I’ve written about the need for liquidity in China’s capital markets before, and no other time has that been as clear as today! Apparently, Market News International got ahold of a few bank people in China that, according to Bloomberg, said that the People’ Bank of China has been pumping RMB50 billion into the Chinese banks in Short-term Liquidity Operations (SLOs) which are essentially putting money into banks directly for 1-3 days in most cases. Why is liquidity so tight? Supposedly, there is an IPO pipeline somewhere in the range of RMB1 trillion to 1.5 trillion set for next week, as IPO’s start coming to market again and Chinese regulators had expected more liquidity thanks to the Shanghai – Hong Kong Stock Connect. This has implications for the Shanghai – Hong Kong Stock Connect, future IPO- and general market performance, and ties in closely to a lot of other analysis and expectations that are covering China’s capital markets. Read on for more of my thoughts on this!
The IPO reasoning for low liquidity really helps explain the ridiculously low turnover on the Southbound Stock Connect link: if you have essentially Alibaba’s whole market cap at float being sold, or 4-5% of the two main stock board capitalization going to market, and other people looking into trading the stocks, possibly adding as much as 50% to cash-on-hand, then you will want more cash to be readied. Especially since you need to have trades completely settled on the Chinese markets.
Then… why RMB50 billion? Adding up the sum of the remaining Northbound link quota balance, in billions of RMB, probably tells the story. 0 + 8.2 + 10.5 + 10.8 + 10.7 = 42.2! Let’s add a few billion for good measure and factor in the delay to expectations of three weeks before the trading started, and we get RMB50 billion. Liquidity might have been a lot tighter than regulators expected, since they’re hoping for 100 new IPOs in the pipeline.
Markets were already on the up-move during the late morning trade after hitting and tripping some major technical levels in the morning and overnight, but the liquidity injection by the PBOC set markets on a fizzy-soda bottle rocket move higher across all markets, from Hong Kong to Japan to US futures.
Looking into this from a slightly different perspective: I have been discussing this at times in terms of an IPO of the general Shanghai Stock Exchange board. In an IPO, there are normally managing banks providing liquidity and buy orders to prevent the price from falling too far (partially also because they stand to gain from any IPO pop), but this might not be the case here for the Shanghai – Hong Kong Stock Connect. Thus, what makes the most sense is probably to actually let the central bank ensure that there is ample liquidity for the China-side of the market at least, given that the first “green shoe” here is further opening of the Aggregate Quotas, and the second is continued financial opening and reform with stuff like cross-border fund investment opportunities. Messing this up is simply not an option, and the PBOC/CCP simply have to manage this “Continuing Global Offering” at a deeper level of involvement than a “best effort” managing bank.
Potential market effects for next week:
Then, do I think we’ll see any liquidity SLOshing around? (Sorry, couldn’t resist.) Probably not: this is still very short-term to meet cash needs, and will probably just round-trip through the financial system. Another reason is that the value is so extremely puny relative to the cash needs (max 5% of liquidity needed for the IPOs), that the interbank funding interest rates are likely to remain elevated. Also, looking at the falls in the market for the week through to yesterday’s close, the A50 index fell by 3.5%, and the Shanghai Composite was down 1.2% on closing basis on Wednesday from its Friday November 14th close.
Liquidity in China’s stock market might be much tighter than the RMB150-200 billion daily turnover on the Shanghai Stock Exchange suggests! It will be really interesting to see how the Southbound trading reacts once the levels of IPO cash demand goes down. This lack of liquidity might mean that there are problems matching orders going north (which seems counter-intuitive given that people would be expecting to sell in China to get more cash on hand) but I know little to nothing on the general bid/ask spreads on the Chinese market. For shorter-term investors looking to rotate in and out of shares this might answer my questions from yesterday on what’s wrong with the A-Shares + SH-HK Stock Connect combination. The analysis however hinges on actual spread values (which I don’t have) and broad knowledge of institutional and retail investors’ evaluation on when spreads are too high (which I really don’t have).
The question is, with all the IPO’s lying in wait following the near yearlong lockup, when will IPO cash set-aside funding needs be met? How will the People’s Bank of China react until then? Will there be more liquidity in the market, delivered through the Shanghai – Hong Kong Stock Connect, or internally by changes in the bank funding system? What are the implications for China’s overall near-term and long-term capital market developments? Anyhow, it is really interesting, and this feels like exactly the type of interconnection between the debt markets, secondary equity markets and primary issuance equity market that I find the most exciting when it comes to China’s capital markets!