The battle between exchanges to host China’s new economy companies has hit a new level of intensity: the collateral damage is also piling up.
Shanghai and Shenzhen stock exchanges issued a surprise announcement on July 14 that they would block mainland China investors from buying companies with weighted voting right structures (WVR) via a mutual market access scheme dubbed Stock Connect.
Hong Kong stock exchange’s chief executive Charles Li flew to mainland China to have a word with his peers.
The result was a fudge. WVR companies will initially be monitored for an indefinite period after which they may be eligible for trading on Stock Connect by mainland investors. The exact details of the scheme will be worked out in a committee.
Surely, such concerns could have been addressed by the Stock Connect partners before smartphone maker Xiaomi listed in Hong Kong under a much-vaunted and well-flagged scheme allowing dual-class shares.
The timing of the mainland exchanges’ initial announcement on July 14 just as Xiaomi's shares were recovering from a lacklustre stock market debut on July 8 makes clear there are no holds barred in the competition to be the venue of choice for trading China’s fastest-growing companies. Mainland investors’ access to overseas opportunities as well as issuers’ ability to achieve the highest valuation possible are of secondary importance.
After losing Alibaba to the US in 2014, Li’s Hong Kong Exchanges & Clearing has made several concessions in its bid to attract China's high-flying companies, such as bending its rules to allow dual-class shares, allowing pre-revenue biotech firms to list, as well as paving the way for US-quoted Chinese companies, such as Alibaba and Baidu, to have a secondary listing in Hong Kong.
Beijing-based Xiaomi was the first company ever to list in Hong Kong with a weighted voting right structure, giving founder Lei Jun’s stock 10 times the voting heft as other shareholders’. Dual-class shares typically allow founders or early investors to maintain control of the company even after selling most of the shares.
While the Reformist has always been opposed to erosions of shareholders’ rights we also uphold investors’ rights to transparent and timely decision-making on market structure and mutual market access.
Shenzhen and Shanghai bourses’ answer to Hong Kong’s growing allure among tech entrepreneurs appeared to be a China Depositary Receipts (CDRs) scheme. It was clear the mainland exchanges wanted Chinese investors to have access to companies such as Alibaba and Baidu via CDRs, rather than the more circuitous route of a secondary listing in Hong Kong and then via elligibility for Stock Connect.
However some financial professionals argue that the scheme was poorly conceived and drafted.
Xiaomi originally planned to issue of CDRs as a mainland-listed proxy for the Hong Kong shares, but announced last month that those plans had been put on the backburner. This very public snub of the CDR scheme may have prompted the following backlash.
“As soon as the CDRs were off the table all bets were off and you couldn't assume any implicit or explicit support from the PRC,” said one investor in Xiaomi. “We invested because we thought Xiaomi’s valuation looked cheap, not because we were expecting a boost from southbound flows via Stock Connect,” he added.
Others were not so savvy as this hedge fund manager. Xiaomi shares had risen in anticipation of joining the Hang Seng Composite index on July 23, making them eligible for Stock Connect inclusion.
A spokesman for HKEX noted that inclusion of blue chips in Stock Connect is not automatic, it does depend on the exchanges' approval. However no stock that has joined the Hang Seng Composite Index has been excluded before.
After the mainland exchanges’ announcement, Xiaomi’s shares fell 9.6% on July 16 before recovering.
Ever the optimist, Li interpreted the mainland exchanges’ move as a blip in the trend towards greater mutual access. Li said in a Q&A that: “The recent differences between the two announcements by the mainland exchanges and HKEX are not about whether to include WVR companies in Stock Connect, but when to include them.”
To be sure, the mainland exchanges said the reason for stopping mainland investors from buying WVR companies is that the structures are little understood. But surely a concerted investor education programme via China’s brokerages could have taken place before Hong Kong’s WVR rules came into effect in April.
Also it is plausible that officials in China could have been alarmed by the prospect of Hong Kong gaining momentum in attracting China’s new economy stocks. If others had followed Xiaomi to Hong Kong, the southbound flows could have amounted to the hundreds of billions of dollars, liquidity that might have been generated by selling shares on domestic bourses.
However, a successful Hong Kong tech hub swollen by southbound flows would also have made future CDRs trickier as they would have been priced off a higher Hong Kong quotation as well as a more volatile one given the predominance of retail investors in China's stock markets.
It is also clear after the announcement that fewer companies may choose to list in Hong Kong if they will be denied liquidity from the mainland which gives a significant fillip to their valuations.
The listing venue for Chinese unicorns, ride-hailing giant Didi Chuxing and fintech behemoth Ant Financial, are still in play.
Li has plenty to fight for, including the future of Hong Kong as a major financial hub. Let's hope the goal of mutual market access is not set back further by the exchanges’ ongoing scrap.
This story has been updated to add HKEX's statement
