ABSTRACT
In order to get the benefits of the foreign capital while warding off the adverse impacts, many emerging capital markets have explicit barriers that hinder international portfolio investment. However, not much is known about whether these specific barriers play a significant role in eliminating or alleviating adverse international shocks on domestic stock capital markets associated with opening the markets. Our paper analyzes the effect of these regulations in China. The Chinese stock market is particularly well-suited for study because it maintains different kinds of listings for common stocks on both the underdeveloped mainland market and the mature market in Hong Kong and discriminates between foreign and Chinese investors. This, in turn, leads directly to the most striking feature of the Chinese stock market: its segmentation causes an internationally unique variety of Chinese share categories. The most important categories are ‘A’ and ‘B shares’, which are traded on the mainland’s two places Shanghai and Shenzhen, as well as ‘H shares’ which are traded in Hong Kong.1 A shares are dealt in Chinese Renminbi and are issued strictly to the Chinese citizens. B-shares, also known as Special Shares, are designated for foreign investors and are traded in US dollar (Shanghai) and Hong Kong dollar (Shenzhen). H shares are the Hong Kong equivalent to mainland’s B shares. This kind of legal investment restrictions set up by China is different from other emerging markets. Many emerging markets began open to foreign investment by creating a closed-end country fund listed on the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE). For example, until the 1980s the closed-end Mexico Fund was the only way US investors could invest in the Mexico market. The Korea Fund partially opened the Korean equity markets to foreign investors in 1984. The design of separate equity market has some similarities to that of Thailand and Philippine. However, there are notable distinctions at the same time.2 As foreign direct and portfolio investment poured into Thailand and foreign ownership limits of many Thai firms became binding in the mid-1980s, the Stock Exchange of Thailand (SET) inaugurated its Alien Board in September 1987. For companies which have reached their foreign ownership limit, Thais continue to trade shares on the Main Board while foreigners submit orders to the Alien Board. Main and Alien Board shares are identical in all other respects,
such as dividends, voting rights, and procedures for settlement and registration. Philippine companies could also issue A shares and B shares until 1994. But the segmentation between two classes of stock are only partial, where A shares may be traded only among Philippine nationals, and B shares may be traded to either Philippine nationals or foreign investors. Foreign investors are allowed to own only the foreign class of shares, but domestic investors can own both local and foreign shares. But the A share and B share markets in China were completely segmented in the early stage because the Chinese capital account is not liberalized and RMB cannot convert freely. Obviously, different shares of the Chinese common stocks have different degrees of link with international capital markets. Most international shocks are expected to be mainly absorbed in share H and B markets and their impact on share A markets will become diminished. However, with increasing integration between different categories’ markets, and between the Chinese stock market and international capital markets, mutual interaction between the Chinese stock market and overseas capital markets is expected to become stronger as time evolves. The possibility of financial contagion, such as one similar to the 1997-1998 Asian financial crisis, becomes larger. In this chapter, we will investigate the influence of international capital markets on the Chinese stock market. In particular, we will examine whether and how extreme downside market risk is transmitted between the Chinese stock market and overseas capital markets. Our detailed evidence on the effect of capital flow barriers and related market frictions has a number of policy implications concerning the design and operation of emerging capital markets and the evaluation of direct and portfolio investments in developing countries.
