The current issues of China’s Stock Market Trend Analysis Weekly (股市动态分析周刊 Gushi dongtai fenxi zhoukan) contains a livid criticism of Newbridge Capital, the controlling shareholder of Shenzhen Development Bank. The author is outraged that Shenzhen Development Bank proposes making all its shares tradeable (that it become a G-share
listed company) without paying “compensation” to current holders of tradeable shares.
A heavy nationalistic strain is involved in the outrage. The idea that American investors think they should be exempt from Chinese “law and policy” when operating in China infuriates the writer, apparently touching sensitive nerves about extra-territoriality from the colonial era.
Sure, in China investors play by Chinese rules. But I think in principle Newbridge is right to refuse to give some of its shares in the bank to other shareholders of the bank without compensation.
Xinhua reports in English on the SDB proposal here. According to the article SDB will pay holders of listed shares some cash if the bank’s share price actually drops significantly following the reform, or they pay-out will happen if the stock dramatically appreciates, but they will get nothing if the price stays within its current trading range. Shareholders will vote on the proposal by July 17 (one imagines the proposal will not pass). Here’s some additional background:
In China the government, in one guise or another, typically owns two-thirds of a listed firm; public shareholders hold the the other third.
Importantly, until an equity re-classification program began last year, all the governments shares (the controlling 2/3) were classified as illiquid (fei liutong gu). They could only be transferred in one-off, negotiated transactions (subject to requisite approvals), not sold on the exchanges like shares issued in IPOs and secondary offerings.
Last year, after a few disastrous prior attempts, China began reforming its share classification system. Although each company is free to come up with its own scheme, the normal deal is that holders of liquid (listed) shares get three “gift” shares for every ten shares they own—in exchange for agreeing that the government’s illiquid shares can become tradeable.
Companies representing about 80% of the market share of the Shanghai and Shenzhen stock exchanges have gotten through or at least begun this process. The rest are supposed to get through the process by the end of this year (once Sinopec joins the list, that alone should push the number above 90%).
Shenzhen Development Bank, as one of China’s domestically-listed firms, also needs to have its shareholding system re(de-)classified, to be converted to a G-share company (ticker symbols for companies that have been through the reform process are designated as G-share companies for gai, a Chinese word for change).
But Shenzhen Development Bank is a special case among China’s 1,300+ listed companies.
It is one of the few PRC listed companies to have substantial foreign investment.
It is the only PRC bank with a controlling foreign shareholder.
It is also unusual among PRC listcos in having a large public float—about 70% of its shares are already listed. This means a couple of things. First, it means the typical 3 for 10 deal would be a massive private to private wealth transfer. It would take shares from Newbridge and give them to current holders of SDB’s listed shares. Whatever one thinks about the PRC share reform scheme, this is simply a fact in this case. Second, SDB’s widely dispersed capital structure means that even under the normal PRC share reform logic SDB’s shareholders need less “compensation” because there is much less of an overhang of non-tradeable shares to flood the market and drive down the price of already-listed shares.
Newbridge acquired a controlling stake in Shenzhen Development Bank in 2004, before the shareholding reform program was announced.
Newbridge in its due diligence should have identified the possibility of shareholding reform as a potential issue (and I imagine they did). But there was no way they could have at the time of the acquisition known for sure if or when or in what manner the shareholding reform process would proceed. Further, it is not clear they would have had reason to expect that an eventual reform would amount to a government “taking” without compensation. (Actually, it’s more of a government-ordered giving, since the government is not directly taking for it’s own use—it’s more like the New London case in the U.S. than a typical government taking, minus of course the compensation).
Many people in China are glad that the shareholding reform process is moving forward. Removing the “share overhang” should be good for China’s stock markets in the long run.
But, in general, I have never understood what legally justifies the idea that the PRC government as a controlling shareholder has a duty to compensate holders of liquid shares—people who bought shares that could go up or down and who were to my knowledge given no assurances that the unlisted shares would stay that way.
More pointedly, in its (still formally) socialist system the PRC government holds state assets on behalf of the whole population, so in giving extra shares to current holders of tradeable shares, the government is transferring property from all the Chinese people to some portion of the Chinese people—people (or institutional investors) who bought shares (I note again without any assurances that they wouldn’t lose money or that the shares they weren’t buying wouldn’t become buyable). It may be good for the markets in the long run, but in principle it looks to me like asset stripping.
As for Newbridge in particular, why should they give their shares (their property) to the bank’s other shareholders without compensation?
They should be subject to Chinese law, but the Chinese Constitution ostensibly protects private property.
If the PRC government wants to buy off holders of tradeable shares, it shouldn’t do it with Newbridge’s money.
. . . If Newbridge finds itself squared off against its shareholders over this issue (making the “takings” arguments I outline above to a PRC judge), it won’t be the first hurdle they’ve faced since buying 18% of the bank. The deal fell apart rather publicly before it went through, and the first man they chose as CEO after the take-over lasted only 18 months.
Still, SDB is trading up now (quite a bit since Newbridge bought in), and if they do manage to make their shares tradeable they could reap some handsome profits, perhaps even without selling their controlling stake to another investor.
