Chinese equities rank as one of the world’s great investment opportunities but can also be one of the biggest short-term risks. This year offered plenty of evidence of both the huge risks and rewards.
The year began with a global sell-off triggered by panic on the Shanghai and Shenzhen exchanges after the People’s Bank of China spooked markets with a sharp depreciation of the renminbi. China’s stock markets later settled down, but a dollar surge in the wake of Donald Trump’s victory in the US presidential election rattled the government in Beijing into imposing “strict controls” on outbound investment in late November in a bid to stem capital flight.“I view this as a cleaning up, and them getting more realistic about outward flows. There’s been a bit of a land grab, and they are pulling that back a bit,” Jonathan Slone, CEO and chairman of CLSA told Asiamoney.
“China’s got a very large capital account and they obviously want to control the unwind. Having a fairly young financial system they are doing the same as every other country. They experiment, confirm some things and pull back on others.”
Opportunity shone again on December 5 with the opening of the Shenzhen equity pipeline, completing the linkage of the two Mainland bourses with the Hong Kong market through Stock Connect. International investors now have access to 881 Chinese A-shares listed in Shenzhen and 568 in Shanghai, while Mainlanders can buy 417 stock listed in Hong Kong. Essentially, a huge single China equity market is being created.
HSBC’s strategy is to tap pent-up demand among global investors for the Chinese A-share universe by setting up a Mainland securities joint venture in Qianhai, just over the border from Hong Kong, in which HSBC would hold 51% of the equity and thus wield control. The JV is still subject to regulatory approval.
“Where we would begin to have an advantage would be in our ability to provide HSBC quality research and execution from an onshore entity,” Rakesh Patel, HSBC’s head of equities, Asia Pacific, said in an interview with Asiamoney.
In this year’s Asiamoney Brokers Poll, HSBC came top in overall regional research (Asia ex-Australia &Japan), rising from third place last year. The bank also displaced UBS from the top spot in overall combined regional research & sales (Asia ex-Australia, ex-China A&B, ex-Japan).
William Bratton, HSBC’s head of equity research Asia Pacific, ascribes this in part due to the bank’s heavy investment in Hong Kong-China research.
“Hong Kong-China is our main research project. It is the product that we do best with clients. It is a product in which we invest relatively aggressively.”
The reward from this investment is apparent already in HSBC’s impressive clutch of analyst awards in this year’s Brokers Poll: nine altogether.
Building up A-share research, which HSBC plans to house in the Qianhai JV, is to meet expected foreign demand. When, as expected, Chinese A-shares are included in the MSCI Index, “there will need to be significant institutional buying over the five to 10 years,” to reach the required weighting, Bratton told Asiamoney.
HSBC clients “have all spoken about the need for quality research of international standards which we abide by. They also want strategic partners to help them understand these Chinese A-shares and which ones to invest into,” Bratton explained. “If we deliver and do well, we will be able to help these clients, and partner with them, when they decide their China investments.”
Patel says the research build-out has also helped to strengthen HSBC’s position in ECM.
“We are a very large commercial bank, but up until a few years ago, we were not leveraging those commercial banking relationships into equity capital markets. That’s the history.
“The reality today is that by using the relationships that we have had for many, many years with corporates, and clearly the balance sheet that we have as well, and retooling a little around investment banking, we are now a very credible ECM house, especially in Hong Kong,” Patel pointed out.
“We have been very strong in DCM for a very, very long time, and we have really just taken the construct from DCM and applied a similar kind of model to ECM.”
For the 12 months to December 1 this year, HSBC ranked sixth in Dealogic’s ECM bookrunner ranking for Hong Kong issuers. The bank was not among the top 10 ECM Hong Kong bookrunners for the same 12 months of 2014-15 but was top in 2013-14, sixth in 2012-13, and top in 2011-2012.
HSBC was top DCM bookrunner for Hong Kong issuers throughout this period.
CLSA is a completely different kind of institution to HSBC, and finds itself in a contrary situation vis-à-vis mainland China.
Acquired by China’s state-owned goliath Citic Securities in 2013, CLSA has always been renowned for its excellence as a research house that treasures the independence and forthright opinions of its analysts.
In November, Citic said all of its international businesses would be merged with CLSA and bear the CLSA name. Tang Zhenyi, a Citic veteran, is to become chairman of CLSA while Slone will remain as CEO.
Slone told Asiamoney this was more than a tidying-up exercise. “Just putting our balance sheets together means we have a much larger balance sheet to work from. It means we can move into more businesses. It means that strategically we are aligned rather going in separate directions. It is quite significant.”
True to form, CLSA retained its top position in the 2016 Brokers Poll for overall regional research (Asia ex-Australia & Japan) as voted by active traders.
Perhaps more surprising is that CLSA vaulted three places to come top in overall regional sales, and for both categories of voters.
“Anybody who understands the reforms that are taking place in the market, and changes in the regulatory structure, understands that aside from having top-level research, you have to have great sales and trading capabilities,” Slone offered by way of explanation. “I think we take a lot of pride in the value-added that we bring to execution, sales and research.”
Clearly, however, the Shanghai-Hong Kong Stock Connect that opened two years ago must have greatly benefited CLSA, as most of the flow of equity orders was ‘southbound’ through the pipeline, from Mainland buyers of Hong Kong shares.
What of ‘northbound’ offshore investment in Chinese A-shares? While Citic can easily manage execution in Shenzhen and Shanghai, CLSA research coverage of ‘A’ shares is a work in progress. At the moment, CLSA covers only one A-share company, although it plans to ramp-up A-shares coverage to over 60 companies in the next few months.
Citic Securities covers 1,200 A-shares but the quality of their research remains largely untested by demanding global investors, many of whom have understandable concerns about general standards of governance, accounting and disclosure at listed Mainland companies.
Fulfilling the requirements of institutional investors has become even more important as a result of the global trend toward ‘unbundling’ of research payments from execution.
Most HSBC clients are unbundled already, and the bank is very used to dealing with them, according to Patel. “We’ve always really had that model within the business. Effectively what it means is that as a bank, when we face clients, the onus is on us to provide excellence in both execution and advisory.”Bratton conceded there is “certainly a lot of ongoing pressure on the advisory business model, our cost structures and what we provide to clients, but what is also happening is a lot of banks are refocusing on their core domestic markets. Our core domestic market to a greater or lesser extent is Asia, and our commitment to doing well in Asia is high.”
Both CLSA and HSBC expressed pleasure at their standings in the Brokers Poll.
“Markets have been quite challenging for most banks and brokerages. What we have done at HSBC is to continue to provide excellence in both research/advisory and sales, and to grab wallet share from the client base away from other banks. That is reflected obviously in the Asiamoney Brokers Poll where for the first time we come in at number one,” said Patel.
“We have all worked incredibly hard for the Brokers Poll result we have achieved, and that is a great combined effort between research and sales throughout the whole year.”
Slone paid tribute to the analysts who have made CLSA’s reputation, such as Christopher Wood, who this year was voted once again Best Strategist.
“We hire people who are opinionated, thoughtful, and we give them free rein to say what they want to say, to opine how they want opine. We are an organisation that is very driven by the marketplace and also very interested in what drives the markets, and we let people freely have their ideas. We don’t try to herd people into one world view,” said Slone.