This article was downloaded by: [University of Hong Kong Libraries]On: 11 November 2014, At: 02:16Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number: 1072954 Registered office: MortimerHouse, 37-41 Mortimer Street, London W1T 3JH, UK
Applied Economics LettersPublication details, including instructions for authors and subscription information:http://www.tandfonline.com/loi/rael20
Reform in China's 'B' share markets and theshrinking A/B share price differentialPaul McGuinnessPublished online: 06 Oct 2010.
To cite this article: Paul McGuinness (2002) Reform in China's 'B' share markets and the shrinking A/B share pricedifferential, Applied Economics Letters, 9:11, 705-709, DOI: 10.1080/13504850210124572
To link to this article: http://dx.doi.org/10.1080/13504850210124572
PLEASE SCROLL DOWN FOR ARTICLE
Taylor & Francis makes every effort to ensure the accuracy of all the information (the Content)contained in the publications on our platform. However, Taylor & Francis, our agents, and our licensorsmake no representations or warranties whatsoever as to the accuracy, completeness, or suitabilityfor any purpose of the Content. Any opinions and views expressed in this publication are the opinionsand views of the authors, and are not the views of or endorsed by Taylor & Francis. The accuracy ofthe Content should not be relied upon and should be independently verified with primary sources ofinformation. Taylor and Francis shall not be liable for any losses, actions, claims, proceedings, demands,costs, expenses, damages, and other liabilities whatsoever or howsoever caused arising directly orindirectly in connection with, in relation to or arising out of the use of the Content.
This article may be used for research, teaching, and private study purposes. Any substantial orsystematic reproduction, redistribution, reselling, loan, sub-licensing, systematic supply, or distribution inany form to anyone is expressly forbidden. Terms & Conditions of access and use can be found at http://www.tandfonline.com/page/terms-and-conditions
Reform in Chinas `B share markets and
the shrinking A/B share price di erential
Department of Finance, Chinese University of Hong Kong, Shatin, New Territories,Hong KongE-mail: firstname.lastname@example.org k
The use of capital controls in mainland China has meant that shares in listed PRCstate enterprises traded in either Shenzhen or Shanghai have been broadlyseparated into `A and `B share categories. `A shares are traded in ChineseRenMinBi and are restricted to trades between indigenous investor concerns, whilst`B shares trade in US$ in Shanghai and HK$ in Shenzhen and have, until recently,been the legal preserve of investors emanating from outside the PRC mainland.Reforms, instituted with e ect from 28 February 2001, have altered this picture,however, with certain parties from the PRC mainland now able to participate inthe `B markets. The opening of the `B market has resulted in a rapid increase in `Bprices. The e ects are analysed in this paper for 40 companies with concurrent `Aand `B share listings in Shanghai. Prior to the reforms, the `A shares traded at pricesthat were, on average, over four times the level on corresponding `B shares. By themiddle of June 2001, this multiple had been squeezed substantially. This short paperexamines the relative changes to the `A/`B share price di erential and nds that `Bprice movement are related to the absolute price levels in `A and `B share pricesprior to the reforms. The results are consistent with a retail market in which a`trading range obtains for prices in the two market sectors.
I . INTRODUCTION
This article examines recent reforms to the `B share mar-
kets in mainland China and the impact of these reforms on
the relative pricing of shares in companies with both `A
and `B listings. Before outlining these reforms, it is import-
ant to realize that shares in the typical PRC state-owned
enterprise are separated into negotiable and non-negotiableblocks of scrip. The non-negotiable block typically domi-
nates and is controlled either directly or indirectly by the
PRC State. This block of scrip often accounts for between
60 and 70% of outstanding equity. The remaining, negoti-
able stock can be traded in one of three non-fungible
forms: as tradable `A, `B or `H stock. Certain combina-
tions of the tradable categories are also permissible for any
given company, with `A and `B listings and `A and `H
listings admissible and common in a number of listed state
`H shares represent stock listed on exchanges outside the
PRC mainland, with Hong Kong and the New York StockExchange the preferred venues.3 `A and `B shares in con-
trast can be listed in either Shanghai or Shenzhen where, in
the case of `A shares, trades are conducted solely in
RenMinBi and limited to parties with Mainland residency.
