September saw a wave of Hong Kong-listed Chinese companies returning to the mainland stock market, helping the Shanghai Stock Exchange surpass Hong Kong to become the sixth largest stock exchange in the world.

From September 10 to 25, the China Securities Regulatory Commission, the securities watchdog, approved the initial public offering (IPO) applications of four large H-share companies, namely China Oilfield Services Ltd.; China Construction Bank Corp., the most profitable state-owned bank on the mainland; China Shenhua Energy Co. Ltd., the largest coal mining company; and PetroChina Co. Ltd., the most profitable company in Asia. This wave of IPOs indicates that the mainland securities market is large and broad enough to handle consecutive IPOs of large companies. The return of the red chips also helps wipe out the image of the mainland market as incapable and incompetent.

Paving the way

In early June this year, the Chinese Securities Regulatory Commission issued a trial regulation guiding IPOs launched by overseas listed Chinese companies, which ushered in the era of the return of red chips.

According to the regulation, the red chips reaching the following standards can apply for IPOs on the mainland: they must have been traded in Hong Kong for over a year; have a total market value of no less than HK$20 billion ($1=HK$7.7566); have an aggregate net profit of the last three financial years no less than HK$2 billion; have 50 percent of the profit or 50 percent of the operational assets coming from the mainland.

The concept of red chips can be traced back to the early 1990s in the Hong Kong stock market when investors referred to the stocks of Chinese companies registered overseas and listed in Hong Kong as "red chips." These can be divided into two categories: old red chips listed before 1997, including small companies such as Beijing Enterprise Holdings Ltd., Shanghai Industrial Development Co. Ltd., China Travel Service; and new red chips listed after 1997, chiefly large state-owned enterprises approved by the State Council, such as China National Offshore Oil Corp., China Mobile, and China Telecom. Of the 100 H shares on the Hong Kong main board, 50 (including PetroChina) have already returned to the mainland stock market.

With the return of red chips, the current mainland market value already outpaces that of Hong Kong. At the end of 2005, the total market value on the mainland was only 3.24 trillion yuan ($1=7.5143 yuan), about 40 percent that of Hong Kong. At the final bell of 2006, the mainland market grew to 8.94 trillion yuan, equal to 67 percent that of Hong Kong. However, the mainland figure had surged to 25.31 trillion yuan by the end of September this year, outpacing Hong Kong's HK$20 trillion.

Most of the H-share companies are large and well performing. Judging from the profitability, total profit achieved by the Hong Kong listed PetroChina and China Mobile in 2006 was equivalent to half of the total aggregate profit of the over 1,000 A-share market listed companies. The quality of the listed companies is crucial to the competitiveness and attractiveness of a capital market.

Individual investors are having mixed emotions about the large IPOs by the returning red chips. For instance, the Shenhua Energy IPO froze 2.6 trillion yuan on September 26, leading to a 1.6-percent plunge of the Shanghai Composite Index. Zhao Xiaoman, a Shanghai stock trader, lost one fifth of her assets on that day. But on October 9 when Shenghua shares were traded and the frozen capital was set free, Zhao quickly recovered her loss.

"It's good that the large companies are returning," said Zhao. "But the frequent freeze and unfreeze of capital in the market really disturbed me."

The benefit of the red chips return is obvious, according to Liu Hongru, Chairman of China Capital Market Research Society and former chairman of CSRC.

First of all, the prodigal red chips will attract more institutional funds to the stock market, which will help rectify the market order. One of the major tasks of the Chinese Government is to encourage more institutional investors to participate in the stock market. Currently, mutual funds account for 40 percent of the tradable market value. "But it is still not enough," Liu contended.

Investors can share the dividends from those profitable companies. For instance, China Mobile was known as one of the "most generous companies" in Hong Kong. Its shareholders got HK$1.54 per share from the company's 2006 profit. As a mainland company, most of the revenues of China Mobile have come from its mainland operation. If it can be successfully listed in the mainland stock market, mainland investors will be able to share the profits of their homegrown company.

The listing of red chips on the mainland will influence the mainland stock indexes and readjust the mainland constituent stock structure. But in the short term, the market will be challenged by the capital shortage if large companies come back one after another, coupled by the government's strengthening measures.

Double-edged liquidity

In spite of the condemnation of excessive liquidity and influx of international speculative money, experts believe the abundant liquidity on the mainland actually provided a rare opportunity for the return of the H shares. In order to return, they needed huge sums of capital for their debut in the stock market which in turn helped squeeze out the liquidity.

Meanwhile, the listed companies can raise more money from the mainland A-share market, because their shares on the mainland market are pricier than their shares in Hong Kong. "This is one of the most important reasons for their coming back," said Liu.

Maturing stock market supervision and a more rational manner of stock trading has also encouraged the red chips to come back home.

Actively promoted by the mainland authorities, most of the H-share companies like Ping An of China, China Life and China Unicom have returned to the mainland.

The IPO of Construction Bank of China raised 58 billion yuan. The respective 50-billion-share IPOs of PetroChina and Shenhua Power will tap into the great potential of mainland investors. According to PetroChina's IPO application, it will issue 4 billion shares. If the IPO price were set at its H share price of HK$14.28, PetroChina would raise about 55 billion yuan in the mainland.

Maturing markets

Since shareholding reform in the mainland was completed in May