What Is China’s A-Share Market?
- The A-share market is China’s domestic market. Shares are denominated in renminbi and can only be purchased by mainland residents and a select group of qualified foreign institutional investors (QFIIs) under a quota system.
- A-shares are issued by companies incorporated in mainland China and are traded on the Shanghai and Shenzhen stock exchanges. The tradable market cap is about US$8 trillion. About 43% of investors are institutional and about 57% are retail, according to broker estimates.
- There are several other types of shares that provide investors exposure to the Chinese market, including H-shares, red chips and P-chips. All three of these share classes are traded on the Hong Kong Stock Exchange and are the primary components of China’s representation in the MSCI market indexes. The A-shares thus far have not been included in international MSCI market indexes.
What Happened in the A-Share Market?
- Before rebounding late last week, China’s A-share market, which started rising in mid-2014, fell 34% from its peak on June 12 to its recent bottom on July 8. Many smaller companies saw their share prices reduced by more than 50%, and trading in approximately half of all listed A-share companies was suspended in an effort to contain losses.
- Unlike the 2005–2007 market boom, this bull market began just as economic growth in China was slowing. Expectations of looser monetary policy, economic reforms and several government measures fueled the rally. By May, A-share valuations were in bubble territory, due in part to the impact of margin financing. The practice was legalized in 2010 and grew rapidly thereafter. By some estimates, margin lending at the peak was equivalent to 8%–10% of the market’s free float, which is a much higher ratio than the 2%–3% typically seen in developed markets.
- Although regulators slowly moved to restrict formal channels for obtaining margin lending, shadow banks stepped in and provided it through informal networks. The recent sharp decline appears to have been triggered by a regulatory attempt to crack down on informal leverage in mid-June. As equity prices fell, margin borrowers were forced to sell stocks. However, since many companies had halted trading, there was little opportunity for borrowers to liquidate and cover their losses. This left many lenders exposed, including banks that had loaned money to brokers for margin financing.
- In July, the government introduced a barrage of measures to reverse price declines and forestall panic selling. These measures included suspending initial public offerings, instructing brokers and fund management firms to stop selling, and guiding the futures market to reduce shorts. At first the measures failed to stem the market decline, weakening confidence in the government. But by the end of the first full week in July, the market had stabilized.
- The market decline dented the notion that the A-share market is a purely domestic market and that there would be no spillover effect to other markets. The MSCI China IMI index, which contains no A-shares, fell 21% in that same period. About half of that index is composed of H-shares, while red chips and P-chips each represent about a quarter of the index.
What Is Capital Group’s Exposure to the A-Share Market?
- Capital Group’s investment subsidiaries are qualified institutional investors in this market but have very limited investments in A-shares. New World Fund® is the only fund in the American Funds family to have investments in that market, at less than 1% of total fund assets as of June 30, 2015. Emerging Markets Growth Fund’s investments in this market were around 2% of fund assets as of June 30, 2015. While our investments in the A-share market are limited, several of our funds invest in China through other share classes, including H-shares. For example, as of June 30, 2015, New World Fund’s investments overall in stocks that we classify as China were approximately 8% of total assets. Similarly, Emerging Markets Growth Fund’s China investments were approximately 27% of total assets. Overall, we view China as an important and vital part of global financial markets.
How Might These Events Affect China’s Economy and Equity Markets?
- The A-share market remains in positive territory for the year to date through July 7. While there may be some volatility, our economists believe there will not be a big negative effect on corporate and household balance sheets. Less than 10% of all Chinese households own stocks, and less than a fifth of those investors trade with margin financing.
- In the view of our Asia economist, the threat of a severe financial crisis resulting from this market slide remains relatively low. The banking system’s exposure to the market is limited. Meanwhile, China’s government will attempt to bring about an orderly reversal of leveraged investments in the market and likely will roll back of some the less-market-friendly emergency measures.
- The country’s central bank, the People’s Bank of China, is likely to continue easing monetary policy as economic growth is expected to slow. While some in the market believe the renminbi will be depreciated in order to support growth, our economists believe that Beijing views this option as risky and will maintain the stability of the currency against the U.S. dollar.
- Our economists expect a slight pickup in growth in the third quarter. While industry continues to suffer from weak demand, the housing sector continues to see strong apartment purchases. There will likely be a lag before construction recovers, given the high level of housing inventories, but on balance the overall trend remains positive.
Differences Among China Share Classes
- A-shares: Companies incorporated in China and traded on the Shanghai and Shenzhen exchanges. Foreign ownership is restricted to qualified institutional investors.
- H-shares: Chinese companies incorporated in mainland China and traded in Hong Kong.
- Red chips: State-owned Chinese companies incorporated outside mainland China and traded mostly in Hong Kong.
- P-chips: Private Chinese companies incorporated outside mainland China and traded in Hong Kong.