry level:

12 Joseph lee and Joanna Poon, “Convergence of A-share and H-share Prices,” SFC Research Paper No. 19, 2005, http://www.sfc.hk/sfc/html/EN/research/research/research.html, accessed December 2005.

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• Limited investment opportunities for local retail investors and asset management companies

• Limited supply of tradable A-class shares Limited investment opportunities for local retail investors and asset management companies: China’s economic growth has been maintained at an average rate of 9% over the past 20 years. This has led to increased income per capita and wealth accumulation – GDP per capita for China was US$1,087 in 2003 which has reached level of a middle-income country after adjusting for purchasing power14. Despite growth in personal wealth, investment options for retail investors are very limited due to relatively underdeveloped local capital markets. In addition, these investors do not have the option of investing overseas due to enforcement of China’s closed capital account policies. As a result, this led to accumulating savings deposits which amounted to US$1,444Bn as of December 2004. This is approximately 10 times the tradable market capitalization of Shanghai and Shenzhen stock markets. Chart A below shows the savings deposits in mainland China from 1997 to 2004. Chart A - Savings Deposits in mainland China (US$Bn)

Source: CEIC On the institutional level, there are 45 local fund management firms of which 12 are foreign joint ventures. These firms managed a total of USD42Bn as of December 200315. Except for select local fund managers that have QDII (Qualified Domestic Institutional Investors) status that entitled them the right to invest outside of PRC, the rest of the managers are restricted to invest only in local bourses. As a result, this channeling of excess capital to limited investment opportunities are driving up demand for A-class shares listed in Shanghai and Shenzhen exchanges. Limited supply of tradable A-class shares: At of December 2004, the market capitalization of A-shares listed in the Shanghai and Shenzhen stock exchanges amounted to US$448Bn16. However,

14 Joseph lee and Joanna Poon, “Convergence of A-share and H-share Prices,” SFC Research Paper No. 19, 2005, http://www.sfc.hk/sfc/html/EN/research/research/research.html, accessed December 2005. 15 Frederik Balfour, “Welcome To China's Mutual Fund Jungle,” Business Week, March 7, 2005, http://www.businessweek.com/magazine/content/05_10/b3923174_mz035.htm, accessed December 2005.

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only one-third of these listed shares are tradable; the remaining 66% of listed A-shares are mainly state-owned shares that are non-tradable. As such, the portion of the market capitalization that was tradable was only US$141Bn14. This created a supply crunch for tradable A-shares. Chart B shows the historical percentage of negotiable17 market capitalization as a percentage of total market capitalization. Chart B - Time series of historical negotiable market capitalization

Source: CEIC

II.II Price differentials between A and H shares on a Company-Specific Level

To deepen our understanding of the drivers of price differentials on an industry level, we initiate a deep-dive approach into 3 companies that are cross-listed on A and H-class share structures. We form several hypotheses about possible drivers of trading characteristics:

• Share price movements of A and H share correspond closely to the local market indices, namely Shanghai and Hong Kong stock exchanges respectively

• Number of free float A-class shares is less than that of H-class shares, hence contributing to a more limited supply of tradable A-class shares

• The investor mix for tradable A-class share and H-class share is significantly different; this has an impact on share valuation

Our criteria in selecting companies for the deep-dive are that they must be in different industries, have significantly different profitability and market capitalizations, and command different P/E valuations. For ease of comparison, we only screen companies that have A-share listed in the Shanghai stock exchange, not Shenzhen stock exchange, as the Shanghai stock exchange is 400 times larger than the Shenzhen stock exchange in terms of market capitalization. The 3 companies selected for the deep-dive are:

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17 Negotiable refers to the shares that freely traded on the exchanges

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• Sinopec Shanghai Petrochemical – one of the largest petrochemical enterprises and ethylene producers in PRC; has USD491MM in year-end 2004 profit; has a price differential of 64% between A and H share price18

• Shenzhen Expressway – engages in the construction and operation of highways and expressways in PRC; has USD51 MM in year-end 2004 profit; has a price differential of 45% between A and H share price19

• Tsingtao Brewery – the largest domestic beer brewer in terms of production scale and market share in PRC; has USD35 MM in year-end 2004 profit; has a price differential of 16% between A and H share price20

Hypothesis 1: Share price movements of A and H share correspond closely to the local market indices, namely Shanghai and Hong Kong stock exchanges respectively

Charts B1 and B2 below show the relative A and H-class stock performances of our 3 selected deep-dive companies with the respective local market indices. These charts show clearly that the A and H share price movements of these companies tend to mirror the daily fluctuations of the local indices. For all 3 companies, the A and H share prices seem to move independently of each other. Chart B1 - Relative Performance of Selected Companies vs. Shanghai Stock Market Index

