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 4-5% 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 U.S.," 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 programme, 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 programme 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% 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 programme 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."
(Reporting by Li Gu and Samuel Shen in Shanghai and Tom
Westbrook in Singapore; Editing by Vidya Ranganathan and
Jacqueline Wong)
