ATC Business Casual
Author: Sun Wei, Founder of ATC Initiative
One of the most eye-catching pieces of China-related news in London recently would be the formal launch of the Shanghai London Stock Connect, with Chinese investment bank Huatai Securities listing its GDR on London Stock Exchange yesterday (Monday 17th June 2019).
London Stock Exchange provided a nice piece of a news release on its website with a well-made video (https://www.lseg.com/markets-products-and-services/our-markets/shanghai-london-stock-connect) and it is also easy to find through google search various info covering the detailed mechanism of the Connect program. Unlike Shanghai Hongkong Stock Connect which enables capital to go to the other market to invest, Shanghai London Stock Connect enables corporate issuers to go to the other market to list (their CDRs or GDRs).
Chinese Vice Premier Hu Chunhua (2nd R, front) and British Chancellor of the Exchequer Philip Hammond (3rd R, front) attend the launch ceremony of Shanghai-London Stock Connect in London, Britain, June 17, 2019. (Xinhua/Han Yan)
The Connect program enables European investors to invest in some listed Chinese firms without the need to use any cross-board access schemes (QFII/RQFII/HK Connect, etc). This is a huge advantage for those investors who are increasingly interested in the China story but still not ready enough to deploy asset into China market directly. But this “issuer moves instead of capital moves” feature also means the investable universe of Chinese firms on LSE would not be very big. Thus passive investment strategies would not find this program particularly satisfying. However, I’d like to argue that for active managers, this Connect program could prove to be very instrumental and effective for their China allocation.
I’d like to use two phrases to describe how the Connect program can be beneficial to European investors. They are “Premium Sampling” and “Sector tilting”.
Not all Shanghai Stock Exchange-listed firms can join the Connect program. A minimum market capitalisation of RMB20bn (GBP2.3bn) is required. This means that only large firms (and hence relatively stable ones) would be eligible. Around 260 Shanghai-listed firms can meet the size requirement. Among these firms, it is natural to expect that those who would seriously consider London GDR listing would be firms with global expansion ambitions and with strong confidence in their financial credibility, corporate governance and European investor relations management capabilities. All these are built-in mechanisms to ensure the quality of the Chinese firms entering the Connect program.
When there is a good number of Chinse firms on LSE representing various industry sectors, investors will find it quite handy if they wish to try to have some exposure to “best in class” Chinese asset—simply investing in these London listed GDRs of Chinese firms could well achieve that. This I would like to call “premium sampling”. It would be particularly useful for inventors/asset managers who wish to have a general Chinese equity exposure.
In practice, most probably Chinese companies in the connect program would not be evenly distributed among different industry sectors. The 260 eligible Chinese firms themselves have clear industry tilt (see table below), towards financial services, TMT, manufacturing, etc. This will certainly affect the number of possible candidates in each sector that could potentially apply to join.
Industry Distribution of 260 Eligible Shanghai Listed Firms
Source: ATC Initiative analysis; Wind
There are other reasons why the sector tilt could happen. Some industries in China could be intrinsically more international: with a bigger market in Europe or with more synergies with European players. There is also the clustering effect: just because the very pioneering firms come from a certain industry (for instance, with Huatai Securities from financial services), companies in the same industry may find it easier to follow suit, because the service providers and the investors have familiarized themselves with this Chinese industry sector and market pricing becomes easier with ready comparables.
Sector tilting actually has a lot of merits and the London Stock Exchange can well leverage it to its advantage. With one or a few strong industry sectors from China represented in LSE GDR offering, the London market could expect much deeper research coverage and a lot more legal, brokerage, consultancy, conference… activities surrounding those Chinese industry sectors, creating an eco-system with a gravitational pull to firms in that sector from other countries. Think about how much Nasdaq in the early days was associated with fast-growing internet firms. A similar story (maybe less known) with Oslo Exchange in relation to the listing of shipping companies. Actually, LSE Group is not unfamiliar with this at all, with Italian Stock Exchange (Borsa Italiana) a particularly strong name for luxury consumer brands listing. A marketplace offering sufficient market depth and abundant professional services in a particular industry sector would certainly present strong attractiveness to investors with interest or even conviction to that sector.
What Chinese industry sectors have the potential to be tilted towards in London? I would like to bet on the following ones:
- financial service. This may seem obvious since it is the largest sector in the Shanghai-listed eligible company universe. More backing for this argument comes from the fact that China is quickly opening up its capital market and Chinese financial institutions are just embarking on a globalization journey. With London as a leading financial centre and, I would add, its welcoming environment, many Chinese financial players will find it hugely rewarding to associate itself with London.
- the medical and healthcare sector. It is not that large in terms of the number of eligible firms. But it is a growing sector in China that has attracted much investor attention from Europe—possibly a demand-driven story. On the other hand, many Chinese firms in this sector have been on a close search for investment targets in Europe, mainly for medical technology and equipment. So this could also be an acquisition-driven story.
- cleantech and energy-efficiency related firms. This is not a single industry, but rather includes firms from a variety of industries that all feature environmental, low-carbon, energy efficiency elements. I make this bet because London has established itself a centre for green finance, and also because ESG has been an indispensable part of European investors’ investment decision making the process. Companies with this business focus will find themselves better understood and favoured in the London market.
Now we are at the beginning of this exciting journey with two-way traffic for leading Chinese and UK firms to embrace the other market. Much remains to be seen but opportunities will surely unfold themselves in their own ways…