Yuan IPOs more attractive to accountants than to investors

A year on, and PricewaterhouseCoopers has yet to get the message that yuan and Hong Kong dollar dual currency listings are a lousy idea

PUBLISHED : Thursday, 04 July, 2013, 12:00am
UPDATED : Thursday, 04 July, 2013, 3:48am

According to yesterday's South China Morning Post, accountancy firm PricewaterhouseCoopers expects two or three big yuan and Hong Kong dollar dual currency equity offerings on the Hong Kong stock exchange over the coming months.

Now, I know Monitor has banged on before about what a lousy idea dual currency listings are, but the last time was almost a year ago, and clearly the message hasn't reached PwC.

So I'll say it again: there are absolutely no advantages at all for investors from buying into the yuan tranche of a dual currency listing - or from buying into yuan-denominated equities, full stop.

That might sound strange, given that many people expect the yuan to appreciate. But if you think about it, you will realise it makes sense.

In a sophisticated market like Hong Kong - and the city is one of the most sophisticated retail markets in the world - investors typically value shares according to their price-earnings multiples and on their prospects for future earnings growth.

At the moment, for example, mainland companies with shares listed in the city are valued at a price to estimated earnings per share multiple of 6.6 times.

So imagine a typical mainland company that expects to make earnings of 1 yuan per share this year. If it goes for a dual currency listing, its yuan-denominated shares will be priced at 6.60 yuan.

Its Hong Kong dollar shares will be priced at 6.60 yuan multiplied by the current exchange rate - HK$1.27 to the yuan - or at HK$8.38.

Now, imagine the yuan rises 10 per cent. The yuan shares will still be priced at 6.60 yuan. But the Hong Kong dollar shares will be valued at 6.6 times the new exchange rate - HK$1.39 to the yuan - or at HK$9.18. That's 10 per cent more.

Because investors are still valuing the company at the same price-earnings multiple, if currency appreciation pushes up the Hong Kong dollar value of the company's yuan earnings by 10 per cent, the value of its Hong Kong dollar shares will immediately rise by 10 per cent too.

In other words, fluctuations in the value of the yuan are automatically reflected in the Hong Kong dollar share prices of mainland companies listed in the city. Denominating shares in yuan confers no extra benefits.

But offering dual currency share tranches could disadvantage investors. Although growing quickly, the pool of yuan liquidity in Hong Kong is still relatively small. And offering two share classes - one in yuan and one in Hong Kong dollars - for a single company would risk splitting liquidity in its stock, leaving investors with two shallow pools, rather than a single deep one to play in.

In short, companies - and accountants hoping to collect fat fees - might find dual currency listings attractive, but there is nothing in the idea to entice investors.

To get a detailed picture of how widely the yuan is being used outside China, we will have to wait until September when the Bank for International Settlements publishes its three-yearly foreign exchange market survey.

But last week we got a snapshot of how successful Beijing has been at persuading the world's central banks to adopt the yuan as a reserve currency when the International Monetary Fund updated its Currency Composition of Official Foreign Exchange Reserves database.

As the chart below shows, the US dollar retains its undisputed status as the world's dominant reserve currency, making up some 62 per cent of all declared reserves.

The euro is second favourite, making up most of the rest, with the Japanese yen and British pound trailing in third and fourth places.

Unfortunately, the IMF's data does not break out figures for the yuan, which is lumped among the minor "other currencies" that together make up 3 per cent of all reserves.

However, given that this category includes such widely held and traded currencies as the Swedish krona, the Korean won and the Mexican peso, as well as the other BRIC currencies - the Brazilian real, Russian ruble and Indian rupee - we can safely assume that China's yuan today makes up less than 1.5 per cent of global reserve holdings, a smaller proportion than either the Canadian or Australian dollar.