After a slow start, the predecessor Shanghai-Hong Kong Stock Connect has picked up pace over time. While we expect to a see similar evolution of trading volumes in the Shenzhen Stock Connect, it is helpful to understand some of the reasons for the low initial turnover.
The first is that the investors in both Shenzhen and Hong Kong are circumspect and are slowly getting used to the idea of the platform.
The second reason is that the mainland Chinese stock markets have had a turbulent 2016 and have under-performed compared to leading regional stock markets such as Tokyo or even Hong Kong. The lower economic growth rate of the Chinese economy has been partly to blame for this.
The third is that the stocks in the Shenzhen stock market are small and mid-caps and are not as attractive to foreign investors as those in Shanghai and Hong Kong. The former also have much higher P/E ratios and hence are considered more risky than other alternatives at present.
Despite these reasons, we believe that over the course of the next few months, new Stock Connect will become more popular. The price differential between stocks in Shenzhen and Hong Kong will provide an incentive to investors in mainland China to use the platform to invest in Hong Kong stocks. The higher returns on Shenzhen Stock Exchange, mainly on the technology-related stocks, compared to its Shanghai counterpart will also be seen as attractive by investors based in Hong Kong.
From the regulatory point of view, the Shenzhen Stock Connect is just one element of the overall policy of China Securities Regulatory Commission (CSRC) to open Chinese capital markets to foreign investment. In November 2015, the China Europe International Exchange (CEINEX) - a joint venture between Deutsche Boerse and two Chinese exchanges (Shanghai Stock Exchange and China Financial Futures Exchange) was created in Frankfurt. Products expected to be traded on the exchange include offshore yuan-denominated products including stocks, bonds and exchange-traded funds. From early 2017, it is expected that Chinese companies would be able to list their stocks on the new exchange, thereby creating a new avenue for raising capital. There has also been an announcement of a possible tie-up between the London Stock Exchange and Chinese exchanges to enable easier trading of stocks in both markets.
The foreign exchange policy of the Chinese Government is going to play an important part in the success of these measures. The recent tightening of foreign currency investment norms for Chinese citizens means that the two HKEx Stock Connects might become the main way in which mainland investors can access foreign markets. Hence, it should drive up volumes in these platforms. However, there is another aspect of the Government’s policy that will have relevance in this regard, and that is the expectation that China could have capital account convertibility by as early as 2020. If that does indeed happen, it could lead to the redundancy of the Stock Connect platforms and of similar steps to open Chinese capital markets. Foreign investors would then be able to invest in Chinese stocks in the same manner as they can in the stocks of other leading economies. There would be no need for a specific platform as provided by the Shenzhen-Hong Kong Stock Connect, or its Shanghai counterpart for that matter. Unless there are compelling regulatory reasons or the success of the platform by then makes it indispensable, it is difficult to see how it would survive the development.
Therefore, there is reason to believe that the recent measures by the Chinese capital market regulator will allow for more open capital markets in China. However, once capital market convertibility is achieved, it might be much easier for foreign firms to invest in Chinese markets and for investors in China to access foreign markets as well. In either case, China is making significant headway in becoming a more integrated global capital market and we expect its progress to continue in the near future.