ONSHORE RETAIL VS OFFSHORE Institutional.
DIVERGENT REGIMES

China's onshore A-share market and the offshore H-share and ADR market have historically exhibited high correlation: both are pricing claims on Chinese corporate earnings, subject to Chinese macro and regulatory conditions. The divergence that has developed since 2021 is not primarily a valuation story; it is a regime story. The two markets are increasingly pricing different beliefs about which investors will bear the costs and capture the benefits of China's evolving political economy.

The A-share market is dominated by retail investors, supplemented by domestic institutional investors (mutual funds, insurance companies, pension funds) that are constrained to hold Chinese equities as part of their mandate. This investor base is structurally more tolerant of policy-driven volatility, less sensitive to corporate governance concerns and more optimistic about the Party's ability to engineer a recovery. The CSI 300 has been relatively stable and has exhibited a significant amount of policy-driven support buying.

The H-share and offshore market is dominated by institutional foreign investors and Hong Kong-based international institutions. This investor base is more sensitive to corporate governance, more likely to value-compare China with global alternatives, and less constrained to hold. The structural selling pressure on H-shares from Western institutional investors reducing China exposure has been a persistent feature of the market since 2022.

The practical mechanics of the divergence have three drivers.

First, liquidity: the PBOC and domestic institutions have at various points provided direct market support through state-owned fund buying in the A-share market. This creates an implicit floor in A-shares that does not exist in H-shares. The offshore market has no equivalent domestic liquidity backstop.

Second, policy signalling: market-moving policy announcements (stimulus packages, sector support programmes, regulatory softening) are often signalled more clearly through state media and official channels that are primarily consumed by domestic market participants. By the time the signal reaches offshore institutional investors, the first move has already happened.

Third, information asymmetry: domestic investors have better access to local government economic data, regulatory conversations and sector-level intelligence than offshore investors. This creates persistent information gaps that manifest as pricing divergence, particularly in policy-sensitive sectors.

The Hang Seng China Enterprises Index (HSCEI) traded at approximately a 30 to 35 percent discount to the equivalent A-share universe on a P/E basis in early 2026. Decomposing that discount:

Governance risk premium: approximately 8 to 12 percent. The risk that regulatory intervention, VIE structure challenges or directed corporate behaviour will harm minority shareholder interests.

Liquidity risk premium: approximately 4 to 6 percent. The risk of reduced market access, capital controls or repatriation difficulty.

Geopolitical risk premium: approximately 6 to 10 percent. The risk of sanctions, de-listing requirements or forced divestment for Western institutional holders.

Regime uncertainty premium: approximately 8 to 12 percent. The uncertainty about the long-run political economy model and the distribution of returns between the state, corporations and investors.

Total implied discount: 26 to 40 percent, consistent with the observed range.

The H-share discount to A-shares will narrow when: the governance risk premium declines (requires credible evidence that minority shareholder protection has improved); the geopolitical risk premium declines (requires de-escalation of US-China technology conflict and removal of de-listing threat); and the regime uncertainty premium declines (requires clearer evidence of the Party's long-run relationship with private capital).

None of these conditions is imminent. The US Holding Foreign Companies Accountable Act compliance question has been partially resolved but not eliminated. The technology sanctions regime is tightening rather than loosening. The Party's attitude toward private wealth accumulation remains actively ambiguous.

The convergence trade periodically attracts Western investors on the argument that the discount is too large. The desk's view is that the discount is not too large given the structural rather than cyclical nature of the risk premia. Tactical bounces are possible on stimulus announcements; structural convergence is not.

The desk's China equity exposure is exclusively through H-shares for international mandates, on the grounds that the governance and information dynamics of A-shares make them unsuitable for fiduciary accounts without domestic market infrastructure.

Within H-shares, the desk maintains overweight in consumer staples, healthcare and selected technology names where the regulatory posture has clearly stabilised, and underweight in property, platform technology companies still under active regulatory scrutiny and state-owned enterprises in sectors where directed behaviour against minority shareholder interest has been most prevalent.