Issue: 2012: Vol. 11, No. 2, Articles

An International Equity Exchange for China? Considering the Options

Article Author(s)

Vijaya Subrahmanyam

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Vijaya Subrahmanyam, Ph.D., is professor of finance at the Stetson School of Business and Economics at Mercer University, Atlanta, GA. 
2012: Vol. 11, No. 2, Articles
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Chinese policymakers are considering reforms to open China’s equity markets to foreign capital. A proposed International Board would allow both foreign firms and China’s domestic private firms to list on the new Shanghai exchange. With China’s increasing role in the global economy, it appears logical for China to open its markets further to foreign capital. However, this proposal has yet to be implemented, indicating there are both potential benefits and possible hidden costs, at least to some of the players involved. This article analyzes the pros and cons of launching an International Board in China, both for China’s economy and for Chinese and foreign firms. The conclusion is that having an International Board is an essential step in the development of China’s financial markets.

China’s stock market development

China began to reform its economy in 1978 when Deng Xiaoping rose to power. Notwithstanding such reforms, firms continued to be largely owned and operated as state-owned enterprises (SOEs), and their lackluster performance implied the necessity of the discipline of a stock market. The government believed that adopting a Western market model, with its diversified ownership and strong regulations, would lead SOEs to become more efficient and competitive in the global marketplace. The Shanghai Stock Exchange was established in 1990. A large amount of investment in technology and infrastructure followed, to develop the exchange. However, while the investment in modern technology was intended to bring the Chinese equity markets up to par with the Western world, the resemblance was minimal at best. In part, this may be a result of trying to fit a U.S.-style stock market into a Chinese-type command-economy, wherein much of the equity market is run and owned by SOEs which, in turn, also regulate the markets. To correct these deficiencies, China has made efforts to be more financially inclusive, and China’s regulatory body, the China Securities Regulation Commission (CSRC), is playing a critical role in changing the composition of market participants.

Chinese firms typically are classified by ownership type as state-owned enterprises, domestic privately-owned enterprises or foreign-funded enterprises. SOEs are either wholly owned by the government or have majority shares belonging to the government (state-holding enterprises). Privately-owned firms by definition are not state-owned but are private limited liability corporations and private sole and partnership enterprises. Foreign-funded enterprises include firms that are registered as joint ventures, cooperatives, sole-proprietorships or LLCs that are funded with foreign funds, including funds from Hong Kong, Macao or Taiwan.1

The government increasingly has been making provisions to attract foreign firms and their investments. Given these efforts, the Chinese stock markets have grown substantially, in both wholesale and retail investment sectors. Financial markets in China offer different types of shares. The most prominent are A-shares and B-shares, which are issued by companies incorporated in mainland China. The main difference between A-shares and B-shares is who is allowed to trade them. A-shares, the largest class of shares in China, are renminbi (RMB) denominated shares, which can be traded only by Chinese nationals and foreign institutional investors classified and authorized as Qualified Foreign Institutional Investors (QFII). B-shares are denominated in foreign currency, USD or HKD. They were originally designed solely for foreign investors, but since March 2001, they also include domestic retail investors with access to foreign currency.2

In 2002, institutional investors made inroads into China’s markets. By 2011 they accounted for only two percent of the total stock market value, but their depth and impact on the Chinese markets was substantial, because of the composition of the participants in the program. Eighty percent of the 192 QFIIs approved since 2002 are long-term investors, including asset management companies, insurers and pension funds. Further, in April of 2012, the CSRC raised the investment ceiling for QFIIs to $80 billion from $30 billion, and in July China eased its investment controls on QFIIS allowing them to enter the interbank bond market. These moves will increase the importance of QFII investors in China. On the flip side, China also has begun to allow domestic institutional investors to invest abroad via the Qualified Domestic Investors (QDII) program, allowing them to diversify risk and reduce excess liquidity.