`B shares in comparison trade in US$, if listed in Shanghai,
or in HK$, if listed in Shenzhen, and, prior to reforms
Applied Economics Letters ISSN 13504851 print/ISSN 14664291 online # 2002 Taylor & Francis Ltdhttp://www.tandf.co.uk/journalsDOI: 10.1080/1350485021012457 2
Applied Economics Letters, 2002, 9, 705709
1 See McGuinness et al. (2000) for more details of these categories.2As of August 2000, 82 companies had concurrent `A and `B share listings (with 41 in Shanghai and 41 in Shenzhen) and a further 19 had concurrent `Aand `H listings (see McGuinness et al., 2000: p. 8).3 Securities in the latter are in the form of ADR, with underlying `H shares held by a custodian bank on behalf of the benecial ADR owner.
implemented with e ect from 28 February 2001, were
intended to be the legal preserve of parties emanatingfrom outside the PRC Mainland.The `B share reforms, announced on 19 February, 2001
and implemented with e ect from 28 February, 2001 (withthe `B markets suspended between these two dates),
a orded indigenous mainland individual investors, withrecognized foreign exchange accounts opened prior to theannouncement, the opportunity to trade `B shares.4 Prior
to the reforms, the `B shares were relatively illiquid andwere typically priced at a discount of 70% or more to `Ashares, even within the same company.5 The opening of the`B markets quickly changed this with the di erential being
squeezed by more than half between March and June 2001.The e ects have not been unduly surprising as the price
`premiums on `A shares have typically been credited tothe huge amounts of savings in China which are essentially`locked into the Mainland by virtue of capital controls.6;7
Allowing some of these savings to nd an alternativeinvestment route the local `B share market has, there-fore, precipitated a sharp change in the `A and `B share
price di erential. Table 1 illustrates the e ect of thesechanges, for 40 companies with concurrent `A and `Bshare listings on the Shanghai Stock Exchange, for various
dates in 2001. In addition to the remarkable shrinkage inthe `A/`B price ratio, the Shanghai `B Indexs perform-
ance since the reform has been remarkable: the Index roseby 53% alone within the rst week of post-reform trading.8
As of mid June 2001, the market had risen by an astound-
ing 143% from its 31 January 2001 level.
II . DATA DESCRIPTION
Particulars of the companies involved in the analysis inTable 1 are set out in the Appendix. The closing pricesshown are adjusted in the case of Heilongjiang Electricand Jinzhou Harbour Co. for bonus issues (stock divi-dends), occurring between 1 January and 14 June 2001.None of the 40 companies experienced stock splits or rightsissues during the period however. Adjustments to the `Aand `B prices for dividends were not made, essentiallybecause such entitlements apply equally to a given com-panys `A and `B shareholders; with the caveat that divi-dends are paid in RenMinBi on `A shares and in US$ orHK$ on `B shares. As dividend yields were also generallyquite low, the e ects on individual `A and `B prices andthe `A/`B price ratio were minimal. All prices and checksfor bonus issues, splits and rights issues were determinedusing Datastream.
