Mainland China has two stock exchanges, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE). As of June 2015, The total market capitalization of all stocks listed on these two exchanges exceeded $10trillion, making it one of the largest equity markets in the world.
There are a number of different share types listed on these exchanges (see below). While all of them offer access to companies whose main business proceeds are derived from mainland China, they usually differ in one or more characteristics, such as company domicile, listing venue or investor geography (domestic vs. foreign).
Some Chinese companies choose also to list their shares in the United States, London or Singapore. The most popular form for overseas listings is American Depositary Receipts, 105 of which are currently listed and traded on the NYSE or Nasdaq, including Alibaba, Baidu and China Mobile.
Although there are multiple share types providing exposure to Chinese companies, A-shares are the principal instrument for accessing the domestic growth story. However, this segment of the market has also historically been the most difficult for foreign investors to access. Mainland Chinese stock exchanges were previously closed to foreign investors due to tight controls, which restrict the movement of capital into and out of the country. In 2002, in an effort to mitigate this limitation, Chinese authorities began implementing the Qualified Foreign Institutional Investor (QFII) system. The QFII is a program that allows licensed foreign investors to buy and sell yuan-denominated A-shares on China’s Shanghai and Shenzhen stock exchanges.
China’s A-Share Market
The Chinese domestic equity market has become one of the key foundations of the country’s economy since the establishment of the Shanghai and Shenzhen exchanges in 1990. Today, the Chinese stock market is one of world’s largest in terms of market capitalization. There are 2,469 A-share companies listed on the Shanghai and Shenzhen stock exchanges with a total market capitalisation of over $10 trillion.
Participation of Retail Investors in the ‘A-Share’ Market
The heavy involvement of retail investors in daily stock trading is one of the main characteristics of the Chinese stock market. Although individual investors hold just 26% of the total, they account for 78% of daily trading volume, which is the main source of the market’s volatility. Along with retail investors, domestic institutions, including stock funds, are also frequently engaged in short-term speculation.
Over the last 12 months the A-share market has witnessed a 148% surge (as of June 2015) in value driven mainly by individual investors. There is strong evidence to suggest that this has been driven by momentum rather than fundamentals. New data from the a China Household Finance Survey show that the most prominent new investment group in China’s equity markets this year is relatively inexperienced retail investors. China has a large population with substantial savings and limited alternative investment options.
Accessing China’s market
Another key characteristic of the market is that it is still largely closed to the outside world. At the end of 2014, the total value held by foreign investors made up only 1.5% of total market capitalisation.
The Qualified Foreign Institutional Investor (QFII) scheme allows foreign investors access to securities markets in China through their home currency.The QFII scheme allows foreign institutions to trade Chinese A-shares and other financial instruments via special accounts opened at designated custodian banks.
But not just anybody can become a QFII. Applicants must meet strict criteria set forth by the China Securities Regulatory Commission (CSRC), including minimum thresholds of capital and assets under management, as well as a certain number of years of business experience. For example, to become QFII eligible investors must demonstrate they have two years’ experience and have managed at least USD $500Mn in securities assets over the past year.
Of the $298bn available through the QFII scheme and its renminbi-based sister programme (RQFII), only $162bn has been granted so far.
QFII and RQFII Quota Breakdown by Investor Type
TOP QFII Quota Holders
The Renminbi QFII (RQFII) program is a modified version of QFII that facilitates foreign investment in the mainland via offshore renminbi accounts. RQFII participants can invest in the same range of investment products as QFIIs and are subject to many of the same restrictions. However, a RQFII uses renminbi to purchase securities, whereas a QFII uses their home currency.
Previously the RQFII program was limited to Hong Kong subsidiaries of Chinese financial institutions, but this year the program has expanded to include additional Hong Kong banks and asset managers, and also to financial institutions in London, Singapore, Taiwan, and other as yet unnamed locations.
The total RQFII quota stands at RMB270bn ($43.5bn), a fraction of that allowed through the QFII program. So far this year, less than half of this quota has been apportioned, likely due to continued fears surrounding the Chinese equities market.
The RQFII program is notable because it has facilitated the creation of several A-share ETFs and bond funds domiciled in Hong Kong. As the RQFII program expands, this market will likely grow as well.
Since April 2006, China’s Qualified Domestic Institutional Investors (QDII) program has given Chinese investors access to markets outside the country, opening new opportunities for investment funds.
QDII products issued by Chinese fund managers show that they tend to allocate investment to the Hong Kong market, to Chinese related securities or to top performing foreign funds. Most banks’ QDII products tend to replicate an index and invest in a single asset class, or replicate an international investment fund.
The Shanghai-Hong Kong Stock Connect program was set up in November 2014, establishing a bridge between the two markets. It allowed international investors to trade in a number of shares listed in Shanghai without having to apply for individual licenses and quotas, and for domestic Chinese investors to trade in some Hong Kong stocks.
International investors have had limited access to China’s domestic stock market using an individual quota system. At the same time, retail investors in China have been restricted from investing in stocks listed overseas. Stock Connect allows more international investors (including individuals and hedge funds) to trade Shanghai-listed shares directly for the first time, while also allowing retail investors in China to trade Hong Kong-listed stocks directly.
Each direction has a quota — RMB300 ($48bn) going north (from Hong Kong to Shanghai) and RMB250bn ($40bn) heading south — and limits the value of daily trade. ‘Going north’, aside from the first few days during which foreigners snapped up A-shares, take-up has been slow: a mere third of the quota has been filled, equating to $16bn. Mainland ‘going south’ buyers have invested even less: only $4bn, a tenth of the money permitted.
Just months after piloting the Shanghai-Hong Kong program, Chinese regulators announced the launch of an additional trial program connecting the stock exchanges in Shenzhen and Hong Kong.
The Shenzhen market is home to a number of so-called new economy companies in sectors including technology, pharmaceuticals and clean energy, which many global investors prefer to the heavy industry and financial stocks that comprise the Shanghai Stock Exchange. Such sectors could emerge as potential beneficiaries of China’s drive to develop a consumer-focused economy.
However the announcement of the launch date of the landmark Hong Kong-Shenzhen stock market link is at present on hold due to technical issues, putting at risk China’s pledge to have the scheme ready by year-end.
By giving foreign investors more access to the market, China hopes to paves the way for domestic Chinese stocks to be included in global indices. This in turn will increase foreign ownership of Chinese companies.
Sources: Deutsche Bank Research, “China’s Financial Markets — A Future Global Force?” as of 3/16/09.
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