China’s equity markets also have witnessed innovations. For example, ChiNext in Shenzhen lists companies in high growth sectors, and there is now a futures stock exchange. Mini-QFII recently was introduced, which allows qualified Hong Kong subsidiaries of China’s securities and fund management companies to channel RMB deposits in Hong Kong into the mainland financial markets via investment products. With a high savings rate, and few investment options because of limited product offerings, when the government and regulators offer new financial products, the market in China responds quickly.

The Chinese markets have grown tremendously, and in June 2012, based on domestic equity market capitalization, both Shanghai and Shenzhen exchanges in mainland China were listed among the top 10 largest exchanges in the world with market capitalizations of 2,411 billion and 1,149 billion USD respectively.3 By the end of fiscal year 2012, the Shanghai exchange had 944 companies listed with A-shares and 54 with B-shares.

The latest development is the expected rollout of the Shanghai Stock Exchange’s International Board allowing foreign companies access to the Chinese markets and domestic investors to share in the returns achieved by international companies. While in theory this seems like a logical next step, market analysts in China have not been completely on board with the idea. Many argue that while the International Board may successfully put China on the global financial map, the ride may be very bumpy because of possible effects on the existing system. The recent global economic downturn has increased funding pressures in the A-shares market, and some market experts voice concerns about the proposed International Board creating pressure to sell existing shares to raise cash to buy stocks on the new exchange. Further, the financial crisis largely has halted the B-shares market, and analysts argue that the introduction of the International Board may result in redundancy with B-shares. Market experts also have pointed out potential problems in share price evaluation, erratic capital flow and supervisory issues that remain unresolved.

Before launching the International Board, China’s regulators need to spell out listing requirements, reporting regulations and disclosures. So far, information has gotten out through news reports. These indicate that the Board will require a company seeking a listing to have a market capitalization of more than 30 billion yuan ($5.5 billion) and a combined three-year net income of more than 3 billion yuan.4 In addition, proceeds of an initial public offering may only be used abroad.5 These are reasonable stipulations by international standards. However, there are concerns around financial disclosures including issues surrounding the use of Chinese accounting standards for non-Chinese companies trading in China, and the type of reconciliation approaches that may be required. Details, if any, are very nebulous on how Chinese regulators would enforce the International Financial Reporting Standards, or the role of auditing and disclosure requirements for non-Chinese firms who list on the International Board. Criteria for non-Chinese accounting firms to audit non-Chinese firms listing in mainland China need clarity, and so far there seems to be little documentation regarding this issue. Critics strongly urge postponing the launch of the Board until some or all the aforementioned issues have been addressed. Hence, while the Chinese government expressed the possibility launching the International Board to allow foreign firms and domestic private firms to list back in 2009, this has not yet materialized.

Benefits to Chinese firms

Research suggests that the fundamental reason for countries to have a stock market is to provide financing and liquidity for corporations.6 Because of the political environment within China that favors state-owned firms and investments, private firms in particular have an uphill battle finding financing for projects or expansion abroad. A large number of foreign firms and private domestic firms have expressed interest in the development of an equity market to be able to gain access to available liquidity. Additionally, since the 1980s, as part of the reform process, China has implemented a policy of zhengqi fenkai, which translates as “separating government functions from business operations.” In the process, China’s SOEs were increasingly privatized. However, this trend has exposed the weaknesses of many of these state-owned companies laden with legacy assets, including obsolete equipment and technology, and expensive social policies that include health care and worker pensions. The potential spillover effect of know-how from foreign firms that may list in the Chinese market is thus considered as a benefit to firms in China. Hence skepticism regarding the opening of the International Board may be only temporary.

While China disallowed non-state-owned companies from the stock markets if they listed elsewhere, it also increasingly made SOEs “public” by issuing shares while continuing to hold majority control. The IPO (initial public offering) process in China is largely mythical since it often is funded by loans from a state-controlled bank and not outside investors. For instance, the Agricultural Bank IPO in 2010 was largely funded by other SOEs. In addition, only a small number of Chinese companies that are not state-owned can trade in the Shanghai markets. The more practical issue is that this leaves no room for non-state companies to raise outside capital, and for listed firms to be correctly valued via trading. Opening the markets to foreign firms should help create liquidity, visibility, depth and better market pricing for firms. To truly reform the Chinese markets, however, the state must exit the equity markets.