Relative Performance (%)

31.39

51.39

71.39

91.39

111.39

131.39

151.39

171.39

191.39

12/31/01 3/12/02 5/22/02 8/1/02 10/11/02 12/23/02 3/4/03 5/14/03 7/24/03 10/3/03 12/15/03 2/24/04 5/5/04 7/15/04 9/24/04 12/6/04 2/15/05 4/27/05 7/7/05 9

Dow Jones Shanghai Index - Index Shenzhen Expressway Co. Ltd. (SHSE:600548) - Common StockSinopec Shanghai Petrochemical Co. Ltd. (SHSE:600688) - Common Stock Tsingtao Brewery Co. Ltd. (SHSE:600600) - Common Stock

Sinopec Shanghai Petrochemical

Shenzhen Expressway

Source: Capital IQ

18 ISI Emerging Markets, Accessed [December/2005]. 19 ISI Emerging Markets, Accessed [December/2005].

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20 ISI Emerging Markets, Accessed [December/2005].

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Tsingtao Brewery

/16/05 11/28

x

e 8 o

Inde

/05

f 16

Chart B2 - Relative Performance of Selected Companies vs. Hong Kong Stock Market Index

Relative Performance (%)

48.73

148.73

248.73

348.73

448.73

548.73

37256 37313 37370 37427 37484 37543 37600 37657 37714 37771 37830 37887 37944 38001 38058 38117 38174 38231 38288 38345 38404 38461 38518 38575 3

Hang Seng Index Shenzhen Expressway Co. Ltd. (SEHK:548) - Common StockSinopec Shanghai Petrochemical Co. Ltd. (SEHK:338) - Common Stock Tsingtao Brewery Co. Ltd. (SEHK:168) - Common Stock


Source: Capital IQ Table 3 below outlines the correlation analysis of the A and H-class share prices wicorresponding local indices. In both cases, there is very strong positive correlationconfirming our hypothesis that share price movements of A and H share track their local in Table 3 - Correlations of A and H-class share prices for 3 deep-dive companies

Class of Share Shenzhen

Expressway Sinopec Shanghai

Petrochemical Tsingtao Brewery

A Share 0.92 0.61 0.49 H Share 0.89 0.82 0.74

Hypothesis 2: Number of free float A-class shares is less than that of H-class hence contributing to a more limited supply of tradable A-shares

Based on our investigation into number and percentage of free float A and H shares, the of free float A-class shares is consistently less than that of H shares for all 3 companies. below illustrates our findings: Table 4 - Free float A and H-class shares for 3 deep-dive companies Free float shares expressed as % of total shares outstanding (A+H)

Shenzhen Expressway


TsingtaoBrewery

A Share 14.7% 12.1% 15.3%H Share 34.3% 32.4% 30.5%

Source: Bloomberg and Capital IQ

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Tsingtao Brewery

Shenzhen Expressway

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shares,

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The relative scarcity of tradable A-class shares over tradable H-class shares results in a lower supply of A-class shares in PRC stock exchanges. This is partly responsible for driving up the prices of A-class shares. However, we note that there may be a small number of companies where their total number of H-class shares listed is significantly smaller to the total number of A-class shares listed. In this case, we expect the converse to be true.

Hypothesis 3: The investor mix for tradable A-class share and H-class share is significantly different; this has an impact on share valuation

Generally, we believe (and hope) that institutional investors are more informed compared to the average retail investors. Consequently, both types of investors would form different valuations for each stock. As such, investor mix would impact valuation levels. Table 5 below shows the percentage of tradable shares in each class of share held by each investor type. Table 5 - Investor base for 3 deep-dive companies

Institutional Retail Institutional Retail Institutional Retail

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A

%each

Share 32.60% 67.40% 6.20% 93.80% 53.00% 47.00% Share 30.00% 70.00% 44.20% 55.80% 100.00% 0.00%

rice premium (A share ver H share)

45.00% 64.00% 16.00%

of tradable shares in share class

Shenzhen Expressway Sinopec Shanghai Tsingtao Brewery

H

Po

Source: Bloomberg LP We hypothesize that a large price differential between A-class and H-class share is driven by retail investors dominating A-class shares and institutional investors dominating H-class shares, because retail investors are more likely to bid up valuations due to their lack of sophistication, and vice versa. Based on this hypothesis, Table 6 below shows how we interpret the results from the Table 5 above: Table 6 - Degree of domination of shares held by retail investors for 3 deep-dive companies Degree of domination of shares hold by retail investors

Shenzhen Expressway


Tsingtao Brewery

A Share High Very High MediumH Share Medium Medium LowPrice premium (A share over H share)

45% (Medium)

64% (High)

16% (Low)

These 3 examples support our hypothesis that differences in investor base partly drive the price differentials between A-class and H-class shares. In the extreme case of Sinopec Shanghai Petrochemical where there is a very large skew towards retail investors in its A-class share investor base compared to its H-class share investor base, this results in a high price differential between its A-class share and H-class share valuation of 64%.

