One China, two stock connects

Nicky Burridge
Ester Zirilli 

Since launching in 2014, Stock Connect has helped bolster Hong Kong’s role in connecting the Mainland with the rest of the world. Nicky Burridge finds out how else the cross-border access scheme has impacted Hong Kong, how investors have benefited, and what the current issues are

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Nicky Burridge
Ester Zirilli 


More than US$60 billion of foreign money is expected to flow into Mainland Chinese stocks, known as China A-shares, during 2019 following a decision by global index provider MSCI earlier this month to increase the weighting of Chinese equities in its benchmark indices. The move will see the proportion of A-shares in MSCI’s Emerging Markets Index quadruple from 5 percent to 20 percent.

The inclusion of A-shares has been helped by Stock Connect, which refers collectively to the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect. “Stock Connect has proven to be a robust channel to access China A-shares,” MSCI says, in a consultation document issued in relation to the planned increase in the weighting.


First launched in November 2014, the Shanghai-Hong Kong Stock Connect enabled international investors to invest directly in shares listed on the Shanghai Stock Exchange through Hong Kong, while Mainland investors could buy equities listed in Hong Kong. The scheme was expanded in December 2016, with the launch of the Shenzhen-Hong Kong Stock Connect. Today it covers more than 2,000 equities in Hong Kong, Shanghai and Shenzhen.

As of 15 November 2018, the total turnover of northbound trading reached RMB8.77 trillion (US$1.31 trillion), with a net inflow of RMB614.8 billion (US$91.5 billion); while HK$6.55 trillion (US$830 billion) was traded southbound, with a net inflow of HK$812.8 billion (US$103.6 billion), according to the Hong Kong Stock Exchange.

Stock Connect has had a significant impact on the investment landscape since it was first launched. “Historically, there was very little interaction between onshore and offshore investors, with both of them restricted to their respective markets. Stock Connect created a direct linkage between the two exchanges,” says Jason Lui, Head of Equity and Derivative Strategy, APAC, at BNP Paribas Hong Kong,

Ferry Choy, Director of Flagship Appraisals and Consulting, explains that prior to programme, international investors had to go through agencies or side products in order to invest in Mainland China’s market. “This was a real obstacle. Now with an account in Hong Kong, they can directly invest in either the Shanghai or Shenzhen exchanges,” he says.

The initiative has brought significant benefits for investors in both Mainland China, known as onshore or southbound investors, and those in Hong Kong, known as offshore or northbound investors, particularly in terms of portfolio diversification.

Choy says: “Stock Connect between Hong Kong and China provides a much wider range of stock options to investors. Hong Kong stocks tend to be more focused on banking, finance and real estate companies. Shanghai stocks tend to be more weighted to industrial and manufacturing industries, while Shenzhen is weighted to technology.”

Lui adds that the scheme gives foreign investors access to some unique stocks that are only listed in Mainland China, such as liquor, household appliances, healthcare and other new China-type companies. “For domestic Chinese investors, having the ability to buy Hong Kong shares is the first time they could allocate their assets overseas,” he adds.

One China, two stock connects

Boosting Hong Kong

Alongside the obvious benefits for investors of portfolio diversification, Stock Connect has also had a number of secondary benefits. Choy believes the inflow of cash has helped with the rapid development of private enterprises in Mainland China. It is also leading to more global buyers holding renminbi, he adds, promoting the internationalization of the currency, which is an important factor in international trade relations.

Dennis Lam, Equity Analyst at UBS Wealth Management, Chief Investment Office, points out that foreign capital flows have also increased the overall liquidity for the three stock markets involved in the scheme.

Lui agrees, saying: “There has been pretty decent growth in terms of the overall Hong Kong market turnover. I remember back in the days before Stock Connect, a HK$100 billion daily turnover used to be the high-water mark, but now we are regularly reaching that.”

“For domestic Chinese investors, having the ability to buy Hong Kong shares is the first time they could allocate their assets overseas.”

Meanwhile, Choy thinks the scheme makes Hong Kong a more attractive place for companies to list. “It opens the door for Mainland companies that face a long waiting time to list on Mainland China exchanges. It is also attractive to those international companies that have a substantial business exposure in Mainland China to be listed in Hong Kong too.

“As international companies are looking to do initial public offerings (IPOs) in Hong Kong, more and more money will flow into Hong Kong, strengthening the city’s international position as the international financial centre in Asia.”

Paul Chau, Managing Director of China Galaxy International Securities, and Chairman of the Hong Kong Institute of CPAs’ Corporate Finance Advisory Panel, thinks this creates opportunities for Hong Kong CPAs. “As a key objective for the programme is to broaden the depth of capital and improve liquidity in both markets, the securities and asset management firms should directly benefit, and therefore so should the CPAs working in these fields, whether in front line or finance functions.”

Another area in which accountants have a significant role to play is in helping to reconcile the two different accounting systems used by companies listed in the Mainland and those in Hong Kong. “One of the existing obstacles is the different accounting systems in Hong Kong and the Mainland. This issue has become more serious after the implementation of new major international standards in Hong Kong, such as Hong Kong Financial Reporting Standard (HKFRS) 9 Financial Instruments, HKFRS 15 Revenue from Contracts with Customers and HKFRS 16 Leases,” Choy says.

Changing investment patterns

While figures are published daily on how much is being invested through Stock Connect, there is no publicly available data on who is behind these investments.

