Hang Seng, which provides the best-known index tracking the Hong Kong stock market, will adjust 10 of its indexes to include Chinese stocks that are listed or incorporated in unusual ways.
Its Hang Seng China Enterprises Index, set up to track mainland Chinese companies that are listed in Hong Kong, in March 2018 will start to include "red chips" and "P chips," taking on 10 companies at first in what surely must lead to full inclusion.
Those types of companies are part of the alphabet soup created as blocked-off mainland companies opened their doors to overseas capital. The upshot is that Chinese stocks have moved another step in the direction toward international acceptance.
The Hang Seng China Enterprises Index to date has been made up of H-shares, which are Chinese companies listed in Hong Kong. I'll explain what red and P chips are in a second!
But first, it's worth noting that another major index provider, MSCI, announced in June that it would start including companies listed within mainland China in its MSCI Emerging Markets Index. That shift therefore includes companies listed on the hard-to-access markets in Shanghai and Shenzhen, which have strict quotas and rules for how foreigners can invest.
Including A shares is a largely symbolic step because the largest Chinese companies are listed outside China, as "anyone who is anyone" went abroad to raise capital. But Chinese leaders see it as a validation of the mainland's markets and the progress they have made in moving toward global standards.
The Hang Seng's changes affect indexes and stocks in Hong Kong, not the mainland. But Hong Kong and its easy-to-access free markets and completely liquid currency always has been the first stop for Chinese companies looking to tap international investors.
No surprise that Chinese stocks are getting a greater look-in. They're not just emerging-market quirks of interest anymore. They've graduated to the big time.
Alibaba (BABA) (listed in New York) and Tencent (TCEHY) (with its primary listing in Hong Kong) now rank among the 10 largest companies in the world in terms of market capitalization. The world's biggest indexes, institutions and passive stock selectors must now factor them into the equation.
Throw in search engine provider Baidu (BIDU) , e-commerce platform JD.com (JD) , game and e-commerce provider NetEase (NTES) and the social media app giant Weibo (WB) and you've got a great little tech portfolio to rival that of the FANGs. Indeed, they've outperformed their U.S. rivals this year.
Weibo has more than doubled in 2017, up 124%, Its $19.9 billion market cap surged past Twitter (TWTR) , now at $11.9 billion, in February and hasn't looked back. Tencent, which with its $393 billion market cap runs a close second to $433 billion Alibaba as Asia's biggest company, is up 70.8% in 2017. Oh, and Alibaba is up just 92.8% this year.
Investors like that those companies typically make most of their money through subscriber fees, trade commissions and in-app purchases instead of relying on advertising. They all essentially are expanding into financial services of one sort or another, with e-wallets and Apple Pay-like systems, but also into disassociated sectors such as automatic navigation and cloud computing.
The Hang Seng Index is the benchmark tracking all the stocks in Hong Kong. The Hang Seng China Enterprises Index is the yardstick for Chinese stocks listed in Hong Kong, and therefore a good proxy for both internationally focused Chinese companies and the market environment within China, which provides some institutional access but is walled off to regular investors such as me.
Hang Seng simply is rationalizing the complex corporate structures that have sprung up to get around China's capital restrictions and fiercely controlled yuan. It makes eminent sense to include "red chips" and "P-chips" in its indexes focused on mainland stocks.
Red chips generally are classified as mainland-based companies that are incorporated overseas and listed in Hong Kong. Hang Seng also defines red chips as being state-owned enterprises, Chinese companies that are at least 30% owned by mainland entities, including national or local governments.
It defines P-chips as Hong Kong-listed companies that get more than 50% of their revenue, or profits, or assets (whichever seems most appropriate) from mainland China but are technically not based there or in Hong Kong. That definition covers companies such as Tencent, which is incorporated in the Cayman Islands but has its primary listing in Hong Kong and makes its money in China.
The exact 10 stocks will be nailed down next February.
Given the size of the companies to be added, the 10 new listings will mean the index will cover 55.8% of the market cap of all Chinese companies in Hong Kong, up from 26.1% now. The share of turnover covered for Chinese stocks in Hong Kong will climb to 55.2%, up from 37.6% at the moment.
The Hang Seng China Enterprises Index has been tracking the performance of Chinese companies on the Hong Kong stock exchange since 1994. It will add the newbie inclusions over the course of a year, following a frankly overly complex cap-adjusted, "inclusion factor" methodology. That change then will bring the number of Chinese stocks in the indexes to 50.
The original 40 members of the index are H-shares, which are Chinese companies that have their primary listing in Hong Kong. Many also now have mainland A-share listings in Shanghai or Shenzhen as well.
The new inclusions must have been listed for at least three years if they had an initial public offering, or six years if they arranged for a "backdoor listing" by buying a company that is already public -- a course of action that at times has been used to list some dubious Chinese companies internationally.
They also must have been profitable for the past three years, and have a volatility that's lower than three times that of the index itself.
After the jailing of three young pro-democracy activists late last week, I wrote that Hong Kong is witnessing the rapid erosion of its freedoms of speech, assembly and even thought. Voicing opposition to the mainland Communist government crosses a red line, according to Chinese President Xi Jinping, although "freedom of speech" to me means you're free to speak your mind. Even neo-Nazis get to do so in other parts of the world.
There's fierce resistance among some sections of Hong Kong society against the creeping "mainlandisation" of the city. That's partly a rift between Cantonese people and more "Han" Chinese; partly a social division between worldly, capitalist Hong Kongers and folks from closed-off Communist society; and partly a realization that there are just a lot more of "them" than "us."
The shape of Hong Kong, socially, is uncertain. The city is struggling to find how it fits in China, and some Hong Kongers don't think it fits at all. But by 2047, it will become A.N. Other Chinese city, at which point I'm sure it will be a financial hub, a focal point for high-end professional services and a significant but declining port. Whatever else, I'm not sure.
The integration of Hong Kong's financial markets is surer, and more welcome. The Shanghai and Shenzhen "stock connect" schemes allow Chinese investors to trade certain stocks in Hong Kong, and vice versa -- although China makes damn sure any money made off that Chinese capital gets repatriated.
Hong Kong always will be a significant window on China's world, even after 2047. Much like New York, I believe it will always be China's financial capital, too -- Shanghai will be another option, but the social and professional infrastructure is already in place in Hong Kong.
Hang Seng has taken a simple step that's part of the process of keeping the Hong Kong markets relevant and representative of what's going on in China. That's very good news indeed.