Shanghai and beyond

Brokers have hailed news of a cross-border stock-investment programme between Shanghai and Hong Kong as a key step in opening China’s markets after a small number of early obstacles are sort out.

Greater China market participants have high hopes that a pilot cross-border agreement between the PRC and Hong Kong on stock investments will be expanded beyond Shanghai once regulators iron out a few early stage wrinkles.

The China Securities Regulatory Commission and Hong Kong’s Securities and Futures Commission announced the link between the two financial centres, dubbed Shanghai-Hong Kong Stock Connect, in April. The initiative allows for limited mutual stock-market access to the two cities’ exchanges.

The programme is expected to benefit both markets. Investors based in Hong Kong and Shanghai will be able to purchase a far greater variety of shares than before. However, market participants have said that the PRC markets may have the most to gain from the project in the longer term – especially if, as some anticipate, it is extended to Shenzhen and to other securities and products besides equities.

Allowing a greater number of international investors to buy shares and other securities of companies listed in Shanghai and Shenzhen via Hong Kong will help create a more liquid and more transparent PRC market, sources say.

“I believe the next phase is to include Shenzhen’s exchange and stocks in the plan,” said a Shanghai-based head of China equities.

Brokers in both cities are preparing for the pilot project’s expected launch in October. It is intended to complement, and not replace, existing international investment schemes, such as the qualified foreign institutional investor and qualified domestic institutional investor programmes.

“Transparency and disclosure are pretty lacking in the mainland stock market, but expected to improve over time. So, for longer-term investors, this [stock programme] presents a good opportunity.”

Brokers preparing for the new market access say they expect the development of the project to start off slow. However, once dealmakers get comfortable with the rules, the scheme can be expanded to include more securities, they say.

Shanghai-Hong Kong Connect is, by design, limited in scope. The initiative allows northbound investors, those based in Hong Kong, to buy constituent stocks of the SSE 180 and SSE 380 indices. Southbound flows can been used to buy the Hang Seng Composite LargeCap and Hang Seng Composite MidCap indices. It also means that more than 100 dual-listed shares are in play.

Giving investors in Hong Kong direct access to Shenzhen-listed shares in the future may also be easier to implement than the current Shanghai access, according to the China equities head.

“Shenzhen has the advantage of being very close to Hong Kong. That proximity could be an advantage for many firms and [my firm] is quite excited about the possibility,” he said.

If the scheme is implemented as planned, the additional trading volume may have a major impact on the Chinese market.

“If the stock-connect quota is actually all used up and, combined with the QFII quota, which hasn’t been used up, both quotas used to capacity would be meaningful for Chinese market,” he said.

“That’s what the regulator is after: increasing international participation in the Chinese market. The stock programme is one way they are doing this.”

However, brokers, investors and regulators in Shanghai and Hong Kong still have a lot of work to do before trades can be made. So, the benefits of the scheme for both cities will not be immediately obvious once it launches.

As such, portfolio managers looking to get a first crack at PRC stock markets will have to invest with longer-term horizons in mind.

“The A shares have pretty much always been a closed market for international investors,” said Steven Sun, head of China equity strategy at HSBC.

“Transparency and disclosure are pretty lacking in the mainland stock market, but expected to improve over time. So, for longer-term investors, this [stock programme] presents a good opportunity.”

MSCI inclusion

In addition, a fully operational cross-border investment scheme will help China in its plan to make the renminbi a more internationally accepted currency.

If foreign investors can get more exposure to A shares through the stock scheme, those are more likely to be included in international stock indices. The indices are key benchmarks for investment funds. Once A shares join big emerging-market indices, EM funds managers will want to – or even will have to – buy more renminbi shares to keep pace with those indices.

In this, China still has a way to go. Index provider MSCI decided not to include A shares in its benchmark EM index in June. The decision was part of a yearly review of the components of the benchmark MSCI EM and China indices.

The reasons for maintaining exclusion are related to investment problems regulators behind the Shanghai-HK scheme are attempting to correct. The index provider says the opportunities international investors have to buy China-listed shares are still too limited. The stock programme, especially if it is extended to Shenzhen, can go a long way towards correcting this.

MSCI put the decision down to feedback from international institutional investors, who say the QFII programmes – for many, the only option to buy A shares – are unnecessary constraints on their investment choices. The company continues to include stocks of Chinese companies listed on other exchanges, including Hong Kong.

The MSCI decision, however, is not final. It may welcome A shares to the EM index after its next yearly review, when the cross-border scheme, if it is implemented as planned, will have had a few months to run.

“We will keep the China A shares on the list for potential inclusion into EM and closely monitor the development of various schemes, such as the Shanghai/Hong Kong Stock-Connect programme, as they are implemented and used by investors,” said Remy Briand, MSCI managing director and head of index research, in the June release.

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