Hong Kong-Shanghai Stock Market Connect

Written by Victor Fan || 28 Apr 2014

On April 10, 2014, the Chinese government approved the proposal for Hong Kong-Shanghai Stock Market Connect program, which will allow mainland investors to directly trade stocks in Hong Kong market and Hong Kong investors to trade equities in A-share markets.

The trial will possibly start six months after the announcement.

Hong Kong investors need to have an account with a Hong Kong broker and orders will pass through securities trading service company setup by Hong Kong Exchange (HKEx), and eventually be executed on Shanghai Stock Exchange (SSE). Mainland investors need an account with one of mainland securities companies and the order will pass through the securities trading service company setup by SSE, and then the order will be executed within HKEx.

Specific regulations regarding equties available for trading were also presented in the proposal. Mainland investors will be able to trade Hang Seng Large-Cap Stock Index (HSLI) equities, Hang Seng Small-Cap Stock Index (HSMI) equities and H-share equities in Hong Kong. Hong Kong investors will have access to SH180 equities, SH380 equities and A-share equities in SSE. The opened investment scope is relatively big, considering current available options for cross-border investement.

At the start of the trial period, regulators plan to set quota for cross-border cash flow. For Hong Kong investors, the current aggregate quota available is RMB300bn, with a daily limit of RMB13bn. For mainland investors, the total quota available is RMB250bn, with daily limit of RMB10.5bn. The somewhat different allocation for mainland China and Hong Kong can be explained by Chinese regulators’ intention to introduce more cash flow from outside to increase the liquidity of mainland capital market.

Moreover, there are thresholds for Chinese mainland investors to invest in Hong Kong. The qualified Chinese investors should be either institutional investors or individual investors with capital of more than RMB0.5 million in their accounts. By limiting the potential number of investors, Chinese regulators try to restrict the money outflow from mainland China and increase the cash inflow from Hong Kong. The Hong Kong regulators also proposed similar restrictions in order to mitigate risks by filtering investors.

Analysts consider the establishment of the stock market link program to be a sign of Hong Kong’s leading position as a financial center. As previously launched Shanghai Pilot Free Trade Zone is thought to be a threat to Hong Kong’s leading position, the new program is a symbol to dispel concerns around Hong Kong’s future. From the perspective of Chinese mainland regulators, spurring the investment enthusiasm for the blue-chip stocks and SSE’s trading, exploring roads for IPO registry mechanism and learning from Hong Kong market are all reasonable explanations for setting up the Stock Market Connect program. From the market perspective, as there are companies which are listed in both A-share and H-share markets, it is thought to have arbitrage opportunities. The stock market connect could also be thought of as a scheme for foreign capital to get into mainland China supplementary to QFII scheme; as well as a scheme for Chinese mainland capital to flow to Hong Kong in addition to QDII. In general, the stock market connect is a rational and beneficial step for opening up Chinese capital market.

The chart below is an illustration of differences between H-share and A-share markets, which is thought to be useful for investors.

H-share / A-share Market Companrison Table

 

H-share

A-share

Industry Distribution

Relatively concentrated on finance, energy and telecommunication industries

All industries are available

Investor types (by trading volume)

Foreign investors approx. 46%

Institutional investors approx 61%

Foreign investors < 1%

Institutional investors < 20%

Cash and liquidity

HK market is more easily affected by international cash flow

Less related to international markets compared to HK market

Market mechanism

More mature in IPO, repurchase and delisting mechanism; more flexible in secondary offering; different trading time, t+0, daily price limit and margin trading compared to A-share market

Less mature and less flexible

Derivatives

HK has more derivatives and structured products; and the trading mechanism is more mature

Because of the regulations, Chinese local derivatives are still in small quantity and the trading mechanism is less mature

Trading and valuation

Larger price fluctuation than A-share markets; lower turnover rate; small-cap shares have valuation discounts compared to large-cap shares

Relatively smaller stock price fluctuation than HK; higher turnover rate; small-cap shares have valuation premium compared to large-cap shares

Source: stcn.com, 2014

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