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Jun 08, 2015

China’s IR frontier

Why do hardly any A-share companies listed exclusively on the mainland have English-language annual reports? Because local investing power is too great and valuations are too high

New foreign institutional investment should trigger a growth spurt for investor relations in mainland China

A hidden kingdom of stocks barely known to outsiders is in the process of being discovered – and, as with so many groundswell changes in the world, this is a story that revolves around China. With last year’s launch of the Shanghai-Hong Kong Stock Connect allowing a flow of stock trading between the two financial centers, the hope is that an influx of foreign institutional investors will tame China’s wild domestic stock market and professionalize investor relations. Today’s reality, however, is that retail-driven volatility, high-altitude valuations and blurry corporate governance make investor relations in mainland China still very much its own species.

Last November China’s stock market overtook Japan as the world’s second-largest behind the US, propelled by more than 30 percent in gains during 2014 to around $4.5 tn in market cap. Until just days earlier, however, when the Shanghai and Hong Kong stock exchanges switched on Stock Connect, foreign investors could barely dip their toes into this massive pool of public companies.

Before Stock Connect, foreign investors could invest in Chinese H-shares listed in Hong Kong or depositary receipts (DRs) overseas and, under a qualified foreign institutional investor (QFII) program, certain institutions had a narrow window on A-shares listed in Shanghai and Shenzhen. Now, through Stock Connect, institutional and retail investors can trade the 568 biggest Shanghai-listed A-share companies, 502 of which don’t have H-shares already listed in Hong Kong. A trial program linking the Shenzhen Stock Exchange and its ChiNext board is in the works. The pipeline runs in the other direction, too, with mainland investors allowed to trade a quota of Hong Kong-listed stocks.

Low trading volumes through Stock Connect for the first few months disappointed the market, but brokers say the slow start was mostly logistics and they’re extremely optimistic. ‘It’s a very big deal – a hugely important catalyst,’ said a sell-side equity salesperson at the IR Magazine Conference – Greater China in Hong Kong last December. ‘Never in the history of modern financial markets has anything this big been done so quickly.’

Once the remaining settlement and operational ‘headaches’ are taken care of, the flow will be strong and steady and the QFII program will no longer be necessary, this sell-sider predicted. What’s more, it’s assumed that MSCI will this year add A-shares to its emerging markets and China indexes, which will hasten an unstoppable wave of investment. Even at the current 30 percent foreign ownership limit, A-shares would represent around 15 percent of the MSCI Emerging Markets Index (H-shares and B-shares already make up 17.2 percent, according to UBS), and the 30 percent cap is likely to be raised.

The future of A-share IR

‘The A-share market is different from any other in the world,’ says Richard Tsang, chairman of Strategic Public Relations Group, a long-established Hong Kong-based consulting firm that quickly opened a Shanghai office as Stock Connect came online.
Because the Chinese market has been closed to the outside world for much of its existence, A-share companies have often enjoyed valuations drastically unlike those of their peers trading in Hong Kong, the US or anywhere else. Even the same company with an H-share as well as an A-share can trade at a completely different price-to-earnings multiple in the Hong Kong and Shanghai market, respectively.

A lot of the attention around Stock Connect has been focused on the valuation gap between the A-shares and H-shares of dual-listed companies, and whether the new link will help close it. But what about the hundreds of companies without H-shares, listed exclusively on the mainland?

Historically, some sectors, particularly banks, had narrow or zero difference in valuation, or the stock price was higher in Hong Kong. But today A-shares trade far more expensively no matter what the sector. The main reason is simple supply and demand: a good proportion of more than 1 bn Chinese people have money to invest but few options for where to put it. In recent months, the frenzy has only grown, with an explosion in the number of brokerage accounts and trading volumes that dwarf the US market.

The QFII program, which was set up in 2002, allowed a quota of outside money to trickle into the market, and four years later Beijing established a qualified domestic institutional investor (QDII) scheme to relieve some of the pressure in the overheated domestic market and let money flow the other way. QFIIs account for only a small percentage of A-shares’ mammoth capitalization, however, while QDIIs have stuck with what they know and haven’t shown much interest in overseas investment opportunities.

So foreign investors aren’t complete newcomers to A-shares. ‘But I wouldn’t say they have changed the course of A-share companies at all,’ Tsang says. One simple piece of evidence: hardly any A-share companies exclusively listed on the mainland have English-language versions of their annual reports. ‘Why not? Because local investing power is too great and valuations are too high,’ Tsang explains. According to one Hong Kong sell-side professional, who didn’t want to be quoted, it’s still difficult for investors to reach A-share companies: ‘They use fax machines! Or you try to call them and they don’t answer the phone.’