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II.III Industry-level narrowing of price differentials between A and H shares

The premiums of A-class share prices over H-class share prices have narrowed from a market capitalization weighted average of 830% at the end of 2000 to 39% at the end of 2004. From 2000 to 2004, the Shanghai A and Shenzhen A indices fell 39% and 52% respectively21. In contrast, the H-share index gained 192% despite the Hang Seng Index (local HK stock exchange index) dropping 5% over the same period. Chart C illustrates the historical performance of the A-share and H-share. Chart C - Relative performance of Hang Seng Index (HSI), H-Share Composite Equity Index

(HSCEI), Shanghai A-Share Index and Shenzhen A-Share Index21

The valuation of the Shanghai A share and Shenzhen A share markets have declined – the PE multiples receded from 59x and 56x respectively at the end of 2000 to 24x and 26x at the end of 2004. On the other hand, the PE ratio of H-share index advanced from 9x to 16x over the same period and the valuation of HSI increased from 13x to 20x21. The tightening of the A-share/ H-share premium may be attributed to the following:

• Selling down of state’s ownership in listed China companies • Possible lifting of restriction on overseas investments

Selling down of state’s ownership in listed China companies: This alleviates the supply crunch of A-class shares, thus lowering the valuation of such shares. At the same time, the share overhang from the sale of state-owned shares and new shares offering further depressed the valuation of A-class shares. (Please refer to Section III – Recent regulatory reform - for more details)

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Possible lifting of restriction on overseas investments: The Chinese authorities are contemplating the implementation of a scheme – Qualified Domestic Institutional Investors (QDII) – which will permit local investors to invest overseas. This scheme provides local investors with more investment alternatives while maintaining PRC’s capital controls. The availability of alternative channels of investments for local investors would reduce demand in A-shares and the subsequent tightening of the A-share/ H-share premium. (Please refer to Section III – Recent regulatory reform - for more details)

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III. Recent regulatory reforms The transition to market economy and the establishment of the Shanghai and Shenzhen stock exchanges have resulted in the rapid growth of the securities market in PRC. However, Shanghai and Shenzhen exchanges have fallen continuously since 2001 and are at their eight-year low as of July 2005. China Securities Regulatory Commission (CSRC), China’s capital markets regulator, is committed to the formulation, implementation and enforcement of regulatory and financial reforms to revive the local markets. CSRC has introduced 2 recent reform policies:

• Shares reform of non-tradable A shares • Increased quota of Qualified Foreign Institutional Investor (QFII) scheme and the

introduction of Qualified Domestic Institutional Investor (QDII) scheme Through the first reform, CSRC hopes to increase the liquidity of the local exchanges. QFII and QDII are reform vehicles that allow China to open up its financial markets while at the same time enforcing its capital controls. Shares reform of non-tradable A-class shares: In August 2005, CSRC announced its commitment to a market overhaul which will reform the shareholder structure of all 1,248 listed A-class companies. CSRC hopes to revive the domestic markets by injecting more liquidity through the release of stated-owned non-tradable shares. With the enforcement of this reform, it is estimated that USD260Bn of non-tradable shares would be released to the markets 22 . As mentioned in Section II, this would alleviate the supply crunch of A-class shares and its corresponding effect of driving up valuation of A-class shares. At the same time, through the reform, the State would reduce its holdings in State-owned Enterprise (SOEs). The increase in public holdings and its corresponding demand for alignment to shareholder interests would add pressure on SOEs to adopt better and more transparent corporate governance. Between late April and late June 2005, the CSRC launched and modified a pilot scheme which led to 46 companies successfully completing share reform22. The minority stock holders of tradable shares were given 2 to 4 shares in compensation for every 10 shares owned. Holders of the B-share and H-share will not take part in the A-share market reform and will not get compensation. However, CSRC has made it clear that the reform will not harm the legitimate interests of B-share or H-share holders. The reform has to be approved by a majority of the shareholders (at least one pilot reform, Tsinghua Tongfang23, has been rejected due to insufficient shareholder support) Qualified Foreign Institutional Investor (QFII) and Qualified Domestic Institutional Investor (QDII) Scheme: PRC regulators have designed a framework where non-PRC investors, after gaining QFII status, will be allowed to invest in the domestic A-class share market. While there are already a number of investors with QFII status, PRC regulators are looking to expand the quota of this investor class. As a policy tool, QFII could increase foreign flow into the local markets and absorb the state-held shares released from the share reform, cushioning any downward pressure exerted on the markets from shares overhang.

