When a domestic rally meets an offshore discount…

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Just as China’s domestic markets have finally started to open up through the Shanghai-Hong Kong Stock Connect scheme, heavily discounted H-share IPOs threaten to put a damper on the attractiveness of A-shares to international investors.

After a delayed start, the Stock Connect scheme began on November 17 last year, the same day the Rmb20,000 daily conversion limit (roughly $3,200) for Hong Kong residents was scrapped. Hong Kong based investors can now put their money to work by purchasing a variety of stocks listed on the mainland, and vice-versa. By the end of this year, the arrangement should also expand to stocks listed in Shenzhen, although an ETF launched by Value Partners readily provides such exposure to foreign punters.

Up to now, the scheme has pretty much all been about Northbound trading, with investors on the mainland largely ignoring the opportunity to snap up Hong Kong stocks. There are several reasons for this: under the scheme, mainland investors must have an account balance of Rmb500,000 to be eligible to trade on HKEx. In addition, a number of them may already be investing in Hong Kong through other means, such as private banking accounts.

At the time the scheme was devised, it was widely thought that Hong Kong investors would take advantage of the wide discount at which many A-shares traded, as compared to counters listed on HKEx. The possible inclusion of A-shares in the MSCI indices in the future was also thought to be another motivation to entice market participants to seek exposure to Chinese stocks.

Same but different

What pundits perhaps failed to forecast, however, was the sharp rally in the A-shares. Year-to-date, the Shanghai Stock Exchange Composite Index is up more than 14%, while the Shanghai Shenzhen CSI 300 Index hardly trails behind, with a performance of +12%. But the one-year rallies, at +86% and +89% respectively, are particularly mind-blowing.

Much of this increase has been fuelled by the primary issuance of A-shares, with new issue volumes of $23.9bn in the first quarter alone, up 57% compared to the same period last year, according to Dealogic. Two rate cuts by China’s central bank have also helped, as growth on the mainland has now slipped to its slowest pace in almost 25 years. Another factor could be the growing need to fund China’s domestic M&A activity, which hit a record $53.2bn in the last three months, an increase of 21% year-on-year.

The situation has led the China Securities Regulatory Commission (CSRC) to turn a blind eye to the price at which H-shares can now be issued.

The IPO of GF Securities, which could reach $3.6bn, making it the largest new listing this year in Hong Kong and Asia, is a case in point. Offered at a discount of 43%-52% to the A-shares, as well as keenly priced when benchmarked to H-shares issued by Chinese brokers, the securities look to many as cheap as chips. For the first time in a while, a cornerstone tranche of almost $1.9bn has been assembled, even if most of its 18 participants are actually Chinese institutions and corporates, rather than international stock pickers.

Mainland stocks being offered in Hong Kong at a fraction of what they are now worth domestically could therefore nip in the bud the nascent Northbound trade on Stock Connect, and foreign interest in RMB-denominated securities — even if IPOs are not yet part of the Stock Connect scheme. In what might perhaps be a related episode, and an indication that renminbi shares are no longer all the rage, the application for Hong Kong Airlines’ much anticipated dual currency IPO in Hong Kong lapsed earlier this month — although in this particular case other factors could be to blame.

Conversely, Southbound interest in H-shares could well pick up at last, as the rules to include new listings are relaxed, and as the cornerstone line-up for the GF deal would seem to suggest.

Meanwhile, in a worrying development and one that readers of my column will already know that I find frustrating, silly syndicates are back in force and are continuing to grace prospectus covers. GF appointed no fewer than 18 bookrunners and 23 joint lead managers for its IPO. Banks have also reportedly underbid each other to ridiculously low levels to secure a sponsor role in China Reinsurance’s $2bn new listing, making almost a mockery of the ban on “no deal, no fee” arrangements, newly introduced by HKEx and the SFC, to improve due diligence and disclosure.

Same same but different, as they say in Thailand.

Philippe Espinasse was a capital markets banker for almost 20 years and is now an independent consultant in Hong Kong. He is the author of “IPO: A Global Guide”, whose expanded second edition was published last autumn, and of  “IPO Banks: Pitch, Selection and Mandate”.

This column was first published on GlobalCapital.