China Equities Portfolio Manager May Ling Wee discusses the buoyant initial public offering (IPO) market and the impact of “re-shoring” and rising cross-border flows on Chinese markets.

  Key takeaways:

• Chinese stocks and initial public offerings (IPOs) have enjoyed strong demand post-COVID, with China’s economy back to growth since the second quarter of 2020.
• Geopolitics do not undermine the attractiveness of investing in Chinese businesses, or Chinese companies’ decision to list on U.S. stock exchanges.
• Cross-border flows, particularly southbound, are increasingly important, as is maximizing value from where IPOs are listed.
• “Re-shoring” of Chinese stocks is changing the composition of the Hong Kong market, mirroring the evolving Chinese economy.

Demand for Chinese stocks has been strong following COVID-19. China was “first in and first out” of the pandemic, which helped its economy grow above pre-COVID levels in the second quarter of 2020. Combined with a strengthening currency, these factors have provided a conducive backdrop for Chinese companies to raise capital via initial public offerings (IPOs) on the Hong Kong, domestic Shanghai/Shenzhen, and U.S. stock exchanges in 2020 and year to date.

The Attractiveness of Chinese IPOs and Businesses Trumps Geopolitics

The previous U.S. administration imposed executive orders preventing U.S. persons from investing in Chinese companies deemed to be linked to the Chinese military. The subsequent delisting of these companies from U.S. stock exchanges and the indices of global index providers (e.g., FTSE Russell, MSCI, S&P, Dow Jones) appear to be almost inconsequential. Although global investors may be invested in some of the affected companies, this will always remain a bone of contention in terms of how close or how removed these companies are from China’s People’s Liberation Army.

Rising Cross-Border Flows, Choice of Market Listing Is Key

In January 2021, southbound trading activity from China was estimated to have been around 30% of total trading in Hong Kong. While global investors typically seek out the best opportunities in the domestic markets of Shanghai and Shenzhen (northbound capital), Hong Kong and the U.S. exchanges, China’s “southbound” investors are also seeking out the best opportunities in the Hong Kong market. These cross-border flows are likely to increase over time as Chinese household financial wealth continues to grow and to find its way into both the Chinese onshore and offshore markets. At the same time, companies are also casting their capital raising nets wider, seeking listings on both the onshore markets and offshore in Hong Kong.

That said, we have also seen some companies choosing to list on the onshore markets. The rationale is that onshore markets have been known to be more receptive of much higher valuations on emerging and strategic industries than investors in the Hong Kong market. For example, Chinese auto manufacturers have selected to list on the domestic onshore markets to fund their EV ambitions. We also saw China’s leading semiconductor foundry conduct a successful public offer in Shanghai, raising around $7.6 billion last year, the largest amount raised by a single company on Chinese domestic exchanges last year. Healthy and buoyant domestic stock markets enable China’s emerging and strategic industries to fund themselves via public capital instead of solely from the state’s coffers or loans.

Conversely, health care companies have tended to select Hong Kong for their IPOs, where demand for high quality health care stocks is stronger because of the smaller universe of healthcare companies compared to onshore markets. Hong Kong has become a popular listing venue for biotech companies.

Implications of “Re-shoring” on Hong Kong

The “re-shoring” or re-listing of Chinese companies previously only listed in the US but now also listed in Hong Kong is impactful. These new economy stocks are shifting the market’s composition, from being dominated by financials, real estate, conglomerates (and previously energy and telecom) companies to one where “newer” economy companies such as those within healthcare, technology and consumer-focused sectors make up more than half the total market capitalization. These highly traded stocks account for an increasingly larger proportion of market turnover, compared with Hong Kong’s “old” economy shares that are typically held for longer for their provision of dividends and income. The make-up of Hong Kong’s market, now largely represented by technology, consumer-facing businesses and service industries is reflective of China’s progression from a fledging, industrializing economy some 30 years ago to the more developed and maturing economy that it is today.

 

¹Source: Morgan Stanley as at 8 February 2021.
²Source: Wind Data Service, as at February 2021, China onshore total equity financing.
^3,5Source: PwC Press Room, 4 January 2021: A-share IPO fundraising is expected to reach a new high in 2021.
⁴Source: Morgan Stanley, 2 February 2021, HK Exchange: Reaching Blue Sky scenario.

 

Glossary
IPO: In an initial public offering, shares in a private company are offered to the public to purchase for the first time.
China domestic/onshore markets: Refers to the Shanghai and Shenzhen stock markets in mainland China. Conversely offshore markets refer to stock markets outside of mainland China where Chinese stocks are listed, e.g., the U.S. exchanges and Hong Kong.
Household financial assets: Assets such as saving deposits, investments in equity, shares and bonds that form an important part of overall wealth of households.
National Security Law: Article 23 of Hong Kong’s Basic Law provides that Hong Kong Special Administrative Region will “enact laws on its own” for the region’s security and to prevent political bodies outside the region from “conducting political activities in the region” or otherwise interfering with Hong Kong’s independent security.