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China’s share class mosaic

By: Mat Lystra, Senior Research Analyst

China is home to the world’s second largest economy after the United States, but for much of its history, foreign investment into Chinese companies has been heavily restricted.[1] Over the last 35 years, China has been slowly opening its doors to offshore investments through a series of reforms. As we will explore below, beginning in 1980 China has offered seven main types of publicly traded share classes, most of which permit foreign investors to gain some level of exposure to the Chinese economy. However, a majority of foreign investors are still excluded from owning the largest class of shares[2] — A-shares — although A-shares represent about two thirds of the entire Chinese equity market and account for some $6.5 trillion in market capitalization.[3]

As you can see on the timeline below, beginning in 1980 the Chinese government initiated a series of reforms intended to improve the performance of state owned enterprises (SOEs) by introducing managerial performance incentives and market-based pricing.[4] As the competiveness of Chinese companies increased, two domestic stock exchanges were established—the Shanghai Stock Exchange in November 1990 soon followed by the Shenzhen Stock Exchange. While the Chinese government still maintained majority ownership of publicly traded companies, domestic investors could now access a limited supply of A-shares. 

A-shares are denominated in Renminbi and have traditionally been treated as the domestic investor share class within China. Shortly after the issuance of A-shares, the B-share class was created to allow foreign investors to own shares in domestic companies. B-shares are traded within China but are settled in either US or Hong Kong dollars. Soon after the introduction of B-shares, their popularity was overshadowed by the issuance of H-shares listed on the more familiar Hong Kong Stock Exchange (HKEX). In addition to access via the more familiar exchange, H-shares are also denominated in Hong Kong dollars—making currency accounting easier to manage for most global investors. H-shares commonly have corresponding mainland A-shares which at times may trade at a premium to their H-share counterparts—adding to H-share desirability.[5] 

A-, B- and H-shares are all linked to companies incorporated within China. The other four share class types mentioned in our timeline above involve companies whose businesses and/or ownership can be traced to China but are incorporated outside the country: Red-chips, P-chips, S-chips and N-shares. [6]

Red-chips are listed on the HKEX and are linked to a mainland government entity. P-chips, S-chips and N-shares have many similarities with the main difference being where they are listed. P-chips are listed in Hong Kong, S-chips in Singapore and N-shares in New York. Companies listed using one of these three share types have a majority owner and are most often incorporated in a tax-advantaged country.

The development of the many share classes over time demonstrates China’s progress from an inward facing economy to one that is now critical to the growth of the global economy. However, as we can see above the domestic-only A-shares represent a large majority of listed securities linked to the Chinese economy. As long as foreign investors' access to A-shares continues to be gated, the Chinese equity market is left incomplete within most global benchmarks and investors' portfolios.

As China continues to open up, FTSE Russell is anticipating a time when A-shares can finally be included in its standard global benchmarks. And as the change take place, FTSE Russell is giving market participants tools like the China A-Inclusion index series which can be used as a bridge between benchmark exposure now and full benchmark exposure in the future.

The second part of this blog series will take a more in-depth look at the seven main types of Chinese share classes including historical performance and correlations to each other.

For more detailed information about China's share classes, please see our report, China through the mosaic of its share classes.

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[1] Worldbank:  http://data.worldbank.org/data-catalog/GDP-ranking-table

[2] Foreign Investors who maintain a Qualified Foreign Institutional Investor (QFII) license with China’s State Administration of Foreign Exchange (SAFE) have regulated access to A-shares.

[3] As at December 31 2015.

[4] Li, W. (1997). The Impact of Economic Reform on the Performance of Chinese State Enterprises, 1980-1989. Journal of Political Economy, Vol. 105 No5, pp 1080-1106

[5] See Capturing pricing anomalies: China A- and H- shares

[6] These are the main stock types although other minor types exist such as L-shares and F-shares that trade in London and Frankfurt.

 

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