This is an excerpt of my article “How To Trade The China A-Share Premium Over H-Shares” explaining some of the background history and differences between China A-shares traded in Shanghai and Shenzhen and China H shares traded in Hong Kong.
A few definitions in case any of the terms in the previous paragraph were unfamiliar:
- “A” Shares refer to shares of Chinese companies listed in Mainland China, traded in local currency Chinese Yuan (Renminbi or RMB).
- “H” Shares are shares of Chinese companies listed in Hong Kong, traded in Hong Kong dollars.
- There are also “B” shares available to foreigners listed in U.S. dollars in Shanghai and Hong Kong dollars in Shenzhen, but fewer and fewer investors are following this market and it may phase out.
- QFII stands for “Qualified Foreign Institutional Investor”, which is a program for foreign institutional investors to receive a quota to convert U.S. dollars into RMB capital for buying A shares or listed bonds. QFII has limited investors from using this quota to buy interbank bonds (most of the Chinese bond market) or from trading futures (including the CSI300 stock index futures).
- QDII stands for “Qualified Domestic Institutional Investor”, and is a program for Chinese investors to receive a quota to invest abroad.
- “RQFII” (R for Renminbi) is a relatively new program which provides asset managers (so far mostly Chinese sponsored ones) to use offshore RMB to purchase onshore investments.
History / Timeline of H-Share – A-Share Convergence
From the point of the view of a U.S.-based or Hong Kong-based investor (or more generally, investors outside Mainland China), access to Mainland Chinese shares, and especially A-shares, can be viewed as a series of steps, both looking back and projecting into the future:
- In the 1990s, foreign investors wanting to invest in onshore listed Chinese companies were limited to the B-share market. China was still seen as a relatively closed, poor, and communist country of little interest to U.S. investors, so there were relatively few U.S. funds and B-shares were a tiny slice of the investment fund space even in Hong Kong.
- In parallel since 1993, there have also been a growing number of Chinese companies listed in Hong Kong (H-shares), New York (sometimes called N-shares), Singapore and London (which could be called S-shares and L-shares). In time foreign investors seem to have greatly preferred these offshore listings over the B-share market (as seen by trading volume and fund assets), but all of these foreign-accessible shares still only covered a fraction of the number and diversity of companies listing on the A-share markets.
- China joined the WTO in 2001, announced the QFII program in 2002, and approved the first QFII quotas to 12 foreign banks in 2003, including U.S. firms Morgan Stanley (NYSE:MS), Citi (NYSE:C), Goldman Sachs (NYSE:GS) and JPMorgan (NYSE:JPM), providing foreign investors access to A-shares for the first time.
- The first “China” ETFs were H-Share ETFs: Hang Seng H-Share ETF(2828.HK) in 2003 and the iShares China Large-Cap ETF (NYSEARCA:FXI) in the U.S. 2004. For most of the 2000s, many foreign investors allocated “China equities” in their portfolios through H-share funds like these.
- Also in 2004, the iShares FTSE Xinhua China A50 ETF (2823.HK) was listed in Hong Kong and was the first ETF to try and track the A-Share market. It did this by holding China A-share Access Products (CAAPs), such as certificates issued by Citi against A-shares held with its QFII quota. These CAAPs were not freely convertible or widely accessible, making arbitraging the ETF very difficult, which allowed 2823.HK to have far wider premium/discount ranges than most ETFs.
- In 2006 in the U.S., Morgan Stanley launched the closed-end Morgan Stanley China A-share Fund (NYSE:CAF). The closed-end fund structure was a better fit than an ETF for the fixed QFII quota of buy A-shares, and the premium/discount reflected investor demand for this fixed pool of shares.
- In 2009-2010, China slowly started allowing RMB settlement in Hong Kong, beginning a slow process of internationalizing the currency by developing an offshore RMB market (as there has been a global U.S. dollar market for decades if not centuries). Hong Kong residents began being allowed to convert HK$20,000 (about U.S.$2,580) per day into or out of RMB, beginning a growing base of offshore RMB deposits.
- In 2011, China began granting RQFII quotas to Chinese firms to allow this offshore RMB to be invested back into the onshore A-Share and interbank bond market. These quotas are approved more quickly than QFII quotas and may soon eclipse QFII in size and importance, because they mark existing offshore RMB rather than providing any new quota to convert RMB into USD.
- In 2013, the Deutsche X-trackers Harvest CSI300 China A Share ETF (NYSEARCA:ASHR) was launched in the U.S., following the 2012 launch of the similar ChinaAMC CSI300 ETF (3188.HK) in Hong Kong. Based on the more dynamic RQFII, this ETF is easier for dealers to arbitrage with quota shares and so provides tight NAV tracking more in line with other ETFs and unlike CAF or 2823.HK.
- In November 2014, the Hong Kong-Shanghai Stock Connect was launched, allowing foreign investors access to A-shares for the first time without any QFII or RQFII quota requirement (and similarly, allowing Mainland Investors access to Hong Kong shares without any QDII requirement). This still only provides access to a fraction of the A-share market (570 eligible A-shares as of this writing, updated on the HKEX website) still are overall limits to how much trading is allowed over this connection, a “closed loop” system to ensure cross-border funds are kept invested in the shares traded on the connect, but this another huge step forward in foreign accessibility to A-shares and eventual convergence of A-shares and H-shares.
- [Added later] In late 2016, the Hong Kong Stock Exchange opened the Hong Kong-Shenzhen Stock Connect, opening foreign investor access to China’s 2nd major stock exchange of A-shares known for having more private businesses than state-owned enterprises. I cover this more in my later article “Shenzhen Connect A Welcome Opening To A Different But Expensive Segment Of The China A-Share Market“.
I have continued using this evolving list as my summary guide to China’s continuously evolving capital markets.
Tariq Dennison is a Hong Kong based CERTIFIED FINANCIAL PLANNERCM Professional and portfolio manager at GFM Asset Management LLC (www.gfmasset.com). GFM is a Hong Kong based asset manager and US registered investment adviser.