Ever since its inception in 1990. China's B-share market has seldom been off the sick bed. Its performance has been on a steady decline since its creation, and has collapsed since the onset of the Asian crisis.
Both B-share indexes in Shanghai and Shenzhen, created at 100 points in the early 1990s, have been almost halved on thin trading volumes. Activity is stimulated only by a renewed round of rumours of government support and market-boosting measures.
As in the past, the rumours included a cut in trading costs, the establishment of Sinoforeign joint venture mutual funds and a move to allow poorly performing firms to buy back their shares. Even if they turned out to be true this time round, the China Securities Regulatory Commission (CSRC), the government department in charge of the industry, doesn't seem to have grasped the root cause of the ills of the B-share market.
The Western investor
The B-share market was created for the Western investor seeking high returns over high risks in investing in one of the world's largest and fastest-growing economies. As the local currency is not freely convertible, two types of shares were created: A-shares for domestic investors and B-shares for foreigners.
Many Chinese companies were selected to issue both A- and B-shares the former would be taken up mostly by the general public, with the latter favoured by Western fund managers through private placement.
Institutional investors tend to invest mil-lions of US dollars in what they perceive as a single good stock, so as to have a meaningful holding for their portfolio. They shy away from small companies below a market capitalisation of, say, US$100m. Small stocks, which dominate the B-share market, are regarded as illiquid and difficult to buy and sell quickly in a word, risky.
This anomaly demonstrates the CSRC's lack of understanding of the very person it aims to attract to the B-share market. Even so, there are managers running small-company emerging markets funds who are pre-pared to take the plunge. However they like to invest for the long term in order to reap the highest reward and, as a result, the trading activities in the market are very limited.
Meanwhile, the vast sums of domestic savings and the lack of alternative investment vehicles helped push the A-share indexes to successive record highs. Last year, the A-share market was one of the world's top performers in terms of returns.
The contrasting behaviour of the domestic retail investor and the Western institutional investor created a strange phenomenon: for equal voting rights in the same company, the B-share was, on average, at a 60-70 per cent discount to the A-share.
Preference for Hong Kong
It was no wonder that some domestic investors, with hard currency at their disposal, found a loophole in the regulations and jumped into the B-share market. Despite some half-hearted crackdowns, the CSRC was in a dilemma: without the domestic participation in B-shares, trading activity in the marketplace would have ground to a halt.
In an otherwise quiet market, any buying and selling interest from the domestic investor, very small in comparison with that of the Western institutional investor, could move prices up and down drastically. The result is greater volatility and therefore even less appeal to the Westerner.
Volatility is only a symptom of the problematic B-share market.
A- and B-shares are governed by different accounting rules, which means that a listed company has two sets of accounts. The annual reports based on international accounting standards are the ones favoured by Western fund managers. More regular updates can only be sourced from the company management, who tend to be more comfortable with the local accounting system. Consequently, when fund managers fly out on site visits, the only figures made available are based on Chinese accounting standards.
These shortcomings have not been obvious to local officials. Mr Yang Xianghai. president of the Shanghai Stock Exchange until early this year, was puzzled about the lacklustre state of B-share market. When visiting Europe last year, he pulled aside a stockbroker and said: "At the moment, the political and economic environment is the same for all listed Chinese companies. The accounting problem is common as well. Therisks are roughly the same and therefore the rewards would be similar. So why are B-shares so unpopular among Westerr investors, particularly after the recen improvement on liquidity'?"
The answer seems to be the lack of a consistent government strategy. "The creation of various shares in the overseas markets completely undermines the government's owr efforts to help the B-share market grow. It i~ a disastrous strategy, if there is a strategy al all," says Mr Simon Nicholson, recently retired as a senior investment officer a1 Gartmore, the UK fund manager.
Probably recognising its own mistake, the CSRC has recently tried to focus on the Hong Kong stock market by reiterating that it would be the best place for attracting foreign investment in mainland companies. Indeed. Hong Kong has already gathered the most important industrial groups which have come to market. such as Shanghai Petro-chemical, Guangdong Kelon, and China Telecom, only second in terms of market capitalisation to Hongkong Bank.
When all these heavyweight companies flocked to Hong Kong to maximise their fund-raising potential, the Hong Kong regulator was anxious to impose tight rules, enforcing transparency and discipline on the mainland companies. "The message is very clear: 1-1-shares are a better bunch than B-shares. So why should any foreign investors bother with B-shares at all?," asks Nicholson.
Hoping for a renaissance
Gartmore has become one of the most active institutional investors in B-shares and Nichol-son was largely responsible for its long-term investment strategy. "Investors will invariably look for value for money. There are good companies in the B-share market and extremely cheap compared with the A-shares and H-shares. We'll wait until the local currency becomes convertible," he adds.
Full convertibility will highlight the value of B-shares and therefore attract investors. Until it happens, administrative measures are likely to have only a limited stimulating effect. Even so, it is probably worth the regulator's efforts to endorse companies with considerable market capitalisation for new B-share listings, to improve market policing, and work with the Ministry of Finance in bringing the accounting system to international standards.
Against the backdrop of Asia's economic crisis, convertibility is unlikely to come soon. But the CSRC could improve market conditions to prepare for a renaissance that is, if it has the will and know-how.