Last updated: January 9, 2013 7:15 pm

End of the road for China’s ‘B’ market

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After years at death’s door, China’s so-called “B” share market may finally be put out of its misery. The 20-year-old experiment is set to be wound down as companies give up on this “zombie” market.

Late last month, China International Marine Containers (CIMC) became the first company to convert its Shenzhen-listed B shares into Hong Kong-listed “H” shares.

Two more companies including China Vanke, the country’s largest listed property developer, have since suspended their shares amid expectations they will soon announce similar plans. Deloitte estimates roughly 40 of the 85 companies with B shares are likely to be potential candidates for conversion.

“It’s not just Vanke, everyone is wondering about the future of B shares. B shares serve no purpose,” says Sun Jianbo, chief strategist at Galaxy Securities in Beijing.

For foreign investors holding B shares – including Vanguard, Fidelity and Commonwealth Bank of Australia – this shift could provide a welcome performance boost: analysts expect stocks that successfully move to Hong Kong to perform well. Some have even asked if unloved New York-listed Chinese companies might be tempted to follow suit.

The B share market was set up in the early 1990s to offer Chinese companies better access to foreign investment. At the time, currency controls and investment restrictions effectively blocked other routes into Chinese equities for foreigners.

Both the Shanghai and Shenzhen stock exchanges have B share markets, where equities are denominated in US dollars and Hong Kong dollars, respectively.

It’s not just Vanke, everyone is wondering about the future of B shares. B shares serve no purpose

- Sun Jianbo, Galaxy Securities

However, the rapid development of Hong Kong’s H share market – Hong Kong dollar-denominated shares of mainland companies that are unrestricted to foreign investment, tracked by the Hang Seng China Enterprises index – has torpedoed the project.

The “liquidity of the B share market is very poor. It’s very difficult for institutional investors to make sizeable investments,” says Agnes Deng, head of China equities at Baring Asset Management. “Overall regulations [in Hong Kong] are much more standardised. That has given much more comfort to international investors.”

The opening up, albeit slowly, of the mainland’s renminbi-denominated A share market to global capital has also undermined interest in B shares.

Last summer, the China Securities Regulatory Commission, the market regulator, eased restrictions on foreign investment in the A share market via the qualified foreign institutional investor scheme, enabling bigger investments from a broader range of funds.

Chinese authorities have in the past tried to fix the B share market. In 2001, they changed the rules to allow domestic investors to buy in, prompting a doubling in the Shenzhen index within the space of a few weeks. But too few domestic investors held sufficient foreign currency to make the project sustainable and China now appears content to let the market fade away.

The conversion process is relatively complex. Companies need approval from the CSRC and must offer existing investors the option to sell their shares rather than swap them for H shares, explains Ringo Choi, leader of initial public offerings at Ernst & Young in Hong Kong. They must also meet the listing requirements of the Hong Kong Stock Exchange.

But there are encouraging signs. Last month, the CSRC relaxed restrictions on overseas listings for Chinese companies in an attempt to ease the pressure caused by the more than 800 companies waiting to list on the mainland. It also gave the green light to the CIMC move.

For the companies themselves, there are good reasons to convert from Bs to Hs. Besides joining a far more active market, the valuations of B shares have been below those of other Chinese stocks. China Vanke’s B shares currently trade at a price to earnings ratio of 9.9 times, compared with 10.7 times for its A shares.

Credit Suisse analyst Du Jinsong believes a B to H conversion would offer “significant relative upside” for China Vanke. “We expect a potential switch of investors of some stocks with rich valuation to China Vanke’s H shares,” he wrote in a recent research note.

The experience thus far of CIMC offers plenty of reasons for optimism to the many foreign investors who still hold B shares. Shares of CIMC have risen more than 30 per cent since their Hong Kong debut.

Expectations of a mass conversion have sparked a rally in B shares. In the past two weeks, the Shenzhen B share index has risen almost 20 per cent to its highest level since the summer of 2011, although on Wednesday it fell 1.2 per cent.

The prospective string of B to H conversions has raised the question of whether New York-listed Chinese companies will be tempted to follow suit. Many of them have suffered from a similar liquidity drought, though for different reasons such as attacks by short sellers, and might prefer to trade nearer their home market.

However, says Mr Choi, moving to Hong Kong would be a “far more complicated process” for New York listings. Companies would have to delist altogether, forcing them to re-evaluate their options. Many might choose to remain private, or look to the A share market instead, he says.

Additional reporting by Simon Rabinovitch in Beijing.

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