China’s equity disconnect


On Tuesday, China’s state council announced to great fanfare a plan that would make it easier for investors outside China to buy and sell stocks traded on the mainland’s second-largest equity board, the Shenzhen Stock Exchange.

In Hong Kong, Charles Li, CEO of Hong Kong Exchange and Clearing Ltd., said the program, dubbed the Shenzhen-Hong Kong Stock Connect, could be up and running before Christmas. The Shenzhen link will be modeled on the Hong Kong-Shanghai Connect, a parallel program launched November 2014 to increase trade between Hong Kong and the Shanghai Stock Exchange.

This ought to be big news. China’s $11 trillion economy is the world’s second-largest, and home to lots of capital and some of the world’s biggest companies. China claims the world’s largest population of billionaires (568 in China compared to 535 in the United States). Chinese companies account for more than 100 of the Fortune Global 500. The market capitalization of the mainland’s two exchanges, Shanghai and Shenzhen, is roughly equal to that of Tokyo and Hong Kong respectively.

And yet the grand vision of “connecting” China’s capital and companies with the rest of the world brought no joy to markets this week. Stock prices in Shanghai and Shenzhen  barely budged today. Among global investors, the responses have been slightly less charitable than reviews of Suicide Squad on Rotten Tomatoes.

What’s the problem?The big drawback to investing in mainland equities remains that “China still hasn’t understood the value of building trustworthy markets,” Fraser Howie, author of several books on China’s financial system, complained in an appearance on CNBC today. “The fact that you can access [China’s exchanges] doesn’t solve that fundamental problem…The regulatory environment in China is still a very dangerous one.”

In a Heard in the Street analysis, Wall Street Journal correspondent Alex Frangos warns that “diversifying into an unattractive market isn’t a smart move.”

The new rules will allow global investors to trade 880 Shenzhen stocks using any stock broker registered with the Hong Kong stock exchange. Mainlanders will be able to trade Hong Kong stocks through brokers registered with the Shenzhen exchange. Caps on trading by individual brokerages under the Shenzhen link would be the same as those now in place for Shanghai, which specify a 13 billion yuan net limit for Hong Kong brokers trading in mainland shares and a 10.5 billion yuan limit for mainland brokers trading on the Hong Kong exchange.

Caps on trading by individual brokerages under the Shenzhen link would be the same as those now in place for Shanghai, which specify a 13 billion yuan net limit for Hong Kong brokers trading in mainland shares and a 10.5 billion yuan limit for mainland brokers trading on the Hong Kong exchange. Notably, though, it appears that Hong Kong’s financial regulator, the Securities and Futures Commission, and the China Securities Regulatory Commission have agreed to forego aggregate quotas on trading under the new Shenzhen link and dispense with quotas currently in place for the Shanghai-Hong Kong Stock Connect.

Regulators had intended to launch the Shenzhen link last year postpone the move because of volatility in mainland markets. Some analysts said Beijing is pushing the policy now as part of Xi Jinping’s effort to demonstrate his commitment to open markets ahead of next month’s G-20 summit in Hangzhou.

In theory, Shenzhen has a lot going for it as an investment destination. As Frangos points out, the mix of stocks that trade there is different from what’s on offer in Shanghai–and far different from the stodgy banks and property developers that dominate the exchange in Hong Kong. Shenzhen is China’s Silicon Valley, an entrepreneurial boomtown. About a quarter of the exchange’s market capitalization comes from technology-related companies. Deutsch Bank says the movement of stock prices on the Shenzhen board bear less correlation to the movement of global stock prices than any other major exchange in the world.

The experience of foreign investors who bought China shares via the Shanghai link offers little reason for confidence. Soon after the launch, China’s policy makers encouraged a runaway stock bubble and then responded ham-fistedly when it collapsed: freezing trading, banning selling by major investors–and villifying foreign investors.

Stocks on the Shenzhen exchange trade at 25 times forward earning, and gyrate wildly on rumor and speculation. Sky high multiples and lax regulation are among the reasons so many Chinese companies that listed first on global exchanges are scrambling to return to the mainland.