Staying home

Since Stock Connect began, A-share companies haven’t expanded their IR programs overseas, says Cara Eio, a former sell-side analyst and head of corporate access who last year launched Strategic Nexus, an investor relations advisory firm.
‘They’re taking a wait-and-see attitude,’ she notes. ‘They may also face logistical issues such as visa approvals and resource constraints. A-share companies don’t feel the need to go beyond what they currently have in terms of investors. There’s no impetus for them to expand their investor relations programs. As long as they keep trading at a premium to H-shares and industry peers, they don’t have any incentive to improve overall shareholder value. In other words, the work of an IR officer at an A-share company has not yet been challenged.’

IR officers at some Hong Kong-listed companies, by contrast, may have been challenged a lot. On some recent days heavy trading through Stock Connect has exposed many of them to the hyperkinetic world of Chinese retail investors. In China’s young stock market, which was created only in 1990, retail investors dominate trading – during trading hours Chinese TV is filled with programs on the stock market – and, as a result, the market is seen as incredibly short term. Never mind next month or next quarter, Chinese shareholders measure their investment horizon in weeks or even days.

At IR Magazine’s Greater China conference in Hong Kong in December 2014, Karine Hirn, a partner in asset management firm East Capital, pointed out that with the market having been closed to the outside for so long, A-share companies are much more used to meeting with domestic investors with that ultra-short-term focus. They’re surprised when she goes in with longer-term questions. ‘We go and ask questions about incentive programs, board composition and long-term plans for the company,’ she said. Even if the companies have good governance – and many of them do, especially larger state-owned enterprises – they may not understand the importance foreign investors place on it.

It’s a vast country, Hirn pointed out at the conference, with huge variation in terms of the quality of executives she gets to meet. Although she would prefer to meet with the chief executive or chief financial officer, at a lot of A-share companies the corporate secretary can also offer good insights and deep knowledge. Interestingly, Hirn has found that A-share companies seldom have prepared presentations and instead just meet with investors and answer questions, which she likes.

Unique investments

The new stock linkage should trigger growth in the IR profession on the mainland as foreign investment increases. This is particularly true in sectors with links to the outside world like finance or mining, less so for companies like local retailers or hotel chains. The latter are novelties for foreign investors, with no way to invest in them via other markets. For that very reason, however, they’re the least outward-facing. ‘It may take those companies somewhat longer to get used to the international way of communicating,’ Tsang says. 

How fast A-share companies make improvements in investor relations will come down to how strong the market incentives are, Tsang suggests. In theory, A-share companies should be eager for a more institutional shareholder base to help tamp down volatility; wild swings in the market are of no benefit to management or major shareholders. ‘Mostly they create lots of problems for issuers,’ Tsang says. ‘There’s got to be a time when issuers say, We need more institutional investors.’

There may also come a time when Chinese investors increase their own foreign investment to the point that Chinese companies start to miss the liquidity and need to ramp up IR, either to convince investors to stay or to attract new ones from overseas. ‘When that time comes, the local companies will need to work harder at IR,’ Tsang notes.

Hirn predicts that the quality of IR – measured in transparency, responsiveness and longer-term outlook – will rise dramatically: ‘My hope is they’ll evolve through having more people like us engaging in the market and doing fundamental analysis rather than making short-term guesses, and that’s why I really like the Shanghai-Hong Kong Stock Connect. But it’s going to take some time.’

Q&A with frontier investor Karine Hirn, a Hong Kong-based partner at asset manager East Capital, who was formerly the firm’s chief rep in China, based in Shanghai

Q. What type of investor outreach do A-share companies typically do?
There’s still very little for foreign investors but we are starting to see some A-share companies at conferences and this will probably improve as foreign brokers beef up their coverage. Local brokers also organize corporate days, of course, but as the A-share market is still completely dominated by domestic retail investors, investor outreach is limited.

Q. Do they have good standards of disclosure?
Disclosure standards are OK and the companies report every quarter. Unfortunately, it seems that information sometimes leaks ahead of earnings calls as we occasionally see suspicious share price movements.

Q. Will the Shanghai-Hong Kong Stock Connect influence IR for A-share companies?
Not immediately but gradually, yes, I think it will. I personally think that’s one of the reasons the Chinese leadership has decided to open up the equity market. Like in other markets, higher requirements from foreign investors will raise the standard of investor relations.

We hope for better IR practices but also for a longer-term perspective on what is communicated. Local Chinese investors are very interested in next month’s sales or margins, asset injections or policy triggers, while foreign investors hope to see alignment of interest between management and shareholders, transparent and efficient incentive programs, clear dividend policies and board members representing minority shareholders’ interests. Unfortunately, so far a lot of this is just a wish list, but there are some improvements, even at state-owned enterprises.

This article appeared in the summer 2015 print issue of IR Magazine