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Risks amid B share rush
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Lin Min
WITHOUT doubt, all stocks in Shenzhen and Shanghai's B share markets, previously the ugly stepchild of China's stock market, will see a sharp rise in prices as soon as trading resumes today following a suspension last week when authorities announced the milestone decision to let individual investors on the mainland trade the hard currency shares, which were originally reserved for overseas investors.
Although a drastic bull run is widely expected, analysts have urged investors to keep their heads. Old B share investors have seen the tiny market soar and plunge with every change of policy in its 11-year history. Pessimists warn history may repeat itself.
The China Securities Regulatory Commission (CSRC) has indicated that the new policy is the first step towards the expected merger between the A and B share markets. The B shares, which have been traded at a hefty discount of around 30 per cent off their counterparts in the A share market, will undoubtedly be the target of a buying spree that will cut the price gap immediately.
Investors already holding B shares will be sure winners, but the new army of eligible mainland investors will be subject to risks. Once prices reach a certain level, a profit-taking sell-off is likely to occur. Lin Rui, analyst with Ping'an Securities, says that so long as the yuan remains non-convertible, a price gap between A and B shares will still exist.
Even though China will probably become a WTO member this year, monetary authorities have not dropped any hints on when the yuan will be allowed to float. The Wen Wei Po, a Hong Kong-based newspaper, said last year the yuan will become fully convertible in 2005. But such a timetable has not been confirmed.
Even if this timetable proves to be true, five years is a long time for a market as volatile as this. Pundits urge investors not to expect the prices of B shares to catch up to their A share cousins in the short term. Even the most optimistic predictions, backed by people like Anthony Neoh, chief adviser to the CSRC, say the A and B share markets would be able to unify only within two to three years. The market would still be too volatile for A shares to cling to the current high prices that have partly justified the well-known belief that China's stock market is worse than a casino.
Few can deny that the A share market is rife with speculation and market manipulation. The B share market may prove to be even worse. Only 114 stocks are traded in the tiny B share market with a total capitalization of around US$6 billion. As a result, a few institutional investors are theoretically able to dictate the movement of a stock. In a market where price rigging and insider trading are rampant, retail investors are most likely to suffer from market frustrations.
Strategic investors, originally invited to stabilize the market, now may become destabilizers as tremendous profits will almost certainly tempt them to give up their original “strategies" and, in effect, take the money and run.
Mainland investors should also be aware of different rules of the game: A shares are traded under the T+1 rule, which means shares purchased cannot be sold until the next day, while the B share market uses the T+0 model, which enables any purchase to be sold immediately. Generally speaking, this would mean higher volatility in the B Share market.
Despite the risks, B shares offer a lot of opportunities for both mainland and overseas investors as the price to earning ratio for Shenzhen's B shares, the measurement of price level as compared with corporate performance, was only around 12 on average before the opening bell today, investment-worthy even by any standard. It stands in stark contrast with the average of 55 in the A share market.
Some analysts even predict that, in some cases, the prices of B shares might be higher than their A share equivalents if a company's A shares are fully purchased for acquisition purposes. In order to control the company, the acquirer might have to buy more shares in the B share market at much higher price.
However, if the market sentiment in the A share market remains weak, momentum in the B share market will wane while risk grows as the price gap narrows.
Winners and losers
B-shareholders: Previously disgruntled investors who have seen their hard currency funds locked in the hitherto stagnant and low-liquidity market will become the biggest winners when the B shares enjoy unprecedented, almost certain take-off when trading resumes today.
A-shareholders: Already suffering a correction triggered by a government crackdown on rampant price rigging and other irregularities, investors in the A share market might face further erosion in prices of A shares as some investors withdraw from the market to invest in B shares through illegal channels. The bubbles in the A share market might be further highlighted after the B share market is opened to mainland investors.
Money traders and scalpers: Legal trading of foreign exchange has been rising and the black market also reportedly flourishes as more mainland investors — who are not eligible to enter the market under the new rules banning foreign currency savings deposited after February 19 from entering the B share market until June 1 — rush their money into the market through regulatory loopholes. The partial deregulation unwittingly benefits illegal scalpers.
From rags to riches
PROBABLY no stock market in the world has ever experienced the kind of dramatic swings of China's B share market.
Stimulated by favourable policies or, in some occasions, local practices not sanctioned by the market watchdog, the B share market witnessed a few crazy bull runs in the past, but they were soon followed by abrupt nosedives triggered by policy corrections. The market itself provides a textbook example of how a developing market has to be directed by policies or administration interventions when the market is too weak to run itself.
Its 11-year history was basically one of humiliation. Trading has been so thin that sometimes a sale order had to wait for months to be executed. When the market was lingering at its lowest point, for example in 1997-1999 when the market was hammered by the Asian financial crisis, sometimes not a single transaction was recorded for a whole session.
The market was also an embarrassment to the policy makers who pinned their hope of attracting foreign capital on the market. Because of the lack of transparency in the operation of B-share firms, and competition from the capital markets in Hong Kong and United States which also list many Chinese companies, the B share market has never been able to play its role as designated by the authorities.
The incurable dysfunction has proved to be a life saving straw for investors whose funds have been frozen in the market. Because it is incurable, it has to be declared dead and the whole system has to be overhauled. The February 19 announcement is in fact a declaration that the old market will be buried and a brand new, unified market will be established to prepare for the globalization of the financial sector.
Key facts
February 1992: B share market launched
May 1992: Shanghai B share index hits all-time high of 140.85
January 1996: The first national law on B shares approved by the State Council
June 1996: CSRC clarifies that only overseas investors are eligible to trade B shares, cooling speculation by mainland investors.
March 1999: Shanghai B share index dips to all-time low of 21.24.
June 1999: Stamp tax on B share trading is reduced to 0.3 per cent from 0.4 per cent, giving a moderate boost to the market.
May 2000: CSRC offers B share firms priority to issue A shares in capital expansion.
December 2000: Shanghai Stock Exchange improves B share trading arrangements.
February 2001: CSRC decides to allow mainland individual investors to trade B shares with their legal foreign currency savings deposited before February 19.
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