China's Enigmatic Stock Exchanges
Following our Week 4 presentation on the fintech industry in China, we took a look at the stock markets in China: how they emerged, how they’ve developed, what makes them unique, and the strengths and weaknesses of this lucrative yet questionable part of the Chinese economy. The predominant trends that we identified were the reliance on bank loans and retail investments, low level of equity financing, lack of widespread investment and confidence, and other fundamental differences in investment practices between China and the West.
When looking at the major stock markets in China, three pop out almost instantly: the Shanghai Stock Exchange, the Shenzhen Stock Exchange (SSE), and the Hong Kong Stock Exchange (HKEX). For starters, Shanghai is home to the world’s second largest stock exchange, trailing only the NYSE in the United States. China’s largest stock exchange is composed largely of everyday investors (“retail investors”), unlike in the US and most other Western countries, where “institutional investors” dominate the investment landscape. Despite its gargantuan size, the SSE is actually fairly lacking in trust among many investors, with little transparency and a troubled reputation. The SSE incorporates the STAR Exchange, which is similarly lacking in transparency, though it has a unique focus on high-growth technology firms and reflects the financial priorities of the Chinese government. Shenzhen, the 8th largest stock exchange in the world, suffers from low growth overall, though its bond market is booming. Hong Kong’s stock exchange has close to 2,500 listed companies as of the end of 2019, with a market capitalization of roughly 3.8 trillion USD. This exchange is more regulated than those of Shanghai and Shenzhen, predominantly through Hong Kong Exchanges & Clearing Limited and Hong Kong Securities & Futures Commission.
As China’s financial services industry becomes increasingly of interest abroad, it is critical to note its differences with Western stock markets, particularly the dominant exchanges in the United States. For starters, China’s exchanges are much younger than those in the US. The Shanghai and Shenzhen Stock Exchanges were not established until 1990, while the NYSE has been in operation since the late 18th century. Despite their youth, China’s stock exchanges have grown at a much greater rate than those of the US, though they are considerably more challenging for foreign investors to access than American stock markets (just 5 percent of Chinese stocks are owned by non-Chinese investors). The investing community also lacks the level of confidence in Chinese stock markets that they have in America’s more stable, transparent exchanges. This difference in volatility is explained by the tendency of Chinese financial markets to be dominated by retail investors as opposed to the more reliable institutional investors that make up the bulk of buyers for U.S. stock exchanges. Chinese investment culture also differs sharply from that of the United States and many other countries; as opposed to choosing investments as a means for a comfortable retirement, Chinese investors see the stock market more as a game than a path to financial security -- adding to the volatility of the financial markets.
Major efforts have been made in order to connect and regulate China’s major stock exchanges. For instance, H-shares are shares of mainland Chinese companies that are listed on the HKEX. They played a major role in the growth of the exchange, especially considering that they are freely tradable by anyone, including foreign investors. These shares are denominated in Hong Kong dollars, though they are regulated by Chinese law. Of further interest is the Shanghai-Hong Kong Connect Program, which was launched in November of 2014. Connecting Hong Kong, Shenzhen, and Shanghai, this unique collaboration enables investors from China and foreign countries to trade securities in each other’s markets via the trading and clearing facilities of their home stock exchange. More than 2,000 eligible equities across the three exchanges are now covered by the program. Foreign investors now have the ability to purchase stock in Chinese companies, while Chinese investors have more opportunities to save money in shares and earn higher returns. Xi Jinping has also helped mastermind the new program; his government’s economic reform plan to aid indebted state-owned enterprises has been boosted with rising share prices that yield more cash from stocks. With many companies now listed in Hong Kong, where stock prices are often lower than on Shenzhen’s and Shanghai’s exchanges, mainland investors are now cashing in on the HKEX.
Our discussion following the presentation focused on (1) the future of China’s financial relationship and competition with the United States over the next ten years and (2) how the potential election of Joe Biden would affect Sino-American relations. While it was extremely difficult to pinpoint how these questions could be answered, we agreed that the former would hinge on China’s ability to reform its financial institutions and the subsequent response from American investors and policymakers. A Joe Biden presidency was agreed to be more aligned to supporting diplomacy, rekindling damaged relationships with America’s allies, and taking a more calculated approach to opposing China’s twenty-first century ambitions rather than Trump’s charismatic, loud style of diplomacy. With so many developments ahead for China and its adversaries, few, if any, of us will accurately predict what will happen as actors continue to battle for power in the international system.
