China’s lifeline for ailing stocks

The China Securities Regulatory Commission (CSRC) has extended a helping hand to listed companies seeking to protect stock valuations and shareholder rights in the face of rocky appetite towards the Chinese economy.

The regulator revised its rules on share repurchase deals for listed firms in December 2023 to give them greater leeway in cutting losses and protecting share values amid an uncertain global financial environment. Companies may now initiate share buyback transactions upon seeing a cumulative decline of beyond 20 per cent in share prices within 20 consecutive trading sessions. This is lower than the previous threshold of a 30 per cent decline to trigger share repurchase deals.

Listed firms are also allowed to pursue repurchase agreements when share prices decline by 50 per cent relative to the highest closing price of that stock in the preceding 12 months. The rules are rather loose and give companies an array of options to kick off repurchase arrangements.

Companies that buy back shares may either reallocate these under employee stock ownership schemes or cancel these repurchased stocks. The latter tends to raise share prices as it creates some scarcity of that stock.

Hand-holding

The CSRC’s new rules provide a much-needed lifeline to ailing stocks at a time of great uncertainty and nervousness towards the Chinese economy.

Basically, the regulator is hand-holding the listed companies to guide them on how and when to repurchase shares. After all, Chinese stocks have seen quite a tumultuous year as issues in the real estate sector and rising public debt have spooked market players, coupled with still high interest rates in the US which have led investors to turn away from Chinese stocks.

Graph 1 depicts the 9.9 per cent drop of the broader S&P China 500 index and the 12.5 per cent decline of the CSI 300 index, which is the main index for shares listed in the Shanghai and Shenzhen indices, as of mid-August. Compared to peak levels seen in February 2021, both indices have plunged by more than 40 per cent, wiping out about USD 5 trillion in total value. Despite some recovery, Chinese stocks are down year-to-date.

This nudge from the CSRC represents a gradual long-term improvement of corporate governance protocols among listed firms. The new rules require company boards to include share repurchase mechanisms in their relevant articles of association and internal protocols. It also mandates board members to constantly stay on guard against sharp swings in the share price. In the same vein, the listed firms are prohibited from issuing new shares parallel to share buyback plans to guard against market manipulation.

Taken together, the rules instil greater vigilance by requiring company officials to proactively respond to meaningful movements in the share price, which altogether target better corporate governance. We expect the impact to be gradual, similar to Japan in the past 10 years, and ultimately lead to a re-rating of the entire equity market.

Success stories

The policy has proven effective in saving listed firms from extreme wipeouts of stock valuations. According to Skybound Capital, there were 1,646 domestically listed companies that implemented share repurchase amounting to RMB 99.5 billion (USD 13.9 billion) as of end-June, well in excess of the RMB 91.4 billion (USD 12.8 billion) for the full year of 2023.

Alibaba Group, a China-based global tech giant, ramped up its share repurchase activities in the first half of 2024 to reach USD 10.6 billion for 142 million American depositary shares (ADSs), more than double the 58 million ADSs it bought back from investors in the US and Hong Kong markets in the same period the previous year.

Alibaba can still repurchase up to USD 26.1 billion worth of shares until March 2027, according to corporate disclosures. If its stock price maintains its descent, it would not be a surprise to see the listed company turning more aggressive in reacquiring shares to save its valuation. Previous share buyback deals have proven helpful in preventing the collapse between 2021-2023, as seen in Graph 2. However, share prices remain far from hitting a new peak.

Alibaba’s rival Tencent also ramped up repurchase deals in 2023 and is looking to re-acquire USD 12.8 billion worth of ADSs this year. Electric vehicle maker BYD also rolled out an RMB 400 million (USD 55 million) share repurchase plan in March to cut the bleeding as its share price dropped by 61 per cent at end-2023 versus its 2022 peak price. In the plan, BYD will buy back 1.48 million shares at RMB 270 (USD 37) apiece, equivalent to 0.05 per cent of outstanding shares.

The revised rules for share repurchases came during what looked like the worst slump China’s stock markets have faced, given the threat of a renewed trade war, elevated interest rates, and low confidence towards China’s economy. It is a welcome respite to recover stock values in the market, rebuild investor confidence, and smoothen the stock market’s overall performance.

Despite the risks, China will remain a global leader in manufacturing and growth, particularly for advanced technology companies, software development, and the renewable energy sector. We view these market segments as highly promising, and we think that investors should take the prolonged Chinese stock market rout as an opportunity to take positions in these segments. For one, A-share companies like Alibaba have share buyback plans slated over the next 3 years, and this could provide some assurance to investors that there are ways to protect share values despite the headwinds ahead.