Is Three a Crowd? Making Sense of Xi Jinping’s Pledge to Bring Stock Trading to Beijing

RESEARCH NOTE

After Xi Jinping’s surprising announcement on September 2nd that a third mainland stock exchange would open in Beijing, the joke among traders in China was that this was the only way for markets to comply with the country’s new three-child policy: China would have to give birth to another exchange. I think foreign investors will probably take a less humorous view and wonder whether this move—which comes after months of disruptive tinkering by China’s financial regulators—is yet another example of state interference in economics, this time an attempt to push the country’s financial capital a little closer to its political one.

It does seem easy to write this off as a political stunt, but I think there’s more to it, and it actually makes a great deal of sense when seen in light of China’s recent social agenda and its current macroeconomic situation. As an active participant in China’s stock market, I often advise foreign investors that one of the most important things to understanding the country’s policy is resisting the urge to frame things as communist vs. capitalist: backsliding from financial liberalization into an anti-markets abyss. Instead, I find it useful to begin by assuming policy-makers are rational, self-interested agents, and then ask why this?—or, put another way, what’s the problem this policy is trying to solve—and why now?

In this case, initially, the why this? seems pretty straightforward. A stock exchange gives companies a place to raise capital. For China’s fast-growing companies to continue growing, businesses need capital to invest. But China already has two stock exchanges, one in Shanghai and another in Shenzhen, so why does it need another one? According to Xi, the Beijing exchange will be specialized, focusing on small- and medium-sized enterprises (SMEs), which usually don’t meet listing requirements to float shares on the main boards of the two existing exchanges (which, for example, won’t list companies that have yet to turn a profit). But that raises another question: Shanghai already has the STAR Market and Shenzhen has the ChiNext board, both of which feature relaxed requirements for smaller, growthier companies. Isn’t that enough?

This is where it’s helpful to ask why now? There’s been much talk recently of China’s “Common Prosperity” plan, a social initiative to deal with the country’s staggering wealth inequality (my colleague, Jason Hsu, has written an excellent article on the aims and implications of the policy here). Of course, common prosperity entails improving the situation of all Chinese people—not just those with relatively cushy jobs and ample incomes in the country’s red-hot tech sector. In that sense, the STAR and ChiNext markets are doing little to capitalize companies that benefit the average worker, as both boards focus on listings in the technology sector. The new Beijing exchange will provide more opportunity to firms in traditional industries—like labor-intensive manufacturing, which still accounts for a large part of China’s employment and economic output—adding financial strength to China’s social agenda.

Now, it’s not as though the state didn’t support old-economy companies before. It’s just that historically, that backing has come indirectly, in the form of loans from (mostly) state-owned Chinese banks. Unfortunately, decades of debt have accumulated and recently become a macroeconomic problem, with the country’s debt-to-GDP ratio topping 270% this year and banks beginning to withhold loans from riskier borrowers. One solution to that is making better use of equity capital to underwrite growth for sectors in which loans are less available. Add to this the geopolitical challenges to raising offshore equity capital—including greater scrutiny of Chinese IPOs by the SEC and legislation requiring beefed up disclosure or delisting for Chinese shares in the US—and it’s easy to see why policy makers are trying to make it easier for capital-starved companies to float equity, and to do it at home.

There’s still the question of why Beijing? and I’m inclined to believe part of the answer is as simple as it seems: Putting a brand-new stock exchange smack dab at the seat of China’s power must be a financial feather in Xi Jinping’s cap—although, even this can be seen as a strategic move, with proximity to China’s political center of gravity offering regulators the greatest level of oversight when the exchange comes online. For me, as an active investor, so long as trading in Beijing mirrors the amateur-driven action in Shanghai and Shenzhen, where retail investors account for over 80% of volume, it will simply be one more place to hunt for alpha.

This article was first published to LinkedIn:
https://www.linkedin.com/pulse/three-crowd-making-sense-xi-jinpings-pledge-bring-stock-phillip-wool/

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