As the line between state-owned and privately and/or publicly owned firms blurs, the challenges that confront them would not be dissimilar. Chinese multinationals have sought growth, requiring additional capital and visibility (branding) that the larger markets abroad more easily offer. Many of these multinational firms have listed abroad because the CSRC does not allow them to list on the Shanghai or Shenzhen exchanges once they incorporate outside of the PRC. As Chinese companies move from an export orientation to an outward FDI strategy, many companies find themselves ill-prepared to compete in the global markets. The lack of qualified manpower and adequate technology, and limited experience and knowledge of strategy and business processes, puts both private- and public-sector firms equally at a disadvantage in the global arena. Liquidity needs and expansion of products and markets are significant factors regardless of ownership type.

In order to gain ground in the global markets, these companies go abroad to seek talent, tap new markets, search for raw materials and acquire new technologies. China’s direct outward investment was only around $20 billion in 2006, but reached around $365 billion by 2011. In addition, while expanding geographically, concentrating largely on developing nations, resource-rich Australia and Canada, since the early 2000s investors have moved more toward Europe and North America.7 While expanding Chinese companies have had to learn to be apolitical and deal with regulatory policies with regards to governance, disclosures, financial reporting and intellectual property rights, thus forcing them to face a steep learning curve upon expansion.

Further, with capital controls still imposed by the State, large firms that list and trade abroad currently are unable to repatriate profits. If foreign firms are allowed to list in Shanghai, they will be able to more easily retain profits within China, which will create greater liquidity in the domestic markets. Thus, by trading both domestically and in foreign markets where they are listed, they could create more depth in the Shanghai market, and their fundamentals would more accurately reflect their true value. In addition, Cavoli, McIver and Nowland’s (2011) study of a sample of Asian markets suggests that higher trade openness, higher output growth and lower inflation may be associated with a greater proportion of foreign listings. They note that the extent of foreign listings on domestic stock exchanges (cross-listings) may serve as one measure of financial and economic integration among nations.

The Chinese investor would then have a potpourri of investment options, including both blue chips and red chips, thus integrating China into the global equity markets. If capital controls were relaxed concurrently with the launching of the International Board, Beijing could allow for cross-border transactions in yuan, thus letting its value be determined in the financial markets via trading. With increasing discussions in the country of making RMB an international currency, this would be an important step toward that goal.

More recently, some Chinese companies have been permitted to settle trade transactions in yuan via Hong Kong banks, and the yuan is being used more frequently in trade conducted between China and its trading partners. In a mere three years, the share of China’s international trade settled in yuan increased from zero to eight percent in 2011. Increasingly, yuan-denominated securities are available for investors, such as the “dim sum” bonds traded in Hong Kong. As China’s economic might continues to grow, the influence of its currency will inevitably increase with it. Consistent with this internationalization, and with plans to make Shanghai a global financial hub, the new Board will list shares by foreign companies denominated in yuan.8

Benefits to firms listing in China

Two reasons largely predominate with regard to why foreign firms list in China. One is to seek capital and the other is to diversify risk. With China’s high growth and savings rate, foreign firms can gain access to new sources of capital and expand their investor base to include those who previously had limited investment options. Reese and Weisbach (2002), Karolyi (2006), Hail and Luez (2009) and others have noted financial benefits for firms that cross-list including increased opportunities to raise capital, higher liquidity, greater visibility, and lowered costs of capital.

With growing consumer sophistication in China, there is a large untapped market for foreign firms to sell their goods and services. For well-positioned foreign firms, the opening of Chinese financial markets may create an investment boom, especially in this post-financial crisis period in the U.S. and Europe. Chinese buyers are likely to be a great market for diversifying products and services offered by these firms. In addition, if Chinese multinationals aim at growing via acquisitions of firms in the developed nations, foreign firms may be able to divest of assets/divisions more easily and it may be a win-win for both. In addition, firms in U.S. and Europe in post-crisis mode may welcome joint ventures and partnership alliances in China to diversify their risks as well as gain new revenues. As China is closely connected to the East Asian Tigers and Japan through fairly well-developed production networks (Prime, Subrahmanyam and Lin, 2012), access to those markets may be available via a listing in China, thus making it more attractive for the long run.

