What Is a Red Chip?

A red-chip company is one that does most of its business in China, and which the Chinese government has a considerable stake in the firm. Red-chips, however, are incorporated outside mainland China and listed on the Hong Kong Stock Exchange. Red-chip stocks are thus expected to maintain the filing and reporting requirements of the Hong Kong exchange. This makes them an important outlet for foreign investors who wish to participate in the rapid growth of the Chinese economy.

KEY TAKEAWAYS

  • Red chip firms are incorporated outside mainland China and listed on the Hong Kong Stock Exchange.
  • A red-chip company, however, conducts much of its business in mainland China.
  • Red chips take their name from China's red flag, and the name reflects the Chinese government's partial ownership of the company.
  • Being a red-chip does not imply that such a company is large, stable, or mature.

Understanding Red Chips

The name "red chip" may sound similar to "blue chip," but the two terms should not be confused. A large, well-known, and financially stable company may be referred to as a blue chip. A distinguishing feature of a red-chip stock, in contrast, is a sizable Chinese government stake in the company. Red chips take their name from China's red flag, and the name reflects the Chinese government's partial ownership of the company. Red-chip firms are not necessarily large or well-known.

Although red chips are listed on the Hong Kong Stock Exchange, they should not be confused with H-shares. H-shares are shares of companies that are incorporated in mainland China but traded on the Hong Kong Stock Exchange or another foreign exchange. Red chips, on the other hand, must be incorporated outside mainland China.

A red chip stock is not the Chinese version of a blue chip.

Advantages and Disadvantages of Red Chips

Red-chip stocks enjoy a combination of impressive advantages, but also have a few drawbacks. They offer access to the growing Chinese market, but their international incorporation and listing in Hong Kong ensure adherence to developed market financial reporting standards. They also combine easy access for foreign investors and the discipline of global financial markets with implicit Chinese government backing.

Government support guarantees a relatively friendly regulatory regime and access to capital in a crisis. However, it also means that red chips may pursue goals other than profit maximization. Like all companies, red chips work for the shareholders. However, the largest shareholders for red chips are often Chinese state-owned enterprises. In theory, other shareholders might see profits placed behind social, environmental, and other political goals.

Requirements for Red Chips

According to FTSE Russell, there are four main criteria for a firm to be classified as a red chip:

  • Chinese government-affiliated organizations must own at least 30% of the company. These organizations may include the government of the People's Republic of China, Chinese provincial governments, municipal governments in China, and Chinese state-owned enterprises.
  • More than 55% of the firm's revenue must come from the People's Republic of China, or the firm must have over 55% of its assets in China.
  • The firm must be incorporated outside of mainland China.
  • The company's stock must be listed on the Hong Kong Stock Exchange.

It should be noted that firms are no longer considered red chips if government ownership drops below 25%. If both Chinese assets and Chinese revenue fall below 45%, the firm will also lose the red chip designation.

Example of a Red Chip

China Mobile was the largest red-chip company as of May 2021, with a market capitalization of more than 1 trillion Hong Kong dollars (over 125 billion U.S. dollars). The firm was incorporated in Hong Kong in 1997, so it is incorporated outside of mainland China. The firm's shares are listed on the Hong Kong Stock Exchange, which is also a requirement for red-chip status. In December 2020, 72.72% of the company was held by China Mobile Communications Group Co., Ltd., which is a Chinese state-owned enterprise.