III . PRICE BEHAVIOUR OF COMPANIESWITH CONCURRENT `A AND `BSTOCK LISTINGS IN SHANGHAI
The interesting issue here is how locally-held foreignexchange funds have spread across the market. Using the40 companies with concurrent `A and `B share listingsdescribed earlier, funds appear to have owed into the`lowest priced stocks rst and, as these have becomemore expensive, possibly migrated across the `B share
706 P. McGuinness
4 For useful descriptions of the `B share reforms see Chinaonline (20 February 2001 and 22 February 2001).5 See McGuinness et al. (2000) for PE ratio comparisons as of August 2000.6 For data prior to the reforms, Sun and Tong (2000) analyse the `A and `B market segmentation in terms of a `di erential demand elasticity argument,where increases in the supply of `B shares (relative to `A) enlarge the `A share `premium. This is predicated on a more inelastic demand curve for `Bshares (due to `foreign investors having greater investment substitutes). Sun and Tong found that `A `premiums tend to increase with new `H and `Red-Chip share listings in Hong Kong, which, prior to the `B market reforms, were likely viewed as alternative investment outlets for `B market players.7 Evidence in Chinas balance of payments indicates that there are, despite the policing of capital controls, substantial outows. Greenwood (2000) on thisissue notes in relation to Chinas Balance of Payments (B of P),
`The third component (of the B of P) is the persistent unrecorded capital outow by the private sector. These outows may partly be the result of illegal or underhandtransactions such as transfer pricing, e.g. over-invoicing of imports or under-invoicing of exports, or the smuggling out of the proceeds of corruption and crime. In the pastdecade these unrecorded capital ows (reected in the large errors and omissions terms in Chinas balance of payments) have increased strikingly. (p. 2, parentheses added).
8 The Index at the close of trading on the last day of trading prior to the implementation of the reforms (of 19 February) was 83.201 points. Tradingresumed on 28 February and, as of 6 March, the Index closed at 127.477 points (Index values obtained from Datastream).
Table 1. `Snap-shots of `A and `B share prices in companies with concurrent Shanghai listings: 31 January, 12 March and 14 June 2001
Average of `A/B priceratio in companies
Shanghai `Ashare index
Shanghai `Bshare index
31 January 2001 4.10 2185.196 85.56512 March 2001 2.56 2114.086 134.09214 June 2001 1.86 2297.383 202.523
Number of companies 40
Notes: Source of closing price and index data: Datastream; 41 companies were identied, courtesy of the SFC (one, PT Narcissus wasremoved due to its delisting in April 2001). Prices in `A shares were in RenMinBi (Yuan) and in `B shares in US$. The `A shares wereconverted to US$ prices using a Yuan/US$ exchange rate, rounded to two decimal places, of 8.28 for each of the three dates (source ofrates: Datastream).
market. This suggests a perceived `trading range in prices.A tight distribution of absolute price levels in both `A and`B shares as shown in Table 2 bears this out.The `trading range e ect is also borne out when running
correlations between the percentage change in the `A/`Bshare ratio (A/B) and the absolute price levels of the `Aand `B shares that obtained just prior to the reforms. Forthis purpose, percentage changes in the `A/`B share ratiobetween 31 January and 12 March 2001 (A/B13), 12March and 14 June 2001 (A/B46) and 31 January and14 June 2001 (A/B16) are calculated. Running correla-tions between these variables and RenMinBi adjusted `Bshare prices for 31 January, resulted in respective coe -cients of 0.5435, 0.5883 and 0.3667. These strong correla-tions suggest that greater shrinkage in the `A/`B pricingdi erential occurred for the lowest priced `B shares.Negative correlations of 0:1323, 0:0262 and 0:3604between (A/B13), (A/B46) and (A/B16) and the31 January `A prices conrmed the mirror opposite: thehigher the value of `A shares prior to the reforms, thegreater the shrinkage in the `A/`B price di erential.
IV. CLOSING REMARKS
In sum, then, this note shows that the adjustments to `Bshare prices, following the recent reform of this market,reect a rather tight `trading range. As the reforms tothe `B share markets have ostensibly drawn in Mainlandindividuals rather than institutions [see Chinaonline (20February 2001)], the results are perhaps not too surprising.The dominance of retail investors may mean that board lotcost is paramount . This argument also presupposes somedegree of myopia with prices seemingly driven more bymoney-ow than fundamentals. As the `B share marketwas somewhat moribund prior to the reforms and, in gen-eral, contains rather small amounts of `oat, such e ectsappear reasonable.
