B is for bleak

While China’s A-share market is growing in value and credibility, its B-share equivalent remains in the wilderness.

Set up in 1991 as a means of raising money from foreign sources – it trades in US dollars in Shanghai and in Hong Kong dollars in Shenzhen – the B-share market has never really prospered. Now most of the A-share companies have implemented non-tradable share reform programs, an A- and B-share merger is seen as inevitable.
"It will happen, it’s just a question of timeframe," said Fraser Howie, author of Privatizing China: The Stock Markets and their role in Corporate Reform. "Merging them makes sense as they are the last major structural problem in the market."
It was such talk of merger plans, reported in Shanghai Securities News, that saw the B-share market gain nearly 10% on September 18, its largest rise in five years. The bubble burst the next day as well-circulated remarks from China Securities Regulatory Commission (CSRC) officials made it clear that no plan was imminent.
"It was wishful thinking," said Xue Lan, head of China research at Citigroup. "Every year people get excited by the B-share market then the hype just dies down."

Neglected market

Underpinning this is the simple fact that B-share reform is currently not a priority. The B-share market comprises 109 companies with a market capitalization of about US$12 billion. The 1,400 A-share companies worth a total of US$500 billion are inevitably the CSRC’s primary concern.

With foreign investors able to access the A-share market through the Qualified Foreign Institutional Investor (QFII) scheme, there is no critical need for reform. B-shares, now largely traded by locals who have foreign currency to spare, have outlived their purpose.

Furthermore, the possible methods of engineering an A- and B-share merger are beset by obstacles. The most straightforward route – the companies buy back all their stock and then re-list on the A-share market – is undermined by the fact that most companies don’t have enough cash.

Even if some did manage a buy-back, they would find themselves at the back of a long queue to list on the A-share market.

"The regulators would rather have PetroChina as an A-share than some B-share company," said Xue.

But the key barrier to B-share reform remains the status of the yuan. If the State Administration of Foreign Exchange (SAFE) approved the conversion of B-shares into A-shares – effectively exchanging foreign currency for yuan – it would puncture China’s capital account.

"When the yuan is ready to be convertible they just change the letter in front of the share," said Bruce Richardson, managing director of research at Xinhua Finance.

In the meantime, China needn’t look hard for examples of how other countries have found ways of preventing non-convertibility from coming between foreigners and capital markets. Richardson points to South Africa, which once set up a shadow rand – not tied to the official currency – for share transactions.

In India, foreign investors can convert US-dollar global depository receipts in Indian stocks into local currency shares to sell up and leave the market, although approval is needed for the money to be taken out of the country.
"You could convert B-shares into A-shares and, if you can prove you have a foreign address, you could repatriate your money on a case-by-case basis," said Howie. "There are only 109 B-share companies, which is a very manageable number. If there are to be trials on convertibility, then this may be a good way to do it."
But it all comes back to how keen the CSRC is to resolve the issue. Given the politics attached to the accessibility and valuation of China’s currency, any move to liberalize the capital account could set an unwelcome precedent. Such leaps don’t need to be made so soon in a financial sector that is still developing its platforms.

Currency restrictions serve to insulate banks from the pitfalls of currency trading and Richardson think it will remain this way until they have proved they can be competitive at home.
"The banks have to learn how to assess forex trading risks but the government would rather they first knew how to assess risk in their own economy."