On Monday, shareholders voted to accept property and entertainment conglomerate Dalian Wanda Group Co’s $4.4 billion buyback for its Hong Kong-listed commercial property unit, Dalian Wanda Commercial Properties Co. The deal, which comes only 18 months after the company’s Hong Kong debut, is the largest management buyout of a Hong Kong-listed group. Wanda’s shares trade a 6.5 times earnings. It has been predicted that when relisted on the mainland, they could trade at multiples of 20 times earnings.

Dalian Wanda’s CEO, Wang Jianlin, China’s richest man, is looking for capital to finance his grand ambition to build a company that can go toe-to-toe with global entertainment heavyweights like Disney. In January, Dalian Wanda acquired Legendary Entertainment in a deal valued at $3.5 billion. Wanda  is rumored to be working on a deal to buy as much as 49% of Paramount.

Chinese companies including Wumart Store and Peak Sport Products Co have bought back shares or are planning to do so. Others said to be actively seeking to list on the mainland exchanges include China Evergrande Group, Guangzhou R&F Properties and state-owned Beijing Capital Land.

A host of Chinese companies, including dating app Momo Inc, online retailer China Dangdang Inc and real estate web portal SouFun Holdings, have announced  management buyout plans. Since 2015, 37 U.S.-listed Chinese companies have received $38.9 billion in buyout offers, according to Dealogic.

For much of last year, Chinese regulators were happy to accommodate the return of Chinese companies to mainland exchanges. But they have since reversed course. In May, regulators said they had launched investigations into many of those deals and it’s not clear they’ll be approved.  More than 700 Chinese companies are waiting to launch domestic initial public offerings.

Here’s are some other China developments we’re following today:

 Apple says it will increase investments in China. CEO Tim Cook, in a meeting Tuesday with Chinese vice premier Zhang Gaoli, promised to increase investment and create Apple’s first research center in the country. The announcement comes as Apple grapples with multiple challenges in China. Last year, China was Apple’s biggest market. This year it’s Apple’s biggest headache. China has shutdown Apple’s online book and movies services, and tightened regulations on cyber-security. Beijing is pressuring Apple and other U.S. technology companies to store data locally, and surrender source code to Chinese inspectors. In May, Apple said it would invest $1 billion in Chinese ride-hailing company Didi Chuxing Technology Co. WSJ

Xiaomi, once considered Apple’s most formidable Chinese rival, is in free fall. Xiaomi’s sales fell by 38% in the three months to June compared to the same period a year earlier, according to research firm IDC. The Chinese company sold and estimated 10.5 million smartphones in China in the second quarter, down from 17.1 million in the same quarter last year. In China, Xiaomi’s market share has tumbled to 9.5%, down from 16.1% last year. The company has slipped to No 4 in China’s market by market share, behind Huawei, and upstarts Oppo and Vivo. Apple, in the No. 5 slot, claimed a market share of 8.6% in the second quarter, down from 12.6 last year.  Business Insider

Meet Jia Yueting, the outspoken entrepreneur who is vying to becoming the China’s equivalent of Reed Hastings, Tim Cook and Elon Musk all rolled into one. Reuters

U.S. general seeks to reassure China on missile defense system in South Korea. US Army chief of staff Gen. Mark Milley met with his Chinese counterpart, People’s Liberation Army ground forces chief Gen. Li Zuocheng, in Beijing and assured him that U.S. deployment of a missile defense system in South Korea is not a threat to China. The US insists deployment of what it calls the Terminal High Altitude Area Defense system, is necessary to counter the increasing security threat posed by North Korean ballistic missiles. WSJ

Could the US and China be drawn into an “accidental war”? The risk is real, argues Wall Street Journal columnist Andrew Browne. “As China flexes its muscles in the South China Sea and East China Sea, the risks of an inadvertent clash on the water or in the air are growing by the day.” WSJ

China launches the world’s first quantum satellite, boosting the security of its communications. NYT, WSJ

China slips to No. 3, behind Britain, in Olympic medal standings. As of Wednesday morning, China claimed 17 gold medals, trailing the United States with 28 and Britain with 19. On social media, Chinese bemoaned the results, which lagged far behind China’s 51 gold medal haul in the Beijing Olympic Games in 2008 and 38 gold medals in the London Olympics in 2012. Some complained that the games put too much emphasis on sports like equestrian dressage where Western countries traditionally excel.  The Telegraph


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