For much of the last decade China has been flexing its muscles internationally – from being the host of Beijing Olympics in 2008 to last month’s recent APEC Economic Leaders’ meeting. But in one area it has been particularly slow – namely, the pace at which it liberalizes cross-border investments. However, that now appears to be changing, with Beijing stepping up its financial market liberalisation efforts, establishing offshore RMB centers from Sydney, Singapore to London and granting foreign companies permission to move RMB across borders with greater freedom.
However, investors around the world remain cautious and several issues remain, including deregulation of interest rates, further internationalization of offshore RMB into a hard currency and improving market access for foreign companies.
The Shanghai-Hong Kong Stock Connect programme, announced in April 2014 and launched on 17 November after more than six months of preparation is another indicator that China wants to play a greater role in international finance. This “through train” scheme has been a topic of interest in the APAC region, with the news sending the Hang Seng Index to a one-month high and the Shanghai Composite Index jumping from 2,000 since its announcement to around 2,763 in December 2014.
This scheme, in theory, should lead to the rebalancing of global capital flows and shows Beijing’s determination to elevate the RMB from being a currency of trade settlement to one of international investment, comparable to the dollar, as well as narrowing the stock price gap for companies that are dual-listed on both exchanges.
Julie Dickson, Portfolio Manager at the Ashmore Group stated recently that “This connect will allow some mutual market access and is a further opening of China’s capital market. The $4 trillion A-share market is far larger than the H-share market for Chinese shares. More and more investors are looking at it for the first time.” (A-share refers to shares denominated in RMB that are traded on both Shanghai and Shenzhen Stock Exchanges, and which generally trade at a premium to H-shares as the Chinese government restricts inbound and outbound investment in stocks. H-shares are issued by companies incorporated in China and traded on the HK Stock Exchange).
Currently, investors outside China can only invest on the Shenzhen Exchange and Shanghai Exchange via the Qualified Foreign Institutional Investors (QFII) programme, which began operations in 2002, and the Qualified Domestic Institutional Investor (QDII) programme, which enables Chinese funds to invest globally. Stocks on the Shanghai exchange are limited to a daily rise or fall of 10%, compared to those in Hong Kong, which can fluctuate by any amount.
Now, with the expansion of existing quota systems to RMB300bn, investors will be allowed to buy a net $2.1bn in 568 selected Shanghai-listed stocks a day and waive the need for investment licenses for global funds looking to trade Chinese shares. This will also accelerate investment flows and eventually eliminate the difference in valuations between mainland-listed A-shares and Chinese companies’ internationally traded H-shares.
Since April 2014, the prices between the two share classes have already started to converge and A-share blue-chip companies not listed in Hong Kong seems to have become the biggest beneficiaries of the stock connect. The liquidity premium has also started to fall with the gradual merger of the investor base across both listings and trading in the Shenzhen Stock Exchange will inevitably start to sync up.
Furthermore, there will be no lengthy “lock in” periods, allowing investors to sell their holdings without delay; taxes are temporarily exempted on profits made from the scheme.
A hurdle facing Stock Connect is mainland China retail investors’ unfamiliarity with Hong Kong stock market regulations. Demand for QDII funds dropped in 2014, suggesting that mainland investors are not as interested in Stock Connect as regulators or the media might expect. By contrast, QFII-approved funds have been increasing sharply over the past two to three years.
Based on the trading performance since its launch, this scheme has attracted strong demand for mainland-traded shares and created a short-term spike in volatility, with small scale Hong Kong stocks being most affected. Contrasting performances between the northbound and southbound fund flows under the scheme were recorded, raising questions about whether the trading quota is sufficient to meet demand, given that the daily quota of RMB13bn was used up by 2pm on the first day of trading.
Although this HK-Shanghai link aims to bring structural changes to the Chinese market – as over 80% of investors are individual with immature investment style, and the rest are retail investors – there is still a very long way to go and much effort is need to bring China up to its peers’ standard.