22 PriceWaterHouse Coopers, “PwC M&A “house views” – September 2005”, PriceWaterHouse Coopers Web site, http://www.pwccn.come/home/eng/m&a_houseview_sep2005.html, accessed December 2005.

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23 PriceWaterHouse Coopers, “PwC M&A “house views” – September 2005”, PriceWaterHouse Coopers Web site, http://www.pwccn.come/home/eng/m&a_houseview_sep2005.html, accessed December 2005.

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http://www.pwccn.come/home/eng/m&a_houseview_sep2005.html

In addition to increasing the number of QFII, CSRC is exploring the introduction of a mirror scheme - QDII (Qualified Domestic Institutional Investors). This scheme allows selected qualified domestic investors in the PRC to invest overseas. The economic boom experienced by mainland China has resulted in the increase of personal wealth and accumulation of saving deposits. With limited investment options, these funds were channeled to local stock markets, bidding up valuation and driving down returns. If implemented, this provides local institutions such as insurance companies, local fund mangers and the National Social Security (China’s Pension Plan) with more investment options and hopefully better returns. This is part of the Chinese government efforts to reform its pension funds which had assets of nearly USD20Bn as at September 200424.

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24 Frederik Balfour, “Welcome to China's Mutual Fund Jungle,” Business Week, March 7, 2005, http://www.businessweek.com/magazine/content/05_10/b3923174_mz035.htm, accessed December 2005.

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IV. Conclusions The securities markets in China has come a long way since the establishments of the Shanghai and Shenzhen stock exchanges in the early 1990s, and the first listing of the H-class share on the Hong Kong exchange in 1993. The transition from a planned economy to a market economy has introduced reforms that have notable contributions in opening up and expanding the local securities market. With China’s accession to WTO, its securities market will face challenges creating the impetus for further change. In particular, we see the need to drive reforms in several key areas, namely:

• Developing expertise and sufficient manpower resources in supervising and enforcing

securities regulations • Improving the business legal framework, especially increasing disclosure requirements

and building clarity into standard accounting practices • Instituting and enforcing shareholder rights

As the Chinese government considers further reforms, it will continue to face the challenge of balancing the dual objectives of freeing up the financial markets and maintaining capital control. The narrowing of the A-class share and H-class share premium differential is indicative of its past successful reforms. As reforms continue, we expect that the current listing structures of A, B, H and Red Chip-class shares to evolve. In particular, as the A shares become increasingly open to foreign investors, we predict that the B-class share listings to diminish in importance and eventually may be folded into the A-class share umbrella.


Bibliography Aham, Brad. China: An Update for Foreign Investors. (Global Active Equity). Balfour, Frederik. “Welcome to China’s Mutual Fund Jungle.” Business Week, March 7, 2005. http://www.businessweek.com/magazine/content/05_10/b3923174_mz035.htm, accessed December 2005. Bloomberg LP, accessed December/2005. Captial IQ, accessed December/2005. Hong Kong Stock Exchange. “Issuer Services – Listing in Hong Kong.” Hong Kong Exchange and Clearing Limited Web site. http://www.hkex.com.hk/issuer/listhk/rules_reg.htm, accessed December 2005. Hong Kong Stock Exchange. “Listing Matters and Listed Companies.” Hong Kong Exchange and Clearing Limited Web site. http://www.hkex.com.hk/issuer/listhk/rules_reg.htm, accessed December 2005. Lee, Joseph and Poon, Joanna. “Convergence of A-share and H-share Prices,” SFC Research Paper No. 19, 2005. http://www.sfc.hk/sfc/html/EN/research/research/research.html, accessed December 2005. PriceWaterHouse Coopers. “PwC M&A “house views” – September 2005.” PriceWaterHouse Coopers Web site. http://www.pwccn.com/home/eng/m&a_houseview_sep2005.html, accessed December 2005. Shanghai Stock Exchange. “Listing on SSE.” Shanghai Stock Exchange Web site. http://www.sse.com/cn/sseportal/en_us/ps/lc/lst_req.shtml, accessed December 2005.






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