The initial wave of southbound investing is thought to have been dominated by institutional investors looking to diversify their portfolios, but more recently, Stock Connect appears to have been gaining popularity with speculative and retail investors. “Our impression is that for the first few years, the southbound Stock Connect was more of an asset allocation inflow, mainly from institutional investors, especially insurance companies, such as Ping An, which is now one of the major shareholders of HSBC,” says Lui. “I think over the past 12 to 18 months, based on the rapid rotation of top-buying and top-selling stocks on a monthly basis, it seems there has been a lot more so-called ‘fast money.’ We don’t know if this is institutional or retail, but the behaviour suggests that it is no longer just asset allocation.”

He adds that there has recently been a lot more rotation in stocks, with a stock that was a top buy one month becoming a top sell a few months down the road. Kevin Leung, Executive Director, Investment Strategy, at Haitong International Securities, agrees: “Over the past two years, we have seen a lot of Mainland capital flowing into Hong Kong and this has resulted in different trading patterns compared with before.” He adds that before Stock Connect, investing in Hong Kong was driven by institutions and tended to be focused on fundamentals and value. Now it is more momentum driven. Stock Connect is also thought to have played a role in driving up equity prices in Hong Kong.

“For both markets, the capital flows from Stock Connect have become an increasingly important factor because the growing influence of such flows could drive the outperformance of certain stocks or sectors favoured by Stock Connect investors,” says Lam. “In some selected instances we did see stocks having outsized returns, which were potentially driven by Stock Connect flows.”

Choy believes that Hong Kong-listed stocks may have particularly appealed to Mainland investors in the early days due to a perception that they were undervalued. “After the launch of Stock Connect, Chinese investors quickly pushed up Hong Kong stock prices. However, this phenomenon did not last long. It just accelerated Hong Kong stocks to match their real value. I think the effect is a better understanding of the difference in risk and liquidity. As you know, stocks can be freely traded in Hong Kong but less so in China when the market is volatile.”

Lui thinks Stock Connect may also have helped to normalize the so-called “A-share premium” in terms of valuations. “Historically, China A-shares tend to trade at a slight premium over H-shares, and that premium has actually started to come down over the past few years,” he says. “There is no way you could say Stock Connect is solely responsible for that, but it certainly makes things a lot easier if people want to express a relative view in one market versus the other.”


Trade and ownership limits

Despite Stock Connect making it easier for northbound and southbound investors to put money into each other’s markets, there are still some restrictions in place, including trading quotas.

The daily quotas for trading have steadily increased since the scheme was first launched, most recently in April 2018, when the daily northbound quota quadrupled to RMB52 billion from RMB13 billion, and the southbound one to RMB42 billion from RMB10.5 billion.

There are few concerns among analysts that the quotas will be reached, with the expected US$67 billion inflow anticipated as a result of MSCI increasing the representation of A-shares in its indices. “We should think of the investment quotas as a moving target. The regulators have made clear in the past that they have a flexible attitude towards the Stock Connect quotas and can adjust or expand them if and when needed,” says Lam.

Of more concern is the foreign ownership limit. Lui explains that under Stock Connect, a 30 percent limit has been put in place on the proportion of shares in a Shanghai or Shenzhen-listed company that can be held by foreign investors. “With the opening up of the Mainland China capital market, we think this 30 percent is inconsistent with where the market is heading.”

He points out that foreign companies can now own majority stakes in the automotive sector and President Xi Jinping has committed to opening up the financial sector to enable foreign companies to own majority shares. “It is our hope that regulators will address this disconnect.”

“We should think of the investment quotas as a moving target. The regulators have made clear in the past that they have a flexible attitude towards the Stock Connect quotas and can adjust or expand them if and when needed.”

Another area that commentators think would benefit from regulatory attention is the issue of bonds. “Recently some convertible bonds have been launched by A-shares. As a shareholder, you have the right to subscribe to those bonds,” Lui explains. “However, if you are holding these shares through Stock Connect, it is currently unclear what the long-term solution for investors to participate will be.”

He would also like to see the investible universe of Stock Connect extended from its current level of just over 2,000 equities. Leung agrees: “People are looking for more opportunities to invest in different products and a fully opened-up market to enable both Hong Kong and Mainland investors to take advantage of offerings they can’t find in their local market.

“Mainland investors may want to tap into the Hong Kong IPO market, while Hong Kong investors want access to different RMB-denominated products.”

Since it was first launched, a number of improvements have been made to Stock Connect, including the introduction of Special Segregated Accounts and real-time delivery versus payment, which enables delivery and payment to happen simultaneously. In 2017, Bond Connect was launched enabling cross-border trading in bonds, while there is talk of an Exchange Traded Fund Connect being introduced, possibly as early as this year.

Meanwhile, Stock Connect is in the process of expanding into Europe. Shanghai-London Stock Connect, which is expected to launch this year, will enable international investors to access China A-shares through buying Global Depository Receipts – namely bank certificates for shares in a foreign company – traded on the London Stock Exchange, while firms traded in London will be able to list Chinese Depository Receipts in Shanghai. The move will enable international investors to trade A-shares during United Kingdom trading hours. They will also be able to make purchases in a range of currencies, including pounds and euros.

Lui says: “It is our view that the Shanghai-London Stock Connect will look quite different from a trading standpoint. The exchanges, as well as the regulators have done a lot of work trying to facilitate smooth trading operations, but because of the time zone and exchange rate challenges, it may not be a 100 percent replica of the Shanghai-Hong Kong Stock Connect.” In the meantime, Hong Kong continues to offer the easiest route for foreign investors wanting to buy A-shares.

The Stock Connect schemes allow Mainland traders to invest in 417 Hong Kong-listed companies out of a total 2,331 companies listed in the city, as of the end of February.

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