China Investing Regulations and Share Classes

By pjain      Published July 12, 2021, 10:55 p.m. in blog Invest   

Regulation of Share Ownership

China investors need to consider:Chinese share classes.

Foreign investment in China is still restricted as U.S. investors cannot simply open a brokerage account and trade locally listed Chinese shares.

There are multiple shares classes of Chinese companies floating around on various exchanges, allowing investors different ways to access this complex market.

Most ETFs Banned from "Strategic" Companies - including FXI

Some of the most popular China ETFs are not eligible to hold all investable shares.

Due to this restriction for "TRUE" China Shares, most ETFs currently access the Chinese market through shares of Chinese companies listed in Hong Kong, the U.S. or a special "B" share class traded in Shanghai or Shenzhen. These "investable" shares consist of H-shares, red chips, P-chips, B-shares and N-shares.

--- MOST China Indexes Work Around Regulations - not "True" China Shares

The key to knowing which share class a fund is eligible to hold lies in knowing which index the fund tracks. FTSE, a leading index provider in the space, to date has considered P-chips to be Hong Kong companies, and has listed them in developed market Hong Kong indexes instead of their China index series.

Indexes, ETFs and Share Class Holdings

FTSE indexes - FXI uses VIEs, N/P Classes to get LCap Coverage

ETFs that track FTSE's China indexes, such as FXI, are only eligible to hold H-shares and red chips, which limit their scope, as the indexers' classification methodology determines where that company sits in their global breakdown.

June 18, 2012, FTSE Reclassify P-chips from Hong Kong to China in their FTSE Global Equity Series, effective March 2013. Then on Sept. 26, 2012, it extended that reclassification announcement to its FTSE China 25 Index. This means that P-chips, such as Tencent, should be eligible for inclusion into FXI once this reclassification takes effect in March 2013.

  1. FXI only H/Red Classes. For example, the $6.1 billion FXI, iShares FTSE China 25 Index Fund which holds 25 of the largest and most liquid Hong Kong-listed Chinese shares, is only eligible to hold H-shares and red chips. So, China's largest Internet company, Tencent Holdings, is excluded because it's classified as a P-chip, even though Tencent has a market capitalization of $64 billion, which would put it within the 25 largest H.K.-listed Chinese companies.

  2. FCHI only H/Red Classes. The iShares FTSE (HK Listed) Index Fund, a "total market" version of FXI with over 120 holdings, is in a similar boat. So again, it misses out on important P-chip names like Tencent Holdings, Belle International, Want Want China, Gome Electronics and Geely Automobile.

Broad A-Class ETFs

Skipping some or all P- and N-share Classes - MCHI

ETFs like the MCHI iShares MSCI China Index Fund, provide exposure to mega-cap P-chips like Tencent Holdings, but exclude many significant N-share technology names like Baidu, Sina and NetEase. This example also shows that significant sector biases result from the share-class issue.

MSCI Indexes - Faked as who can hold A shares?

MSCI's scope is wider than FTSE because its charter lets indexes are eligible to hold P-chips. Still, MSCI does not include N-shares in its indexes. According to MSCI's methodology, a security's country classification is determined by the location of its incorporation and primary listing.

QFIIs - BlackRock is not eligible!

Except for a select few qualified foreign institutional investors (QFIIs)-and via some unusual products -most investors cannot readily buy A-shares.

--- China Share Classes Overview - Restrict who can Buy What!

There are multiple shares classes of Chinese companies floating around on various exchanges, allowing investors different ways to access this complex market. THIS APPLIES TO FUNDS AS WELL!

Depending on the underlying index that an ETF tracks, some funds are eligible to hold only a certain type of shares. This matters because the different share classes an ETF is eligible, or ineligible, to hold can significantly impact the fund's performance, and ultimately determine the type of Chinese companies in the portfolio.

A-shares for Locals

Local investors in China buy what are known as "A-shares" for companies traded on the domestic Shanghai and Shenzhen stock markets, quoted in renminbi.

Except for a select few qualified foreign institutional investors (QFIIs)-and via some unusual products -most investors cannot readily buy A-shares.

A-shares: Chinese companies incorporated on the mainland and traded in Shanghai or Shenzhen, quoted in RMB.

B-shares

Chinese companies incorporated on the mainland and traded in Shanghai and quoted in USD or traded in Shenzhen and quoted in HKD (open to foreign ownership).

H-shares

Chinese companies incorporated on the mainland and traded in Hong Kong.

Red chips

State-owned Chinese companies incorporated outside the mainland (mostly in Hong Kong) and traded in Hong Kong.

China's Complex P, N-Shares, VIEs

P-chips

Nonstate-owned Chinese companies incorporated outside the mainland, most often in certain foreign jurisdictions (Cayman Islands, Bermuda, etc.) and traded in Hong Kong.

N-shares

Chinese companies incorporated outside the mainland, most often in certain foreign jurisdictions, and U.S.-listed on the NYSE or Nasdaq (ADRs of H-shares and red chips are also sometimes referred to as N-shares).

Many N-shares are incorporated in tax havens like the Cayman Islands or Bermuda, and have their primary listings in the U.S. (N-shares and the regulatory and legal risks associated with them are discussed in detail below).

VIEs - Avoid Traps of NOT Owning complex Truestsa

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