China Depositary Receipts: a win for Hong Kong

China’s regulators took the lid off their hotly-anticipated guidelines on CDR at the end of March, in an attempt to encourage share sales by “innovative” enterprises on the mainland.

The trial programme will allow overseas-listed names, like Alibaba Group Holding, as well as unlisted firms, to trade in China’s A-share market. But with Hong Kong recently putting the finishing touches to a plan with largely the same aims, some observers have characterised the mainland’s move as a blow to the Special Administrative Region’s ambitions.

There is merit to this argument. China’s CDR efforts come after Hong Kong finally approved IPOs with dual-class shares, after years of hand-wringing about the loss of Alibaba to US exchanges.

ECM bankers and issuers had cheered Hong Kong’s decision to drop its sacred cow — the “one share one vote” policy — and embrace the dawn of a new age of IPOs from entrepreneur-driven, internet-enabled companies. China’s push for CDR will ruin the party, say the pessimists.

But such a view is extremely narrow. The China Securities Regulatory Commission’s (CSRC) efforts clearly show it is not intent on stealing business from Hong Kong.

The guidelines maintain that the CSRC will tread cautiously on the size and pace of CDR listings, while setting a high bar for issuers. The criteria include a market capitalisation of at least Rmb200bn ($32bn) for firms seeking a secondary listing, and a valuation of Rmb20bn and operating revenue of Rmb3bn for private firms.

The parameters are so strict that only five large offshore-listed companies meet the requirements, according to research from Morgan Stanley. The five are Alibaba, Baidu, JD.Com, NetEase and Tencent Holdings.

It is true that big Chinese technology names like Xiaomi and Lufax are seriously considering whether selling equity at home would be preferable to listing in Hong Kong. Alibaba, for its part, has already mandated Citic Securities to look into how it can complete a CDR listing before the summer, according to sources close to the deal.

Yet CDRs do not dim Hong Kong’s appeal as an international fundraising destination. The biggest banks are looking at an IPO pipeline that is bursting at the seams with dozens of companies hoping to raise funds, with no sign of a slowdown. Goldman Sachs analysts see up to $5tr of potential China new-economy listings, while China’s Ministry of Science and Technology estimates there were 131 Chinese unicorns as of 2016.

Moreover, any company that is serious about having global recognition or obtaining a diverse shareholder register with strong international and institutional investors will still put Hong Kong at the top of its list of IPO destinations. The mostly domestic A-share market is not a contender in this regard.

Hong Kong, more importantly, is in pole position to attract China’s new economy floats with its inclusion of weighted voting rights and lossmaking issuers in the new listing regime. As attractive as CDRs are, not everyone will qualify and the guidelines do not tackle the issue of dual-class shareholding structures. That leaves the window wide open for smaller firms that are not able to list on the Mainland.

Also, there is nothing preventing companies from seeking a listing in the US, Hong Kong as well as China if they so choose, given that all three markets tap into different pockets of liquidity. The existence of CDR merely presents another option to issuers.

Hong Kong ultimately stands to benefit from China’s technology success stories moving closer to home. The IPO fervour is only just beginning.