A curious thing happened as China’s renminbi-denominated A-shares tumbled on Wednesday. While they dropped by 6.4 per cent, the alphabet soup of other classes of Chinese company shares fell by sharply differing amounts.
The so-called H-shares, mainland Chinese companies traded in Hong Kong, fell just 2 per cent while mainland-listed, foreign currency-denominated B-shares fell more than 9 per cent.
The performances provided a reminder of the degree by which shares in Chinese companies are priced at large discounts or premiums depending on where and in what currency they are traded, thanks to China’s capital controls and the different perspectives of domestic and international investors.
By the market close on Wednesday, A-shares listed in Shanghai and Shenzhen were trading at an average of more than 34 times estimated 2007 earnings, against 17.5 times for H-shares. This is somewhat counterintuitive considering the 143 mainland companies traded in Hong Kong are generally China’s biggest and best.
Valuation gets even more confusing when individual companies have listed in more than one market.
By close of trade on Wednesday, the 42 companies actively traded in both the H-share and A-share markets were on average 93 per cent more expensive in Shanghai and Shenzhen than in Hong Kong, even after on Wednesday’s large drop.
And there are the B-shares, which trade in US dollars in Shanghai and in Hong Kong dollars in Shenzhen. There are 86 companies with both A- and B-share listings and on average, the B-shares are nearly 70 per cent cheaper than their A-share counterparts.
Steven Sun, regional equity strategist at HSBC, said: “There is no practical difference between the various share types except they trade in different markets and are not fungible because of China’s capital controls.”
Without the ability to arbitrage between the different markets, prices vary depending on investor sentiment in the various jurisdictions.
Zuo Xiaolei, chief economist at Galaxy Securities, said: “The fundamental reason for different valuations is that global investors don’t think these shares are worth as much as domestic investors think they are.”
Xiang Huaicheng, chairman of the National Social Security Fund, China’s largest institutional investor, described the typical risk appetite among mainland investors last week: “The Chinese stock market is like a glass of beer. If there are too many bubbles it doesn’t taste good but if there were no bubbles who would want to drink it?”
Wednesday’s introduction of a stamp duty on share trading managed to push prices down but the underlying reason for so many Chinese investors to punt in an overheated market remains.
The country’s citizens have very few investment options and are being tempted into a market that has quadrupled in less than two years. At the same time, inflation of more than 3 per cent means the money they deposit in low-yielding bank savings accounts is earning negative real interest.
With individual bank savings deposits of more than Rmb17,400bn ($2,275bn) there is still plenty of fuel to add to the stock frenzy.
To add to the authority’s list of concerns, recent market movements have also highlighted the problem with the anachronistic B-share market.
Last Thursday, after Alan Greenspan, former US federal reserve chairman, warned that the Chinese market was due for a dramatic correction, the A-share market barely moved.
But on the same day, B-shares, originally reserved for foreign investors, dropped more than 5 per cent, ostensibly because the market is more responsive to sentiment outside China.
In fact, B-shares had been extremely volatile of late and had fallen almost 7 per cent a day earlier. Also, the vast majority of B-shares are held by individual domestic investors – they have been allowed to buy these shares since 2001 – many of whom have never heard of the venerable Mr Greenspan.
Since then, the relatively tiny and illiquid B-share market has seen plenty of sharp movements. But instead of reflecting the more cautious view held by foreigners on the Chinese markets, B-shares are most likely to move on rumours that the government is about to merge the market with the much larger and more expensive A-share market, a move senior regulatory officials have said is just a matter of time.
But the merger has been delayed because of disagreements within the government about implementation.
In particular, questions remain over what to do about the remaining foreign holders of B-shares, who are not legally allowed to own A-shares, except through a limited qualified foreign institutional investor scheme. As Mr Xiang says: “We have done all the easy reforms already and they have been successful but there are many harder things to be done. We have drunk the soup and what we are left with are the bones.”