EPISODE 6

Leyla Gulen (00:00):

Hello and welcome. I'm Leyla Gulen, I'm the co-host of Quantitative Investment Insights presented by Greenwich Quantitative Research. Greenwich Quantitative Research is an Asia-Pacific market-neutral quant fund, and the founders have experience trading Chinese stocks going back two decades. Well, the current market focus on DiDi has highlighted the complexity of the many types of Chinese share classes that are traded globally. We're here with Gene Reilly, the Chief Investment Officer of Greenwich Quantitative Research to discuss the variety of share classes that exist and why.

 

Gene Reilly (00:35):

Great. Thank you, Leyla.

 

Leyla Gulen (00:36):

Okay. What are the reasons for the different share classes?

 

Gene Reilly (00:40):

Yeah, it's a great question that really requires us to think a little bit about the history of how the Chinese equity markets have evolved, and there's reasons for the different share classes. From a Chinese regulatory perspective, control which investor base, domestic or foreign, can access the stocks. From a Chinese company perspective, it's all about accessing capital and their ability to list. For local listings 20 years ago, there was a limited pool of capital available onshore, and the listing requirements are very stringent. In the US, there's significantly more liquidity available in capital markets, and the listing requirements for IPO for growth capital companies are much less restrictive.

 

Leyla Gulen (01:25):

Well, Gene, can the same company list on multiple exchanges or have multiple share classes?

 

Gene Reilly (01:31):

Yes, some companies will list concurrently on different stock exchanges in order to reach a wider pool of investors. Companies that list on both domestic and foreign stock exchanges will necessarily be issuing different share classes.

 

Leyla Gulen (01:44):

Now, we've mentioned N-shares and H-shares so far, it would be great if you could give us a complete overview of the different share classes.

 

Gene Reilly (01:51):

Historically, Chinese companies have had a variety of options for issuing shares on domestic and international exchanges. That's resulted in a number of different share classes. We would broadly divide them into two major categories, share classes that are incorporated inside of China, and shares that are incorporated outside of China.

 

Leyla Gulen (02:10):

What are the share classes incorporated inside of China?

 

Gene Reilly (02:14):

There are A-shares, B-shares, and H-shares, and the A-share market represents the majority of shares listed on Chinese stock markets. A-shares are listed on the four major exchanges, the Shanghai Stock Exchange, the Shenzhen Stock Exchange, the National Equity Exchange, and the Beijing Stock Exchange. H-shares are also widely traded by investors, but they are listed in Hong Kong.

 

Leyla Gulen (02:39):

Okay. What about B-shares?

 

Gene Reilly (02:41):

B-shares were listed in 1992 as a channel for foreigners to access the Chinese equity markets. Foreigners were not permitted to invest in A-shares at that time. B-shares are listed on the Shanghai and Shenzhen Stock Exchanges. The majority of B-share stocks are companies that don't have significant interest from investors, so they're no longer particularly relevant. As a result of restricting B-shares to foreigners from 1992 to 2001, not many strong companies chose to go to the B-share route since there were fewer investors. But with the introduction of QFII in 2002, international investors had multiple channels to access Chinese stocks, and essentially the entire B-share concept was made obsolete.

 

Leyla Gulen (03:28):

Can all investors access A-shares, and H-shares, and B-shares?

 

Gene Reilly (03:34):

A-shares are open to all domestic Chinese investors who have an account. Foreign investors can access A-shares via the QFII channel or the Stock Connect channel. The Stock Connect channel doesn't provide access to all of the A-share universe and doesn't provide access to even everything listed on either the Shanghai or Shenzhen stock exchanges. The H-shares are fully accessible by foreigners, just like any other developed market, given that they're listed in Hong Kong. Anyone who can trade a stock on the Hong Kong exchanges can buy H-shares. Mainland Chinese investors can access the H-shares via the Connect channel on the southbound route. B-shares are open to foreign investors and domestic investors who have foreign currency, but they are not commonly invested in by Chinese domestic investors.

 

Leyla Gulen (04:26):

So what currency are these share classes denominated in?

 

Gene Reilly (04:30):

The A-shares are denominated in renminbi, the H-shares are denominated in Hong Kong dollars, and the B-shares have a face value set in renminbi, but actually trade in US dollars.

 

Leyla Gulen (04:41):

Okay. So for the three share classes that you just mentioned, A-shares and H-shares are very relevant to investors. Investors may read or hear the term B-share, but they should remember that B-shares are not really relevant anymore. So now let's hear about the share classes incorporated outside of China.

 

Gene Reilly (05:01):

All the stocks incorporated outside of China are also listed outside of China and can be accessed by foreigners in the same way that foreigners can access stocks in any developed market. Both state-owned and private companies are incorporated outside of China. Private companies issued outside of China, the main difference among private sector Chinese companies incorporated abroad is the exchange in which they're listed. Each has a different name or reference.

 

Leyla Gulen (05:28):

For the private companies, those share class names would be N-shares, L-shares and S-shares. Is that correct?

 

Gene Reilly (05:36):

Yes. N-share would denote a stock that's listed in the United States, incorporated outside of China, primarily incorporated in Hong Kong, the Cayman Islands, Bermuda, or BVI. L-shares are listed on the London Stock Exchange, also incorporated outside of China. Most likely a Hong Kong, Cayman Island, Bermuda, or BVI, or Jersey incorporation. The S-shares are listed on the Singapore Stock Exchange, incorporated outside of China, primarily Singapore, but also potentially the Cayman Islands, Bermuda, or the BVI.

 

Leyla Gulen (06:14):

I've also heard the names red chip shares and P chip shares used. Can you explain what those are?

 

Gene Reilly (06:21):

Sure. Red chips refer to state-owned Chinese companies that conduct the majority of their business outside of China and are listed in Hong Kong. The P chip shares, in contrast, refer to privately-owned Chinese companies that conduct the majority of their business outside of China and are listed in Hong Kong.

 

Leyla Gulen (06:37):

Your very clear description of the different share classes should help investors when they hear these terms used in the future. So while we're discussing the share classes, could you explain why the price of Hong Kong listed H-shares is generally lower than domestically listed A-shares, even though the underlying company is exactly the same? I'm talking about the A/H Premium. We would expect arbitrage to keep the prices of the A-shares and the H-shares in line. However, over the years, A-shares have traded at a persistent premium to H-shares.

 

Gene Reilly (07:13):

It's historically been a very big pricing anomaly in the market that has attracted a lot of attention. But I think the bottom line reason why we see the difference is short selling is more difficult in China, and essentially there's also no arbitrage. The shares are not fungible, the investor bases are different. There's a much more retail-driven market in China, versus a more institutionally-driven market in Hong Kong. There's also differences in terms of how those constituencies react to economic data and news. It's interesting to note that the premium is generally lower on large cap names, where there is significant stock borrow available, and widest on less liquid shares.

 

Leyla Gulen (08:02):

Well, Gene, I want to thank you so much for that informative chat. That's all the time we have for now. I'd like to thank our listeners, and we look forward to covering more topics in the future. Thanks again, Gene. We'll see you next time.

 

Gene Reilly (08:15):

Thank you. Bye-bye.