Stocks of Chinese companies attract interest from investors worldwide. One of the factors contributing to this interest is the stable development of the Chinese economy, consistently ranking among the world’s top in terms of nominal GDP (second place after the USA) and GDP based on purchasing power parity (since 2016, surpassing the USA by more than 25% as of 2022). It’s not surprising that investors anticipate rapid growth from stocks of Chinese issuers and want to properly assess the features of the Chinese stock market, its opportunities, and markets.
From this article you will learn:
- China’s stock market is characterized by a unique blend of state intervention and market forces, with government policies playing a significant role in shaping market dynamics and investor sentiment.
- The Chinese stock market is known for its volatility, driven by factors such as government regulations, economic data releases, and global market trends. Understanding these drivers is crucial for investors looking to navigate the market effectively.
- Despite its challenges, the Chinese stock market offers significant opportunities for investors, particularly in sectors aligned with China’s strategic initiatives such as technology, consumer goods, and healthcare.
Structure of the Chinese Stock Market
Currently, the Chinese stock market consists of four exchanges:
- Shanghai Stock Exchange (SSE)
- Shenzhen Stock Exchange
- Hong Kong Stock Exchange
- Beijing Stock Exchange
Shanghai Stock Exchange
The Shanghai Stock Exchange (SSE) is the largest mainland China platform. Founded in 1990, it primarily deals with shares of major financial companies (blue-chip stocks). Today, with a market capitalization of around 8 trillion dollars, the exchange ranks third globally, trailing only NYSE and NASDAQ, listing over 1660 companies and more than 2099 securities.
SSE is a non-profit organization fully managed and regulated by the Securities Regulatory Commission (SCRC).
Within SSE, there is a separate platform called the Star Market, designed for trading startup and innovative company securities (similar to NASDAQ). In just three years of its existence (from 2019 to 2022), the market capitalization of companies traded on it exceeded 1 trillion dollars.
The main listings on the Shanghai Stock Exchange include:
- Financial sector companies
- Industrial enterprises
- IT sector
Shenzhen Stock Exchange (SZSE, SHZ)
The Shenzhen Stock Exchange (SZSE, SHZ) is the second largest exchange in China, just like the Shanghai Stock Exchange, and is among the world’s largest platforms. Its main feature is that the majority of traded securities are issued by Chinese state-owned enterprises or companies with state participation. Unlike the Shanghai Stock Exchange, where predominantly financial sector and medium-sized business securities are traded, Shenzhen focuses on shares of industrial enterprises.
Its market capitalization exceeded 5.3 trillion dollars in 2022. Like the Shanghai Stock Exchange, it is under the management and regulation of the Securities Regulatory Commission (SCRC). Similarly to Shanghai, it also has a platform for high-tech companies called ChiNext.
Beijing Stock Exchange
The Beijing Stock Exchange is the youngest trading platform in mainland China, created based on the New Third Board organization, whose task was to facilitate off-exchange transactions for companies not listed on the two main exchanges. It brought together small and medium-sized businesses (more than 10,000 enterprises with a capitalization of over 2 trillion yuan).
The new exchange is intended to provide these companies with conditions for issuing securities for public sale. The first 66 selected representatives from the New Third Board, mainly from the raw materials, processing, IT, and healthcare sectors, gained access to it. The exchange is still young (its official registration was announced only on September 6, 2021).
Hong Kong Stock Exchange (HKEX)
The Hong Kong Stock Exchange (HKEX) is one of the largest global exchanges (with a market capitalization of around 6 trillion dollars). It is typically not considered part of the Chinese exchanges due to Hong Kong’s specific economic autonomy within China. However, in practice, it is a full participant in the Chinese stock market and is a leader in collaboration with foreign investors. The HKEX trades over 8,500 financial instruments.
Hong Kong Stock Exchange is connected to other mainland Chinese exchanges through the Stock Connect investment channel (Shanghai-Hong Kong Stock Connect launched in 2014, and Shenzhen-Hong Kong Stock Connect in 2016). As a result, Chinese investors gained access to instruments listed on the Hong Kong Stock Exchange, while traders on the latter gained access to more than 880 Shanghai shares and 500 Shenzhen shares.
