MARKET VIEWS

Growing pipeline for secondary listings in Hong Kong expands Chinese equity universe

Growing pipeline for secondary listings in Hong Kong expands Chinese equity universe

More and more Chinese tech giants listed in the US are returning home to Asia as they take up secondary listings in Hong Kong. 

To be eligible for a secondary listing in Hong Kong, the issuer must be listed for at least two financial years on a qualified exchange, and must have either market cap above HK$40bn at the time of listing, or market cap between HK$10bn and HK$40bn and revenues in the latest financial year of no less than HK$1bn. According to an estimate by Goldman Sachs as of early June, there are 39 qualified American depositary receipts, or ADRs, (stocks that trade on U.S. exchanges but represent shares in a foreign corporation)1. This number excludes those that have completed secondary listings. 

Internet leaders on the way
These 39 companies that qualify for a secondary listing in Hong Kong are mostly industry leaders from a diverse range of sectors such as e-commerce, social media and livestreaming. We believe they represent great investment opportunities. Digitalization has penetrated every facet of daily life in China. There are more than 800 million internet users spending 4 to 6 hours per day on the internet2. COVID-19 has reinforced this digital trend and many internet companies reported stronger-than-expected results in Q1 2020 as they strived to provide creative solutions to meet customers’ demand.

Mitigate de-listing risk amid uncertainty over US-China relations
In May, the US Senate unanimously passed the Holding Foreign Companies Accountable Act, tightening listing requirements and raising the risk of de-listing of Chinese companies that are currently traded on US exchanges. We believe this risk can be mitigated by faster secondary listing in Hong Kong.

There is a good pipeline of companies planning for such a move in Hong Kong. Besides those that have completed secondary listings, a few other major Chinese companies listed overseas have also expressed interest3. Under the current arrangement, Hong Kong-listed shares and ADRs are fully fungible, which means that valuations on the two exchanges should be the same, giving investors the option to convert their ADR holdings to Hong Kong-listed shares.

A diversified and higher growth investment universe 
With more ADRs seeking secondary listings in Hong Kong, we expect the Hong Kong market to provide investors a diversified and higher growth investment universe going forward. Financials has been a dominant segment in the Hong Kong market, while most ADRs are in the communication services and consumer discretionary sectors. These sectors offer much stronger earnings growth than financials as they are benefiting from many structural growth drivers underpinning China’s economic rebalancing. We believe their potential listing in Hong Kong will lead to a positive change in growth characteristics of the Hong Kong market thanks to a higher representation of these companies.

Besides listing in Hong Kong, ADRs can also consider listing on China’s domestic exchanges thanks to accelerated financial reforms on the mainland. The STAR (Science-Technology Innovation) board in Shanghai, launched in 2019, allows companies with weighted voting rights (WVR) structure and variable interest entity (VIE) structure to be listed via depositary receipts. Meanwhile, ChiNext will start to pilot a registration-based IPO system this year.

Potential Southbound inclusion could drive valuation re-rating
At present, mainland investors can invest in companies with primary listing in Hong Kong on the cross-border investment channel Stock Connect. For companies to be eligible, they must meet southbound eligibility requirements – trading volume of the security in Hong Kong should exceed 55% of the global trading volume. 

We believe that given the growing importance of dual-listed ADRs in Hong Kong, regulators will consider adding companies with secondary listings into the Southbound universe. Once eligible, these companies will be available for mainland investors who will finally have the chance to trade the shares of the country’s most competitive companies. Southbound has grown into an important source of liquidity to Hong Kong market since its inception. We believe it will help drive further re-rating of these companies thanks to healthy demand from mainland investors for high-quality internet companies.

China all-share approach to capture the best opportunities
We believe the best way to position into Chinese equities is to follow an all-share approach. It is about selecting the best opportunities irrespective of listing locations. Chinese offshore equity markets provide a large selection of opportunities with strong growth potentials in our view, such as the technology companies. We believe there are also opportunities in China A-share markets, for example, consumer staples and healthcare.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

^1 Source: Goldman Sachs Investment Research. As of June 1, 2020.
^2 Source: McKinsey Global Institute, Statista. As of September 2019.
^3 Source: Bloomberg. As of June 2020.