This begs a further question: how far will the `A/`Bdi erential be squeezed. As `A and `B shares representseparate blocks of stock albeit o ering shareholders thesame entitlements, when issued in a given company theycannot be traded between the respective markets. Theabsence of arbitrage processes clearly limits the extent towhich the di erential can be squeezed. It is also probablytrue that better quality companies exist in the overall `Amarkets, of which 1000 or more company listings exist(compared to the limited number on the `B share mar-kets).9 There is also evidence that illegal means of divertingforeign exchange from the Mainland has contributed to arecent rise in `H share values in Hong Kong. The specula-tion is that some of this money has been driven from the `Bshare markets, as P/E ratios in companies with `H listingshave appeared increasingly attractive relative to spiralling`B share values (even though the companies involved insuch listings are di erent).10
The author would like to thank the Research Departmentof the Securities and Futures Commission in Hong Kongfor their help in identifying companies with both `A and`B share listings in Shanghai and Hong Kong, and OscarSo and Chris Tse for their assistance in collecting variousdata items from Datastream.
Chinaonline (2001) Come on in: China opens B-share market,http://www.chinaonline.com/topstories/010220/1/. Accessed
20 February 2001.
Chinaonline (2001) B patient: China issues forex controls to reg-ulate B-share trading, http://www.chinaonline. com/top-
stories/010222/1/. Accessed 22 February 2001.
Reform in Chinas `B share markets and shrinking price di erential 707
9 See McGuinness et al. (2000: p. 4) for a recent breakdown of listings.10 See Ogden (2001) and Chinaonline (19 June 2001) for recent commentaries.
Table 2. Mean price levels for `A and `B shares with `B prices converted into RenMinBi
Mean Std Dev. Minimum Maximum N
Price `A (31 Jan) 15.74 4.65 7 28 40Price `A (12 Mar) 14.78 4.62 6 29 40Price `A (14 Jun) 17.76 6.01 6 36 40Price `B (31 Jan)* 3.90 1.18 2.48 8.86 40Price `B (12 Mar)* 5.94 2.05 3.06 12.92 40Price `B (14 Jun)* 9.53 2.57 4.97 14.41 40
Notes: Source of closing price and index data: Datastream (see Table 1 earlier).* Prices in `B shares were in US$ but are converted into RenMinBi (Yuan) for means of comparison. The exchange conversion wasachieved using a rate of 8.28 Yuan/US$ for each of the three dates (source of rates: Datastream). Note that the average (price `A)/average (price `B) is not equal to average price (`A/`B).
Chinaonline (2001) CSRC cracks whip on illegal H-share trading,http://www.chinaonline.com/topstories/010619/1/. Accessed
19 June 2001.
China Securities Regulatory Commission (2001) News release onthe termination of the listing of PT narcissus,
www.csrc.gov.cn. Accessed 25 April 2001.
Greenwood, J. (2000) The impact of Chinas WTO accession oncapital freedom, Paper presented in Session 2 of a conference
entitled `Globalization, the WTO and Capital Flows: Hong
Kongs Legacy, Chinas Futures (Cato Institute and theHong Kong Centre for Economic Research), Hong Kong,
McGuinness, P. B., Lee, J., Wong, V., Cheung, K. and Yuhong,Y. (2000) Market segmentation in the pricing of di erent
categories of stock in Mainland-incorporated companies,
SFC Bulletin, Hong Kong, JulySeptember 2000, 118.http://www.hksfc.org.hk/eng/index.htm.
Ogden, J. (2001) Red alert threatens red chips: H shares tumble as
crackdown on ood of hot mainland money puts rally inChina plays at risk, South China Morning Post, Business
Post, 13 June 2001, 1.
Sun, Q. and Tong, W. H.-S. (2000) The e ect of market segmen-tation on stock prices: the China syndrome, Journal of
Banking & Finance, 18751902.
708 P. McGuinness
Reform in Chinas `B share markets and shrinking price di erential 709Appendix