Types of Stocks on the Chinese Stock Market
The following types of stocks are traded on Chinese exchanges:
- A-Shares – issued by companies registered in mainland China, denominated in yuan, available for trading only to residents and (with restrictions, such as daily and total turnover) to foreign investors with Qualified Foreign Institutional Investor (QFII) status.
- B-Shares – shares of Chinese issuers denominated in yuan but traded in foreign currencies (U.S. or Hong Kong dollars, respectively in Shanghai and Shenzhen). Chinese residents with currency accounts and foreign investors have access to trading.
- H-Shares – shares of Chinese issuers listed on the Hong Kong Stock Exchange (denominated in HKD).
- N-Chips – shares of Chinese companies with foreign registration, whose main revenue is generated in China. The majority of these are American Depositary Receipts (ADR).
- P-Chips – shares on the Hong Kong Stock Exchange issued by issuers under the control of private individuals from mainland China, generating revenue in mainland China.
- Red Chips – shares of Chinese state-owned companies registered in Hong Kong with their main business operations in mainland China.
Chinese Stock Market: Key Features
The structure and management, as well as the division of shares into several types, define the key features of the Chinese stock market. All of them can be well described by the word “rigid”.
Rigid Division into Onshore and Offshore Markets
The onshore market is accessible only to residents of China, and its turnover is concentrated exclusively on Chinese stock exchanges. Out of the nearly $18 trillion market capitalization of the Chinese stock market, around $12 trillion belongs to the onshore market. Its foundation consists of A-shares traded in Shanghai and Shenzhen. Apart from residents, access to them is available to foreign Qualified Foreign Institutional Investors (QFII) who have obtained status and a license from the Securities Regulatory Commission (SCRC).
The offshore market is represented by shares listed on the Hong Kong Stock Exchange, which are accessible to foreign investors without restrictions. This category also includes shares of Chinese companies listed on foreign exchanges (the lion’s share being on American ones).
It is precisely this rigid division that is responsible for the slow pace of growth of Chinese stocks, despite the fact that the Chinese economy is outpacing almost all other countries in terms of development. In fact, over the more than 30 years of existence of the Chinese stock market (since the 1990s), its cumulative growth has barely doubled. This situation is explained by:
- The restriction on trading to Chinese residents only.
- The strict control of the government over money flows.
- Effective measures to restrain inflation and artificial regulation of currency exchange rates.
As a result, there are no critical fluctuations in demand or supply observed in the market, which ensures particular stability. The average return on company stocks lies within the range of 4-5%. While there are growth stories, the overall market capitalization serves as a powerful inertia filter.
Another peculiarity of such division is the existence of dual listings for some companies, for example, A-shares in Shanghai or Shenzhen and H-shares in Hong Kong. Their quotations usually differ significantly since capital flows on the HKEX are not under control, and the investor base varies significantly. As a result, stocks on mainland exchanges are generally more expensive, with the difference being substantial (sometimes exceeding 40%). However, A and H shares cannot be converted into each other, making it impossible to conduct super-profitable arbitrage operations.
Stringent Requirements for Issuers
Mainland Chinese stock exchanges are considered to have some of the most stringent conditions for issuers worldwide. For listing on the Shanghai or Shenzhen stock exchanges, a company must:
- Demonstrate a non-zero (and naturally, non-negative) net profit over the past three years.
- Have at least 1,000 shareholders before listing.
- Have a capitalization of more than 30 million yuan.
- For capitalization exceeding 400 million yuan, have a free-float of shares of no less than 15%.
As a result, going public (IPO) on mainland Chinese stock exchanges is far from easy, and the reliability of issuers who have succeeded in doing so is quite high.
Rigorous Government Regulation
The familiar principles of a free market are not always realized on Chinese exchanges. The government often applies administrative measures during trading, such as:
- Prohibiting transactions with securities of certain companies to foreign market participants.
- Providing some issuers with additional preferences through its own methods, such as reducing loan rates for the company, setting prices for initial placements regardless of the number of applications submitted, etc.
Thus, the Chinese stock market, although it may appear very attractive to investors, has many peculiarities. Trading on it will require adaptation. In this regard, the Hong Kong Stock Exchange is more familiar, and perhaps most retail investors should focus on its assets.