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Chinese stock listings in Europe face liquidity hurdle

REUTERS/Toby Melville
During the first five months of 2023, nine listed firms on the London Stock Exchange were approached by PE firms

China’s ambitious plan to get its companies listed in London and Zurich stock markets needs fine-tuning, analysts say, as the sparse liquidity in traded Chinese companies there has created market arbitrage opportunities for investors.

The Shanghai-London Stock Connect has seen only five Chinese companies issue global depository receipts (GDRs) in London in its four years of operation, and another 13 are listed in Switzerland via a younger rival Connect link. GDRs allow investors to buy shares of foreign companies in their local exchanges.

The small cohort of participants has failed to generate enough demand for Chinese companies traded in those bourses, but has attracted investors who exploit price anomalies.

The arbitrage opportunity opens up as soon as companies issue their GDRs, most at a discount to attract investors. Hedge funds rush to swap the GDRs for their China-traded equivalents as soon as they can and pocket the price difference.

“Deducting all costs, we expect to earn four to five percent return from owning the GDRs and later converting them into A-shares,” said Miles Jian, analyst at a China-based hedge fund, referring to stocks listed on the mainland.

The issue has become a vicious drag on the GDR market as investors turn wary of falling turnover, threatening China’s aim to deepen ties with Europe and create alternate financing venues.

For a growing number of Chinese companies seeking to diversify their global footprint in a geopolitically complex world, “it is more sensible to raise that company’s capital in Europe and the United Kingdom than in the US”, said John Edwards, UK trade commissioner to China.

But he said “having low trading volumes is not good. Having hedge fund arbitrage is not good. It’s not what we are looking for in the long run as a viable capital raising channel”.

A Chinese lawyer said many investors swap GDRs into A-shares and some brokers are even designing derivative products to lock in such profits.

No quick fix

A fix is not straightforward and requires time, but bourse and government officials are rolling up their sleeves.

The London Stock Exchange Group (LSEG) and UK trade officials visited several cities in China to promote UK capital markets recently.

Wilson Xu, a banking veteran from CITIC Securities pioneering the Stock Connect program, said liquidity will improve when there is a critical mass of Chinese listings.

The Shanghai-London Stock Connect was launched in 2019 and the link was expanded last year to include Shenzhen and Switzerland. A similar program will be officially launched soon to link China and Germany.

The SIX Swiss Exchange cited low appetite for Chinese risk exposure amid currently difficult market conditions and the novelty of GDR instruments as factors for the low trading volumes.

As a result, issuance is weak – with Chinese companies raising just several hundred million dollars on average on the Six exchange – and almost all of these companies including Sunwoda Electronic Co Ltd and Hangzhou GreatStar Industrial Co Ltd having to cancel some of their GDRs after the minimum holding period due to arbitrage activities.

Even arrangements by Six to allow roughly 2.5 hours of trading in a session for Chinese GDRs didn’t help.

“They condensed it into this tiny little window in order to squeeze more liquidity. It hasn’t worked,” said Jon Edwards, China chief representative of LSEG, though acknowledging the problem was not unique to Six.

“For many of ours, yes, you also saw arbitrage funds taking part,” Edwards told a conference promoting the Shanghai-London Connect.

Chinese companies, however, have been positive in public disclosures about their forays in Europe which have given them an alternative channel to raise funds and access foreign currency for their operations abroad.

Sunwoda Electronic and Hangzhou GreatStar did not respond to Reuters requests for comment. GreatStar said in an earlier statement their remaining GDR shares were now less than 50 percent of initial issuance.

One other challenge for companies seeking to attract long-term investors into Chinese GDRs is that most institutional investors already have exposure to Chinese stocks through other cross-border channels, such as the qualified foreign institutional Investor program or China-Hong Kong Stock Connect, Dean Ding, director of securities services at Standard Chartered Bank, said at a recent conference.

London is working to solve the chicken-and-egg dilemma.

“We need a certain volume of listings before we can have the sufficiently large investor base that necessitates liquid markets,” said a trade UK official who declined to be named.

“Having fresh sources of long-only capital is also vital to the long-term success of the Connect scheme and London has that in spades.”