The Shanghai-Hong Kong Stock Connect scheme was launched in November last year and although it was highly anticipated by global investors, it has seen a lukewarm start. There are several reasons for this and I don’t think any of them are fundamental problems.
"Despite the slow take-up, the Connect scheme... has enhanced Shanghai’s status as an international financial centre while strengthening Hong Kong’s role as a gateway for China."
Ivy Au Yeung, CEO, ANZ Hong Kong
The more risk-averse institutional funds want to ensure trading systems are operating smoothly before dealing in large volumes. Meanwhile, many tracker funds will wait until MSCI includes China A-shares in its benchmark indices.
And don’t forget, Shanghai’s stock market had been among the worst performing markets globally in recent years before its latest bounce and the benchmark SSE Composite Index is still well below its 2007 peak.
Despite the slow take-up, the Connect scheme remains a key milestone in China's capital market liberalisation. It has enhanced Shanghai’s status as an international financial centre while strengthening Hong Kong’s role as a gateway into China.
Importantly for investors, the historical reform opens up bilateral portfolio flows and provides unprecedented access to investing in China’s equity market directly, in addition to the existing QFII and RQFII schemes.
The Connect scheme controls the flows on a consolidated basis as opposed to previously firm-based licensing. So the link-up program will bypass many complicated application and approval procedures and red-tape. The daily quota totals RMB23.5 billion ($A4.8 billion), and if fully utilised, could result in a total flow of roughly RMB470 billion a month. This is larger than the average value of cross-border RMB trade-related remittance between Hong Kong and the Mainland (which is estimated at RMB350 billion). So the RMB payment flows are massive.
Moreover, the mutual access means Hong Kong immediately becomes China’s ‘international board’. Chinese investors, including pension funds, other institutional investors and high-net-worth individuals, will have the access to high quality foreign companies listed in Hong Kong.
From an historical context, compared with Japan in the past, China has noticeably stronger pressure to invest abroad given its higher foreign reserve position (Figure 1). China is expected to invest more abroad. Before China opens its domestic stock exchange for foreign companies, Stock Connect will encourage more multinational corporations (MNCs) to use Hong Kong as a short cut should they want to attract Chinese investors, boosting IPO activities in Hong Kong in the long run.
Our chief Greater China economist at ANZ, Liu Li-Gang, says Hong Kong’s regulatory standards are perceived to be higher and more transparent. Hong Kong is also a platform for China’s state-owned enterprises (SOEs) to tap the global investor base. Li-Gang believes the mutual access will likely encourage more high quality Chinese companies to list in Hong Kong.
He says in the long term market forces may also encourage the Shanghai Stock Exchange to lift its regulatory standards or face losing competitiveness.
In response to the scheme, the Hong Kong Monetary Authority removed the daily conversion cap of RMB20,000 per day for Hong Kong residents on the same day of the launch. This has allowed investors to convert more RMB and to fully participate in the stock connect. It also encouraged customers to invest in other RMB denominated investments and transactions including bonds, deposits and offshore purchases.
The increased demand for RMB helps to internationalise the currency and makes money exchange arrangements easier for customers. Many banks nowadays, including ANZ, offer direct exchange of RMB to other currencies rather than first converting RMB to USD. This improves efficiency, saving time and cost for the customer and the bank. It is also important to navigate the volatility risks when dealing with direct exchange from RMB to other currencies.
Li-Gang believes the Hong Kong pilot, if successful, would likely lead to China expanding the scheme to other portfolio investments and eventually achieve full capital account convertibility by 2020. We understand another Connect project is slated for Shenzhen this year.
To me, the 'lukewarm' start is perfectly understandable. All sides, governments and market players, are testing out the system. The Chinese government is analysing patterns of trade and issues like tax implications.
The scheme gives international investors the opportunity to trade into the Shanghai A-shares via the Shanghai Stock Exchange (SSE) and Chinese investors the access to invest in Hong Kong H-shares via the Stock Exchange of Hong Kong (SEHK). It comprises a Northbound Trading Link (NTL) and a Southbound Trading Link (STL). Under the NTL, the investors can place orders through their Hong Kong brokers, and a securities trading service company to be established by Stock Exchange of Hong Kong (SEHK) to route orders to Shanghai Stock Exchange (SSE). Likewise, the STL allows eligible investors to do the same for the shares listed in SEHK.
Investors are looking at the infrastructure build up. What I envisage at a point in the not too distant future is a tipping point, a time when all sides relatively suddenly appreciate the scale of the market opportunities and facility of the infrastructure.
That moment could be quite revolutionary, rather like the impact of the shale gas phenomenon which bubbled along for several years before becoming transformational.
For the moment, all sides are looking at the infrastructure and asking what more is needed, what refinements, what sort of governance initiatives.
I envisage the Chinese government responding to these developments, in appropriate steps and investors will become more and more confident. That will be the tipping point.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
16 Oct 2014
05 Dec 2014