Banking & Finance

Mind the gap

Hyped cross-border trading scheme off to a slow start

Hong Kong Exchanges and Clearing Ltd. Chairman Chow Chung-kong and Hong Kong Chief Executive Leung Chun-ying hit a gong, along with officials from the Shanghai Stock Exchanges live broadcast on the screen, during the launch ceremony of the Shanghai-Hon

Big bangs: Hong Kong and Shanghai officials strike the opening gongs

The last time that Charles Li, the chief executive of Hong Kong’s stock exchange, was mentioned in WiC he was in an awkward spot. He hoped that Alibaba would float on the territory’s exchange, but was reluctant to cede to its demands to waive some listing rules.

Such was his dilemma that he even debated it in his dreams (see WiC211). Ultimately, he said no and Alibaba headed off to New York instead.

This week Li was in a happier mood, celebrating the debut of a new channel for direct trading between the bourses of Hong Kong and Shanghai.

Once envisaged as a “through-train” linking investors in the two markets, the long-awaited scheme is now known as the Shanghai-Hong Kong Stock Connect.

So Monday’s launch was an exciting moment, and Li could be forgiven for mixing his metaphors as he tried to manage expectations about the scheme’s debut.

He asked the public to judge the scheme’s progress over the longer term and not on its first day adding that “whether the initial trains are sold out with large crowds left on the platform or the train departs with some empty seats may not be as important”.

But he then switched transport mode to urge caution once more, telling reporters that “safety and smooth travel is much more important than how many cars have actually crossed the bridge”.

Happily, there weren’t any glitches on debut day and the trading flow out of Hong Kong into Shanghai had reached its one-day cap of Rmb13 billion ($2.1 billion) in five trading hours.

Early trading in ‘southbound’ traffic from China was more subdued at 17% of its own quota, reaching just Rmb1.8 billion on the first day. Day two was more lacklustre, with participation falling in both directions as usage rates for Hong Kong and China declined to 37% and 8% of their respective quotas.

On day three only 2.4% of the southbound quota had been used, prompting Li again to call for patience.

So who can use the new scheme?

Well, Shanghai shares can now be traded via Hong Kong by all Hong Kong and overseas investors while the trading of Hong Kong shares via Shanghai is open to all mainland institutions, plus individuals with at least Rmb500,000 in their brokerage accounts. Under the current arrangements both channels are subject to daily and cumulative limits. But in the longer run the prospects seem significant, especially if quotas are relaxed and the scheme is expanded. For instance, if stocks listed in Shenzhen are added next year, the combination would become the world’s second largest share market, behind the New York stock exchange.

HSBC – which thinks that the Stock Connect will turn out to be a “game-changer” – says this would create an amalgam of more than 4,000 companies, with over $7 trillion in market cap and annual turnover of more than $9 trillion.

Despite the cautious beginning, Hong Kong is counting on securing more interest from mainland investors, whose personal deposits were said to be worth Rmb50.4 trillion in September. Traditionally, the Chinese have been relatively unenthusiastic about the prospects of buying overseas shares, showing little interest in earlier channels like the Qualified Domestic Institutional Investor (QDII) programme, which lets them buy stock in foreign companies through mutual funds. HSBC puts some of this down to ‘home bias’, quoting studies that Asian investors prefer to hold a much larger percentage of their assets in “home” markets (85% of assets invested in Asia, for instance, compared to the 60% of European assets that stay in Europe). Only about 2% of the three million retail investors said to be financially capable of participating in Stock Connect had signed up by day one.

One dampener is that many of Hong Kong’s stocks move in step with the Chinese markets, giving investors less chance to spread their risk. Another is that investors might be concerned about exposure to the Hong Kong dollar, which has been depreciating against the Chinese currency. Or maybe those rich enough to participate are already trading illicitly in Hong Kong stocks, reducing the appeal of the new link.

There are some incentives to join the scheme, however, including an opportunity to put money into Chinese stocks currently unavailable on the mainland, such as Tencent and China Mobile (although both were fallers in Hong Kong early this week, suggesting this trend is yet to materialise).

Also a positive is that Hong Kong’s shares aren’t bound by the 10% daily movement limit that applies to their mainland peers.

Meanwhile the authorities have tried to drum up interest by announcing that mainlanders won’t need to pay capital gains tax on their Hong Kong-listed stocks for three years.

But bigger picture, another beneficiary of the new link is the renminbi, which is continuing its steady spread into international markets.

As an example, the Hong Kong authorities expected that investors would want to buy more renminbi to make their new investments in mainland stocks, and that there could be a squeeze on the supply of offshore yuan in the city.

In anticipation the local monetary authority scrapped a 10-year old conversion limit preventing residents from buying or selling more than Rmb20,000 a day, and appointed a group of local banks, including HSBC, as “primary liquidity providers” to manage demand for the currency. This effort to make it easier to get hold of the yuan offshore has also been apparent at China’s central bank, which has been setting up clearing arrangements with designated partner banks in a number of international cities.

Companies from countries without clearing facilities have to convert funds for buying and selling in China via an intermediate currency, usually the US dollar – an extra step that adds time and cost.

Cities aspiring to become “renminbi hubs” have also been clamouring for more direct access to the Chinese currency. This month Bank of China started converting euros directly into yuan with a number of German banks in Frankfurt, for instance, while Bank of Communications began offering the same service to Korean banks in Seoul.

Other countries are poised to set up similar arrangements. Canadian Prime Minister Stephen Harper announced that Canada would do so during his trip to the recent APEC summit in Beijing, while Malaysia has confirmed a similar deal, becoming the second country after Singapore in ASEAN to get yuan clearing. Also this month, Qatar said that it is going to be the first country in the Middle East to join the group. Continuing the global push, the central bank in Australia announced a new deal to set up yuan clearing in Sydney too.

Back to Hong Kong, and HSBC says the Stock Connect must clear up an issue if volumes are to soar. “Money managers, who run traditional mutual funds and pension funds, are facing a legal glitch on whether they actually own the shares bought through the scheme. The compliance requirements at traditional asset managers will prevent them from participating if this glitch is not resolved. That being said, we do expect these issues will eventually be solved, as the regulators are committed to make the Stock Connect a commercial success,” the bank points out.


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