Signup for our free newsletter:

Investing in Shanghai Stock Exchange A-Shares

Written By Briton Ryle

Posted November 10, 2014

In a week’s time, China will be lifting yet another barrier between it and the west – this one on foreign investments in mainland stock exchanges.

Until now, the only Chinese stock exchange that international investors were permitted to purchase shares on has been the Hang Seng exchange in Hong Kong. Apart from listing on the Hang Seng, the only other way for mainland China’s corporations to attract foreign investors has been to incorporate holding companies overseas – such as Alibaba did through its recent NYSE IPO of Alibaba Group Holding Limited which is domiciled in the Cayman Islands.

The only two choices foreign investors interested in Chinese companies have had, therefore, is to purchase their Hang Seng listed shares (known as H-shares), or their overseas-listed holding companies.

But beginning next Monday, November 17th, a new link will be established between Hong Kong’s Hang Seng stock exchange and the Shanghai stock exchange in mainland China – known as “Shanghai-Hong Kong Stock Connect” – allowing foreign investors to directly own many of Shanghai’s largest companies’ shares (known as A-shares).

The benefits of the new link are many for all involved – foreign investors, Chinese corporations, and the Chinese economy alike.

Major Benefits of “Shanghai-Hong Kong Stock Connect”

• For investors: The most obvious benefit delivered by the new link between the two exchanges is bestowed upon foreign investors, who will soon be able to invest directly in mainland Chinese companies’ principal stock (A-shares) through the Hong Kong exchange.

Why will this be better than the current means of investing in Chinese companies? Because the current means grants investors shares in offshore-listed holding companies, not in the mainland Chinese companies they represent. Though these Chinese companies have made commitments to distribute profits and in some cases dividends to the shareholders of their offshore holding companies, there does exist the risk that some unforeseen economic or political stress can sever the link between offshore holding companies and the mainland Chinese companies they supposedly represent. The new link between Hong Kong and Shanghai allows direct A-share investments with not holding company intermediary.

The link also presents foreign investors with an opportunity for price arbitrage, which many investment firms and especially high-frequency traders have already expressed particular interest in.

“Many international investors are completely excited,” Charles Li, chief executive of the Hong Kong Exchanges & Clearing related. “This is probably the last frontier market that has yet to open, and [global investors] probably have never seen a rebalancing possibility like this scale anytime in past history.”

The rebalancing, or arbitrage, opportunity that the link between the two exchanges will afford investors is in the difference in price between a Chinese company’s A-shares listing in Shanghai and its H-shares listing in Hong Kong. As occurs with all stocks listing on multiple exchanges, the price on one platform will regularly deviate from the price on another platform, even if by only a few cents. Yet large investment accounts and high-frequency firms can turn those small penny-gaps into millions of dollars of profit each year simply by buying the cheaper shares and selling the more expensive ones at the same time, locking-in the profit in between.

• For companies: Another important benefit the linking of the two exchanges allows is greater access to investors, as well as price stability. The more actively a stock is traded, the greater its liquidity will be, allowing shareholders to jump in and out of a stock with the smallest of bid/ask gap losses.

Increasing trading volumes also keep the stock price stable by reducing cascade selling which often triggers major sell-offs, as low volume often exacerbates price declines as investors try to get out en masse.

• For the Chinese government: Of course, the government of China isn’t creating this link simply to be a nice guy. It expects the linking of the two exchanges to contribute to stabilizing China’s currency, the Yuan.

Since Shanghai-listed A-shares trade only in Yuan, foreign investors will ultimately be purchasing Yuan and then storing them in Chinese companies’ stocks, increasing the demand for and use of the Chinese currency, and thus contributing to its stability.

“The exchange link marks one of China’s biggest steps toward opening up the capital account, increasing use of the yuan and turning Shanghai into an international financial center,” Bloomberg explains. “It will give foreign investors greater access to Chinese companies tied to the nation’s consumer spending, which [Chinese] President Xi Jinping is counting on to reduce the dependence of the world’s second-largest economy on exports and infrastructure spending.”

