It’s the one China’s financial markets have been waiting for…scheduled for launch this quarter, Shanghai-Hong Kong Stock Connect – the initiative by the China Security Regulatory Commission and the Securities Commission in Hong Kong to allow mutual stock market access between the Shanghai and Hong Kong stock exchanges – will mark a major step in Beijing’s overall plan to accelerate renminbi and financial market liberalisation.
Nicknamed ‘the through-train’, the Shanghai-Hong Kong Stock Connect does indeed look destined to create a more effective high-speed line to accelerate the take-up of Chinese equities.
Because the reality is that global investors are underweight China relative to its global economic influence – as if China’s bullet train were puffing along like Thomas the Tank Engine. China’s current weight in the MSCI AC World Index is only 2.2% and global mutual funds have perhaps less than a 2% allocation in China. And yet China is the world’s second largest economy, with:
- over 12.3% of global GDP
- 11.3% of global trade
- 23% of global fixed asset investment and
- 7.9% of global consumption
China’s onshore and offshore equities markets, which together represent 10.5% of global market capitalisation, is the world’s second biggest behind the New York Stock Exchange, and we believe Stock Connect could be just the catalyst to trigger a China re-rating.
Faster financial market and renminbi liberalisation
With the Stock Connect, onshore mainland investors and international investors will be able to bypass QFII/RQFII/QDII (1) restrictions and directly access Hong Kong and Shanghai-listed shares without pre-approved licences and quotas. The programme is open to institutional and retail investors on both sides, the only limitation being for mainland Chinese investors who will have to maintain a minimum trading account balance of RMB 500 000.
Stock Connect will create the second largest global equities market by market capitalisation (USD 6.7 trillion (2) ). For international investors, this means an additional USD 4 trillion of market capitalisation being added to the investable universe.
In Phase 1 of Stock Connect, qualified China-based investors will gain direct access to a list of 266 southbound eligible shares traded on the HKSE (H-shares); international investors will have access to a menu of 568 northbound eligible companies listed on the Shanghai SE (A-shares). As a percentage of all China onshore and offshore listed equities, Phase 1 eligible stocks make up 45% of total market capitalisation, 27% of the free-float, and 28% of the average daily value traded (ADVT). Regulators have already hinted that initial daily and aggregate quota limits (3) will be relaxed once the programme is smoothly underway.
Stock Connect opens up a number of northbound arbitrage opportunities for the experienced managers with a strong A&H-share track record and we have a number of strategies to monetise on mispriced assets (Click here for the full paper).
Implications for China product strategy
Stock Connect paves the way for the integration of China’s equity market with the global community, and is an important component of China’s overall financial system reform, bringing capital account liberalisation and renminbi internationalisation one step closer.
As to the future ‘rail map’ for Stock Connect, Shenzhen regulators have already confirmed plans for a Shenzhen-Hong Kong ‘branch line’ that could launch as early as Q1 2015. ETFs and derivatives could be added by end-2015 and fixed-income, primary issuance and commodities may follow in 2016/17. If successful, the system could well be replicated with regional Asian stock exchanges such as Singapore and Taiwan.
In our opinion, participation in Stock Connect is a ‘must’. The new paradigm will remove barriers to entry, allowing asset managers to compete on a level playing field. More and more, emphasis will be placed on sourcing managers with a combined A&H-share track record.
(1) Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) schemes giving international investors access on a quota basis to Chinese capital markets; Qualified Domestic Institutional Investors (QDII) programme to channel outward investments by domestic Chinese investors. All three licence programmes are only granted to institutional asset managers and have restrictions such as quota caps, lock-up periods, fund repatriation restrictions, asset allocation rules, etc.
(2) Sources: World Federation of Exchanges, Bloomberg, Goldman Sachs Research, September 2014
(3) The initial daily volume cap for northbound trades is RMB 13 billion (equating to around USD 2 billion), and southbound is RMB 10.5 billion. Phase 1 maximum aggregate quota for northbound is RMB 300 billion, and southbound is RMB 250 billion. Both the aggregate and daily quotas will apply on a “net buy” basis.
Please click here to access the full paper.
You are welcome to contact the authors of the paper with any questions/ comments.
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