Regulation ad hominem on Xiaomi is a bad omen

The decision of China’s exchanges to bar mainland investors from dual-class stocks may not seem like much in the grand scheme of things, but it is the darkest moment for China's market reform path since the infamous summer of 2015.

  • By Paolo Danese
  • 17 Jul 2018
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The Shanghai and Shenzhen exchanges announced on July 14 that foreign stocks, stapled securities and — surprise surprise — dual-class shareholding stocks are ineligible for Mainland investors using Stock Connect's Southbound channel.

The Hong Kong Exchanges and Clearing (HKEX) made known its displeasure with the decision, albeit in the meekest of terms.

"[P]rior to the listing of the first company with weighted voting rights (WVR) in Hong Kong, HKEX tried to reach a consensus with the Mainland exchanges on the inclusion of WVR companies in the list of eligible securities for Stock Connect's Southbound trading," the exchange said in a statement. "HKEX considers that these companies should be included as soon as possible [...]."

The legality of the onshore exchanges' moves is not at dispute here, as they have the right to decide what securities are eligible under the scheme. That being said, even the HKEX had to acknowledge the situation was out of the ordinary.

"The mechanism allows exchanges on both sides to exclude certain index constituents from Stock Connect under special circumstances but this has not happened before,” the statement added.

Charles Li, CEO of the HKEX, tried to sound conciliatory in remarks made to the media.

"We admit there are some differences, which happen anytime commercial institutions decide to work together. This is no different between exchanges."

Wrong. No one cultivates the illusion that the onshore exchanges made their call on "commercial" terms. The decision — specifically with regards to Xiaomi Corp’s dual-class stock — was dictated by at least three factors, and none of them have anything to do with sound business decision-making.

First, the timing of the exchanges' announcement stinks, given the onshore stock market is down 28% since mid-January and the authorities are less than happy about it. What does Xiaomi, a Chinese smartphone and appliances maker that debuted on the Hong Kong exchange early last week, have to do with this?

Quite a lot. Xiaomi recently withdrew its application for an onshore listing of China Depositary Receipts (CDRs), which would have been the debut in the asset class. With that listing on the backburner, onshore investors keen to get their hands on a juicy new stock by a household name in China had only one place to go. With southbound quotas recently quadrupled to Rmb42bn ($6.27bn) per day, and the onshore market tanking, the authorities must have been worried about a rush for the exits, which could have hurt the A-shares market further.

Second, there seems to be a sour grapes element to the announcement. The disagreement between Xiaomi and the onshore authorities about its fair valuation, which appears to have been the main cause of the CDR application’s withdrawal, must have stung. So the exchanges’ move to pull the rug from under Xiaomi also seems to tell firms with similar aspirations: ‘If we can't have you, neither can Chinese investors’. This hurts not only companies and investors but also the market’s broader development.

Third, the whole situation brings back memories of the previous stock crash in China in the summer of 2015 and of regulators’ intervention to stabilise the market. One could argue they have not done any of that this time. But the step to bar onshore investors’ access to Xiaomi is arguably worse for a different reason.

The HKEX, Xiaomi and investors that put their hard earned cash into the IPO did so with a clear view that Mainland investors’ inflows would drive the stock's performance over the long run. But the decision by the Chinese exchanges to issue their statement over the weekend — after the weighted voting rights rules were approved, after Xiaomi announced its IPO, priced it and started trading in Hong Kong —  is essentially a massive blow to all the three parties.

Even worse, this probably marks the first time the onshore authorities have extended their terrible market-meddling habits across the border.

All this leads us back to an age-old question: what is the role of market regulating entities? The consensus seems to be that it should be about setting the rules and making sure there is a fair and level playing field for investors. The Chinese regulators and exchanges are clearly still not on board with that. 

Once again, they see their role as being directly linked with ensuring the equities market goes up. When it doesn’t, they step in to “fix it”.

How long before someone can finally explain to them that's not how global financial markets work? More importantly, by the time that is made clear, will foreign investors still be around to care? It’s worth a thought. 


  • By Paolo Danese
  • 17 Jul 2018

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