Shanghai-Hong Kong Stock Connect

Stock Connect and the broader significance of China’s financial liberalisation

February 2015

The Shanghai-Hong Kong Stock Connect programme, China’s latest financial reform scheme to free up capital flows, is gaining attention and acceptance.

In the two months since it came into effect, the initial participants in the cross-border stock trading link have been retail investors and hedge funds1 who were largely excluded from existing channels of access such as the Qualified Foreign Institutional Investors and Renminbi Qualified Foreign Institutional Investors schemes.

Global institutional investors have been on the sidelines and are taking their time to familiarise themselves with the two vastly different and disparate markets and systems. Stock Connect is one of the many available channels to access China and many view the country as a market for long-term and strategic asset allocation.

Indeed, the programme is a long-term and transformational development of China’s capital markets, and many years down the road, a bridge for the eventual integration of its currency, the renminbi, with the global economy.

The internationalisation of the renminbi is one of China’s strategies to further open up its capital markets. As the Chinese financial market liberalisation progresses, global investors may eventually be able to trade in renminbi freely without having to be limited by a quota.

A gateway to China

Stock Connect isn’t just limited to the internationalisation of the renminbi, it’s a broader scheme of China’s financial liberalisation and helps to position Hong Kong as the leading gateway to the country.

This is especially significant as the Chinese government plans to set up three more free trade zones2 after Shanghai — in Guangdong, Fujian and Tianjin City. The Shanghai free trade zone was set up in September 2013 as part of wider financial reforms for China to free up interest rates, advance commodity futures trading and increase the use of the renminbi in global transactions.

Further discussion by the Chinese government on expanding Stock Connect to the southern city of Shenzhen3 will give international funds even greater access to China. In addition to a wider geographical reach, expanding the scope of investment products into other asset classes, including non-index stocks and fixed income instruments, would also further enhance the effectiveness of the programme.

There is little doubt that global investors increasingly see the importance of Asia Pacific in their portfolios, and Stock Connect can be a catalyst. From an investment perspective, it’s a channel to directly capture the opportunities of China’s growth.

Understandably, there are uncertainties that need to be resolved and regulators are also in the process of learning and adapting to the new market environment. The complicated trading procedures, uncertainties over asset segregation, the different trading hours and holiday schedules and the presence of quotas are a few of the issues4 that need further clarification. The constraints of Stock Connect will be ironed out in time, it’s a question of when.

On the horizon

More immediately, the additional access to China may be a boon for product development in the financial services industry. It can expand the investment universe of asset managers and give them an additional market to look into, and more importantly, another way of adding value to portfolio construction.

As investors seek efficient solutions to overcome the current technical issues under the programme, new opportunities are emerging for service providers and preferred brokers, including equity trading, portfolio solutions, foreign currency services as well as custody and settlements.

With China’s CNY56.9 trillion5 economy being the second largest in the world, Chinese equities are certainly a market that many global investors would want to include in their asset allocation decisions.

 

1 The Through Train: Stock Connect’s Impact and Future, Asia Securities Industry & Financial Markets Association and Thomson Reuters, December 2014.

2 The State Council of China’s website, December 2014. http://www.gov.cn/guowuyuan/2014-12/12/content_2790192.htm

3 Report on Li Keqiang’s visit to Shenzhen, Shenzhen Special Economic Zone Daily, Shenzhen Press Group, January 5, 2015. http://sznews.com/

4 Survey on the potential of Stock Connect, Hong Kong Investment Funds Association, January 2015.

5 China’s 2013 gross domestic product, National Bureau of Statistics of China. http://data.stats.gov.cn/workspace/index?m=hgnd