China has been gearing up efforts to set up an international board for foreign firms to list shares on the mainland. Fang Xinghai, director general of the Shanghai Financial Services Office, said last week that rules for the new board will be ready by the end of this year.
Rules only get you so far. The international board is an initiative designed to promote the clout and influence of China’s capital market – volatility may cripple it. A successful launch must therefore extinguish the problems before they arise, and this means careful arrangement of trading mechanisms and sufficient investor education.
China first considered an international board over three years ago but the idea was placed on the backburner as regulators strived to revive the domestic equity market amid worries about a stock glut. It returned to the spotlight last year when the State Council issued guidelines for letting overseas firms sell shares and bonds in Shanghai. The initiative is in keeping with the city’s ambition to become a global financial center by 2020.
According to Fang, foreign firms that are well-known in China and have local operations will be among the first to list. He said the authorities have already been approached by overseas conglomerates from the financial, consumer, telecom and manufacturing sectors.
Companies including HSBC (HBC.NYSE, HSB.Euronext, HSBA.LSE, 0005.HK), Standard Chartered (STAN.LSE, 2888.HK), NYSE Euronext (NYX.NYSE, NYX.Euronext), Bank of East Asia (0023.HK) and Unilever (UL.NYSE, UNA.Euronext, ULVR.LSE) have shown interest in selling shares on the mainland. Coca-Cola (KO.NYSE), General Electric (GE.NYSE) and Wal-Mart (WMT.NYSE) are also reportedly interested.
Permitting overseas companies to sell shares in China is essential if the country is to bring its capital markets in line with international standards. But the initiative will, by necessity, have a strong local flavor. As long as China’s currency remains non-convertible foreign firms will be restricted to listing assets held by their mainland-incorporated units and then using the renminbi-denominated proceeds for local expansion.
This is not an unattractive prospect. Despite recent declines, the valuation of the mainland bourse is still higher than those on mature overseas markets after shares rebounded strongly last year from a plunge in 2008. A Chinese listing would also allow foreign firms to diversify their shareholder bases and boost public awareness. adding individual investors who may be willing to pay a premium for global brands. Once listed, it would be easier for these firms to seek additional stock sales to finance future growth. They might even be able to sell stakes to mainland strategic investors.
Furthermore, with China expected to resume gradual appreciation of the renminbi against the US dollar, it would be in foreign firms’ interest to issue more local-currency stock.
Speculation – and the market volatility it threatens to create – remains the biggest concern.
When ChiNext, the NASDAQ-style small- and medium-sized board, opened in Shenzhen last year the frenetic turnover saw some stocks double, treble or more on their trading debuts. The massive highs were followed by equally large lows in subsequent sessions. In addition, irregularities such insider trading and market manipulation were rife.
It is unclear whether the regulators will set a capital threshold or other kinds of restrictions on investors trading on the international board. But one thing is for sure: there will be a supply shortage of equities when the market kicks off. In other words, if authorities don’t allow a large batch of companies to go public in a one-off manner, shares of overseas firms are likely to be massively oversubscribed. As a result, they will trade at a premium to those listed in foreign markets.
In the long term, Chinese investors will benefit as they gain access to the world’s best organized and most profitable companies. The problem, as is always the case in China, is that institutional investors will get access first – either as cornerstone investors or first-movers that cash out when the speculators flood in. It is a recipe for volatility and not quite the image Shanghai wants to project as it bids to become an established financial hub.
The priority for the securities regulator is education. Protecting the interests of minority investors is as important to the development of China’s capital markets as bringing in foreign companies.
Investors must be told about the risks of the international board; they must be given complete and timely information on the participating companies; and they must be given a wider array of investment options – such as stock index futures, short selling and margin trading, which are currently being trialed in China – so as to help manage liquidity.
These measures should be included in a comprehensive plan for the international board that maps out how it will evolve – in size and sophistication – over the next two years. On the cover of this plan the authorities should print a warning: A new market is no guarantee of making money – even if it is populated by members of the Fortune 500.
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