State shareholders in Bank of China (BOC), the mainland's second-largest lender, have agreed to a political compromise not to convert their holdings into H shares upon the lender's planned US$7 billion Hong Kong public share sale in May. The decision could mean BOC's exclusion from the Hang Seng Index, which in turn would mean a smaller investor following until all its share capital is listed later - either in Hong Kong or the mainland - following a domestic A-share initial public offering. 'Many fund managers track the [Hang Seng] index,' a source said. 'Exclusion from the index will therefore hurt investor interest.' Under the agreement with the government, all the BOC shares held by China SAFE Investments, the wholly state-owned financial holding company, will be converted into tradable shares. The National Social Security Fund, the fund of last resort to plug provincial social security fund shortfall, has struck a similar pact. However, the two agencies - owning about 83 per cent of BOC between them - have agreed to defer the decision as to where the shares will be listed until a later date, according to sources close to the situation. China SAFE previously wanted to convert all its shares into H shares upon BOC's listing, as in two earlier precedents. It reaped handsome capital gains from last year's public offerings of two key lenders in which it held stakes, the Bank of Communications and China Construction Bank Corp. However, the China Securities Regulatory Commission (CSRC), under pressure to improve the quality of the domestic stock market, insisted that part of BOC's existing shares be reserved for later conversion into yuan A shares to give the lender a strong incentive to pursue a domestic share sale soon. The final compromise was reached after the two sides failed to agree on the ratio of existing state shares to be converted into H shares before the Beijing-based bank's Hong Kong initial offer. As a result, BOC would fail to meet the revised Hang Seng selection criteria issued last month that paved the way for H shares' inclusion to make the blue-chip index more representative of the market. H shares were for years barred from the index because they were only partially listed in Hong Kong. Last month's revision made it possible for all new H-share firms, even those with A-share listings, to qualify for the index as long as they had no unlisted share capital. Construction Bank, which sold US$9.2 billion worth of shares in a Hong Kong initial offering last year, is widely tipped to be the first H share to join the index. Equity fund-raising on the mainland stock market was put on hold in April last year to make way for the reform to float until now non-freely tradable shares. However, even if a share sale resumption is imminent, analysts expect CSRC to revert to the usual practice of pacing large offerings for fear of depressing the markets.