Plenty for Investors to Choose From

When it is first introduced next week, the link between the Hang Seng and Shanghai exchanges will permit foreign investors to hold shares in 560 mainland Chinese companies as listed on the SSE 180 Index and the SSE 380 Index.

“The Stock Connect program would widen the investment choices of foreign investors who are optimistic about China’s growth,” Chen Li, head of UBS’ Chinese equity strategy, promoted.

But hasn’t China’s economy been slowing? Just how much growth does it promise going forward?

Yes, China’s economy has slowed considerably from its recent peaks of 10-13% annual GDP growth, and even from its average 8-10% growth rate this century, as noted in the graph below.

chinese economy gdp


But with annualized growth forecasted to be 7.21%, 7.48%, 7.33% and 7.26% in the next four quarters, the second largest economy in the world, and home to the largest population in the world, is still growing very robustly.

Investors looking to capitalize on such growth – which can only improve over time – will now have an additional half a trillion dollars’ worth of capitalizations to choose from. Here are just three of the largest.

(Note that although these companies are listed on the American exchanges NYSE and NASDAQ, investors will be able to purchase their mainland Chinese A-shares come next Monday, the benefits of which are noted above.)

• China Petroleum & Chemical Corp. (NYSE: SNP) – China is energy hungry, first in the world in electricity consumption (5.322 trillion kWh in 2013, CIA World Factbook), fourth in natural gas consumption, and sixth in natural gas imports. Despite being fourth in the world in crude oil production (4.197 million bbl/day in 2013), it is still second in crude oil imports (5.664 million bbl/day in 2013), meaning that it burns over 9.861 million barrels of oil per day – which is more than Saudi Arabia’s daily production of 9.570 million barrels.

Through its numerous subsidiaries, CPCC owns and operates oil and gas fields, pipelines and refineries, producing gasoline, kerosene, diesel, chemical feedstock, intermediates, synthetic resin, synthetic fiber monomers and polymers, synthetic fiber, synthetic rubber and chemical fertilizers.

While CPCC’s stock has been stagnating as of late, it has outperformed both the Hang Seng and Shanghai indices since the global recovery began in 2009, and has powerful growth ahead of it as it feeds China’s enormous energy appetite.

• China Unicom Limited (NYSE: CHU) – Though this mobile communications services provider is not as large ($35 billion market cap) as the nation’s number one China Mobile ($252 billion), it has been growing faster, and its stock has been performing better since the recovery began. It also has more modernized cellular, landline, broadband, and communications infrastructure, and currently services some 444 million customers – more than the entire population of the United States (319 million).

With China still in the midst of relocating some 300 million rural citizens into urban centers over the next 30 years at a rate of 10 million new city-dwellers per year under its urbanization program, communications network providers will have an ever growing supply of new clients for decades to come.

• Melco Crown Entertainment Limited (NASDAQ: MPEL) – Though this $13 billion resort and casino owner operator in one of the world’s largest gambling centers of Macau, is not as large as Wynn Macau, MGM Resort International, or Sands China whose market caps range from $136-$350 billion, it is still one of the fastest appreciating gambling stocks on the planet, rising as much as 1,600% from 2009 to the beginning of this year, before slipping to just half that gain at some 800% – still four times greater than the S&P’s 200% gain since the economic recovery began.

Yet this recent pullback might present an amazing long-term opportunity. “Melco Crown’s forward price-to-earnings (P/E) ratio is lower than any of the other casino owners, and its implied upside of nearly 60% is much higher than either Las Vegas Sands or Wynn,” reports 24/7 Wall Street.

In addition to nearly 2,000 hotel rooms across all its hotels, the company also owns 20 restaurants and bars, 70 retail shops, leisure facilities, fitness clubs, spas, and banquet halls. As China’s economy continues to grow along with other economies the world over (eventually), Macau will similarly continue its growth trajectory as the leading gambling center in the world, with Melco Crown holding a front row seat at the show.

All three aforementioned stocks are graphed below, alongside the S&P 500 index (black), the Hang Seng index (orange), and Shanghai Composite (yellow), spanning the recovery since March of 2009.

Hang Seng Index Shanghai Composite Standard Poors


Joseph Cafariello