* Zhejiang Southeast Electric Power to convert B shares to A shares - sources
* Will necessitate decision on how to handle foreign owners of B shares
* Policy could allow for conversion of other B shares to A shares
* Announcement likely before Feb. 9 - company source
By David Lin and Pete Sweeney
SHANGHAI, Jan 28 (Reuters) - A Chinese company is preparing to move its dollar-denominated B shares to the mainstream A-share board, sources at banks advising on the deal told Reuters, the beginning of a potential migration that could see individual foreign investors owning yuan-denominated shares in Chinese equities for the first time.
An exodus of companies attempting to escape China's moribund B-share market to the larger domestic A-share board offers a potential loophole for foreign individual investors attempting to get their hands on Chinese equities.
It also highlights the uncertainty surrounding the sustainability of a rally on the B-share index that has seen it surge nearly 30 percent since late November.
A source at China International Capital Corporation (CICC) and another source at Morgan Stanley's Chinese joint venture, Morgan Stanley Hua Xin, said that Zhejiang Southeast Electric Power Co is planning to convert its B shares in Shanghai into A shares.
A shares are only open to mainland investors and on a highly restricted basis to qualified foreign institutions such as banks or funds, which must apply for investment quotas.
The foreign-currency denominated B-share market was originally created specifically to allow foreigners to buy shares in Chinese companies, but it lost popularity after regulators began letting Chinese companies access foreign capital directly by listing in Hong Kong and New York.
"We are paying close attention to the plan to move B shares to A shares, because it may serve as a model for other pure-B share companies," said Cao Xuefeng, an analyst at Huaxi Securities. "The plan, when announced, should shed some light on policy preferences."
A source from Zhejiang Southeast Electric Power declined to confirm it is planning to migrate its shares, but said he expects the firm will make an announcement before the Chinese Spring Festival, which begins on Feb. 9.
If the plan is approved by the China Securities Regulatory Commission (CSRC), it would require regulators to decide how to handle the foreigners currently allowed to buy and sell the company's B shares. Foreign individuals are not permitted to directly trade on China's yuan-denominated A share market.
Technically speaking, allowing foreign owners of B shares to hold A shares could also constitute an additional opening of China's capital account.
Ironically, the recent enthusiasm for B shares is due to policy moves to wind down the B-share market.
The CSRC set off a panic in mid-2012 when it raised the standards for maintaining B-share listings, leading many investors to bail out, fearing a wave of delistings.
But no such purge occurred, and instead regulators began signalling they might cast a favourable eye on applications from qualified companies to move their listings.
When two firms - China Marine Shipping Containers and China Vanke - received approval to move their B shares to Hong Kong, and Chinese investors - ordinarily banned from trading in overseas shares - were given the option to swap their B shares for new H shares, the B-share index surged as investors rushed to bet on the next wave of migrating tickers.
However, analysts are now considering whether at current valuations, the B shares still represent bargains or have become overvalued traps.
If most B-share companies are allowed to migrate, either by cashing out shareholders at a premium or converting them into A shares, the B-share rally could be sustained.
But if policymakers only allow a few select firms to abandon the B-share market for warmer climes, leaving the smaller, weaker tickers behind to sink, the rally could be short-lived.
Analysts say most of the companies currently on the B-share do not meet Hong Kong listing standards, so how China handles the other companies is critical for the future of the rally.
Sources at CSRC did not respond to emailed requests for comment.
"Smaller companies may want to switch their B shares to the A-share market because they may fetch a higher valuation there compared to Hong Kong," said Zhong Hua, a Shanghai-based strategist with Guotai Junan Securities.
"But it remains to be seen if CSRC will make a special dispension in these cases given the current freeze on new IPO approvals."