Wish Upon a STAR: A Q&A About China’s New Stock Exchange

Global and International Perspectives by Nick Niziolek, CFA and Dennis Cogan, CFA

China’s new STAR Board has been in the headlines since debuting on July 15. In the Q&A below, we take a closer look at how the exchange fits into China’s longer-term strategy, and the implications for foreign investors and the Chinese economy.

Q. What is this market and why was it created?

A. The STAR Board is being called China’s version of the NASDAQ exchange. STAR stands for Shanghai Stock Exchange Science and Technology Innovation Board and is intended to be a subset of the Shanghai Exchange focusing on the most innovative companies (hence the NASDAQ comparisons). In addition to promoting innovative Chinese companies, this exchange is also an opportunity for China to experiment with several exchange mechanisms not currently available on other Chinese exchanges. These include wider price limits, allowance of loss-making companies to IPO, and unequal voting structures. Chinese President Xi Jinping personally advocated for the opening of this exchange, and his perceived support has likely contributed to the speculation in this market since its launch.

Q. How has the STAR Board been received?

A. The application process for listing began in March and the market reports to have already received more than 150 applications. Of those, there have been more than 25 IPOs, and several more companies are approved and ready to IPO shortly. While this will be many companies’ initial listing, some Hong Kong listed companies may choose to dual-list to raise additional capital within the local market. For example, one company already listed in Hong Kong chose to dual-list on the STAR Board and saw its stock appreciate by more than 100% during its IPO with the equity continuing to trade at a substantial premium on the STAR Board relative to the Hong Kong listing.

On the STAR Board’s first day of trading, the 25 listed companies raised $5.4 billion in new capital and saw their average share price increase by 140%. As we are a global investor with the ability to navigate multiple markets, the STAR Board may not appeal to us today given the valuations and premiums, but conditions may change in the future.

Q. Are there opportunities for foreign investors to invest in the STAR Board?

A. Currently, there is limited access for foreign investors via QFII license. We expect access will evolve in a similar manner to the Shanghai and Shenzhen exchanges. Domestic retail investors with an investment account greater than RMB500,000 ($71,000) and two years of trading history are allowed to participate. The Shanghai Stock Exchange has estimated this group to be less than three million retail investors.

The Exchange believes institutional involvement will promote the stability and growth of the STAR Board. IPO allocations are being favored toward institutional investors, with 57% of initial allocations going to Institutional investors and an additional 15% to strategic investors with a one-year lock-up. The next Stock Connect Northbound eligibility review would be December 2019, which is the earliest we’d expect these stocks to be included in the current A-Share Stock Connect program if they meet other eligibility criteria.

Q. What impact does the STAR Board have on the Calamos Global and International portfolios today?

A. The direct near-term impact is minimal, but like many reforms in China, the STAR Board provides insights into the priorities of China’s leadership and where future resources could be allocated. We believe the STAR Board launch aligns with many recently implemented financial reforms designed to deepen domestic capital markets, which should increase companies’ ability to raise capital while also increasing China’s overall attractiveness as a destination for capital. Given some of the limitations of China’s capital markets, several high-profile IPOs have chosen to list on Hong Kong and NASDAQ exchanges. China would prefer to have the next generation of innovative companies listed on local exchanges, increasing China’s attractiveness as a destination for capital and investment and allowing for more local participation.

Over the medium term, should the STAR Board become eligible through the A-Share Stock Connect program, it could increase the opportunity set of interesting and innovative growth businesses in China for investment consideration. We are also monitoring the impact this may have on Hong Kong’s importance as a capital center for China, which would impact companies currently benefitting from this relationship.

Longer term, the STAR Board shows that China continues to execute on a strategy of rebalancing from an export-oriented and investment-based economy to a consumption-and-services-based economy. This transition would continue to drive its current account from surplus to deficit, which will necessitate increased capital inflows to maintain balance of payments. In simpler terms, China will no longer be saving as much domestically, so it needs savings from the rest of the world to help fund the increase in consumption. This can come in the form of foreign direct investment or portfolio flows, which would require deeper capital market including equities. The latter is where STAR Board can play a part, though it’s a relatively small part and much more progress will be needed in other areas.