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Chinese Depositary Receipts: China Launches A Trillion-Dollar Industry

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The Chinese government has approved the creation of a trillion-dollar investment vehicle, Chinese depositary receipts, or CDRs. Through these vehicles, the Chinese are allowing mainland Chinese citizens to invest in Chinese companies that are not listed on the mainland Chinese stock exchanges.

The CDRs are modeled after American depositary receipts(ADRs), which allow American investors to invest in foreign companies without having accounts with overseas brokerages or exchanges. In 2016, the ADR market was valued at approximately US$2.9 trillion. Since the Chinese economy has been valued to be larger than the American economy, by some economic valuation methods, CDRs could reasonably be expected to be worth more than ADRs.

Advantages of CDRs

The Chinese government would like its companies to focus on more on China than overseas markets and investors. If the mainland Chinese are allowed to invest in their local companies via CDRs, then the companies will be forced to redirect their focus to the Chinese mainland, because they will be accountable to the Chinese investors who are pouring money into their coffers.

The influx of cash into Chinese companies will also create a stronger bond between the Chinese government and Chinese companies that are not listed in mainland Chinese stock exchanges. This enables the Chinese government to exert more direct and indirect control over the companies, and to enlist them in its effort to promote China and its policies.

In addition, the influx of cash reduces Chinese companies’ dependence on foreign investment and makes them less susceptible to foreign influence.

Finally, the ability to invest in local companies not listed on mainland Chinese exchanges allows the mainland Chinese to profit from the hard work, success, and competitiveness of their own companies.

Drawbacks of CDRs

CDRs are not perfect, nor have the kinks been worked out.

One big problem that will have to be dealt with is how will investors in CDRs be treated, compared to ADR investors and those who directly invest in the company by buying its stock.

Also, how will the Chinese government control and monitor the pricing of the CDRs so that there will not be any secondary markets selling them at inflated prices?

Another issue that firms must handle is how they can control the volatility in ADR prices when there are likely to be large amounts of trading on a daily basis by the CDR investors in mainland China.

Furthermore, how will the prices of the CDRs be determined relative to the prices of other investment vehicles used to attract capital to the mainland Chinese firms? The demand for CDRs will likely be so great that they may well have inflated prices on the secondary market. But people investing in mainland Chinese companies from outside who aren’t using CDRs are not likely to be willing to pay the inflated prices mainland Chinese will pay for a piece of a local company that they were previously denied access to.

What we know . . .

Mainland Chinese are hungry for the opportunity to invest in some local companies, and they are willing to pay handsomely for the privilege to do it. But while the companies will enjoy a windfall of capital, and the firms’ focus will be redirected towards mainland China, there is the issue of investor accountability. In addition, with China in the midst of a bear market, the launch of the CDRs has encountered a number of hurdles.

For example, Alibaba Holding Group, Weibo, Baidu, and Xiaomi were expected to issue CDRs in 2018 – none have done so.

Xiaomi had planned to issue US$5 million in CDRs in the summer of 2018. Currently, it has put the issuance of CDRs on hold – indefinitely. Its issuance of CDRs was frustrated by:

  • securities regulators discomfort with and disapproval of Xiaomi’s business model;
  • securities regulators level of discomfort with the risk to be taken on from CDRs;
  • the decline in the value of the yuan;
  • the decline in value of the Shanghai stock exchange; and
  • the trade war between China and the USA.

CDRS may not be at the forefront of China’s investment and market capitalization agenda, but they are still in the game.

China can create its own trillion-dollar investment industry. If it does, the entire world may want a piece of it.

 

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Disclosure: Alisa Hopkins does not own shares of any companies mentioned. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.