The scarcity of resources and human capital, caused by Chinese multinationals also vying for the same resources and workforce as the foreign multinationals, could be a hindrance. On the other hand, because employment opportunities are being limited in Europe and the U.S. for trained professionals in the post-crisis era, Chinese firms or foreign firms in China may offer employment opportunities, thus positively impacting global unemployment. Hence there are numerous positive outcomes that could result from establishing an International Board in China.

Many Chinese companies have been successful and today appear in the Fortune 500. However, restrictions are still imposed by Chinese regulations on domestic firms listing on the Shanghai exchange if they have listed abroad. As the Chinese government contemplates the introduction of the International Board, transparency of information, corporate governance, price discovery and economic development are all necessary for efficient functioning of a public stock market. These are areas in which the Chinese government needs to invest time and effort so China can compete internationally to attract domestic and foreign firms to list in China. This would also greatly benefit Chinese firms, as they would learn to respond to policy structures and changes domestically before expanding globally.

While it is not clear as to when the Chinese government will launch the International Board, for China to be a major player in the global markets, this is a necessary step. China’s financial markets have witnessed a major transformation in the past couple of decades, but the global financial crisis of 2008 seems to have dampened that process somewhat. Recent media reports indicate, however, that the government in China is focusing on the technical details with regard to listing, leadership of the Board, and related policies, and may have more definite plans concerning the opening of the Board possibly in the coming year. Reports indicate that more than 300 international companies have contacted the CSRC expressing interest in listing with the Board.9 For the country’s growth and development to continue, the Chinese government should launch the International Board allowing foreign firms and all private domestic firms to list in the Shanghai markets. The focus going forward should be on creating and sustaining an efficient, diversified, liquid and stable financial market.


Cavoli, T, R, McIver and J. Nowland, “Cross-listings and Financial Integration in Asia,” ASEAN Economic Bulletin, Vol 28 (2), 2011, pp 241-56.
Hail, L. and C. Leuz, “Cost of capital effects and changes in growth expectations around U.S. cross-listings.” Journal of Financial Economics, 93, 2009, pp 428-54.
Karolyi, G.A., “The world of cross-listings and cross-listings of the world: challenging conventional wisdom,” Review of Finance, 10, 2006, pp 99-152.
Prime, P. B., V. Subrahmanyam and C.M. Lin, “Competitiveness in India and China: the FDI Puzzle,” Asia Pacific Business Review, Vol 18, No. 3, July 2012, pp. 303-333.
Reese, W. and M. Weisbach, “Protection of minority shareholder interests, cross-listings in the United States and subsequent equity offerings,” Journal of Financial Economics, 66, 2002, pp. 65-104.

  1. Details of ownership types are provided in, “An Analysis of State‐owned Enterprises and State Capitalism in China,” by Andrew Szamosszegi and Cole Kyle (page 8, Table III-1); Prepared by Capital Trade Corporation for the U.S.-China Economic and Security Review Commission, October 26, 2011
  2. In addition, there are H-shares that can be traded by companies incorporated in the PRC and are traded in HK and denominated in HKD; N-shares that are denominated in USD and include companies incorporated in the PRC and listed and traded on the NYSE; L-shares include companies incorporated in the PRC and listed and traded on the LSE; Red chips are Chinese companies incorporated outside PRC and listed in HK, and are often state-owned or state-controlled companies; and S-shares are like H-shares but are traded in Singapore.
  3. World Federation of Exchanges 2012
  4. Compared to NYSE and NASDAQ, these requirements appear reasonable. See details in,
  6. Mitchell, Lawrence E., Who Needs the Stock Market? Part I: The Empirical Evidence (October 30, 2008). Available at SSRN: or;
  7. Daniel H. Rosen and Thilo Hanemann, “The Rise in Chinese Overseas Investment and What It Means for American Businesses,” China Business Review, July-September 2012.