The real China growth story is in the domestic market

Goldman's Mark Machin looks at the similarities and differences between China's capital markets now and then, and highlights some surprising developments.
Mark Machin
Mark Machin

Ten years is an odd slice of time for the China markets. Some things have changed a lot and some things have not.

The similarities include that 10 years ago we were in the midst of a capital markets boom -- we had enormous issuance from state-owned enterprises (SOEs): the IPO of PetroChina first, then China Unicom and Sinopec later in the year. Finally we had the record $7 billion China Mobile dual tranche equity and convertible deal. These deals alone raised almost $19 billion. And while the underlying economic growth was strong, the Hang Seng index was at this stage down more than 20% for the year, buffeted by international factors.

The differences include that 10 years ago there were no publicly-listed Chinese banks or insurance companies; the remaining international issuance away from the SOEs was small; the domestic A-share market was developing; and the domestic renminbi debt market was very small for corporates. 

Today, Chinese banks are the largest and arguably the most robust in the world, the domestic A-share market is the second largest stock market in the world, behind the US only, and the domestic renminbi debt market is on some measures the third largest domestic debt market in the world.

The real story in terms of growth is in the domestic market where issuance volume has grown from a total of $12 billion in 2000 to $36 billion year-to-date. There has been a 70% increase in the number of listed companies and, despite the volatility, a more than 400% increase in market capitalisation of those companies.

The domestic bond market is even more impressive with volume of issuance up from about $20 billion for the whole year 2000 to $94 billion year-to-date.

So what has been surprising and what has not? 

What has not been surprising to me is that the state-owned sector has continued to grow, and that the private sector has grown from what was less than 5% of the international issuance 10 years ago to account for a large proportion of the issuance volume today. It is no surprise that the domestic market has flourished. It is also no surprise to me that, despite the doomsayers who predicted the domestic markets would not have fund-raising capacity or that there would be an end to overseas capital raising, these two markets have grown hand in hand. China has kept all doors open for companies to raise capital.

Things that have surprised me include:

1. The growth and sustainability of Chinese IPOs in the US market. For several years, IPOs in the US market alone (without a dual listing in Hong Kong) would quickly be forgotten and would turn into orphan stocks with low liquidity and poor research coverage. Out of time zone, out of mind. 

But pioneered by some of the tech IPOs in 2000, a critical mass of growth companies have today clustered in the US market and the weight of investors and analysts looking at them has weathered the downturns and looks to be here to stay.

2. The reform of non-tradable shares in the A-share market was brilliantly carried out. We and many others (at one point there were over a 1,000 schemes posted on the CSRC's website) had thought long and hard about how the government could deal with the massive over-hang of making non-tradable shares in the A share market become free-float. To appreciate the scale of the challenge, it had been calculated that if the European privatisation approach was adopted, using reasonable assumptions for how much sell-down the market could sustain given its size, liquidity and free float, it would take 30-50 years to solve. 

The approach adopted of getting each company to negotiate an individual scheme of compensation acceptable to shareholders de-centralised the process, calmed the markets and resulted in the situation taking two to three years to resolve, at least to the point of the shares becoming freely floated, if not actually sold. This reform was what has allowed the A-share market to develop much more effectively in the past three years.

3. CDRs/HDRs (China/Hong Kong depositary receipts) have not happened and are unlikely to happen. Ten years ago there were detailed discussions with the regulators about creating a security that could allow Hong Kong and international companies to be listed and traded in the A-share market and for A-share companies to list and trade in the Hong Kong market. While there has been progress in the form of virtually concurrent domestic and international offerings for some large SOEs, and the development of QFII's and QDII's, which has given investors some ability to invest cross-market, and there has been much discussion around an International Board in Shanghai, CDRS/HDRs are unlikely to happen any time soon.

So for the next 10 years?

There will be increased convergence of the Hong Kong and domestic China capital markets. Again, my view is that both will thrive and grow and one will not totally eclipse the other. More companies will become dual listed in both international and domestic markets. And capital raising will have to take into account investors domestically and overseas. The domestic market will become deeper and more layered with the growth of the ChiNext market and the likely launch of other over-the-counter (OTC) markets. 

Finally, from the recent launch of margin trading and financial futures we can expect significant but carefully supervised growth of multi-strategy investors and more diverse financing instruments in both the equity and debt markets. In fact, China will become more like the developed capital markets in the world in terms of depth and maturity. The golden era for China capital markets professionals is, I think, ahead of us.

Mark Machin is co-head of investment banking for Asia ex-Japan at Goldman Sachs.

¬ Haymarket Media Limited. All rights reserved.

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