China Grants Long-Awaited Cross-Border Stock Trading

The announcement today that the Hong Kong and Shanghai stock markets will be linked into what has been called the “northbound and southbound stock through trains” is expected to generate a huge boost to the Hong Kong Stock Exchange, with volumes leaping upwards by 20-25 percent for the HKex and 15-20 percent for the Shanghai bourse.

Immediately after Chinese Premier Li Keqiang told the annual Boao Forum in Beijing that the two markets would be linked, Hong Kong’s Financial Secretary John Tsang and the China Securities Regulatory Commission simultaneously broke the news that anticipated “Mutual Market Connectivity” is to be officially launched within six months.

The decision to get the trains moving has been on the cards since last October’s Third Plenum of the Communist Party and is very much at one with the premier’s vow to make the country’s economy more market-oriented. It was triggered by the success of an experiment starting in April 2013 in which Taiwanese, Hong Kong and Macanese investors were allowed to open onshore brokerage accounts.

By July, more than 30,000 such accounts had been opened, with their owners acquiring RMB4.2 billion worth of A-shares through roughly 9,000 active trading accounts. This suggested that Beijing could extend the program to all Hong Kong residents in reciprocity for the outward investment scheme

In addition to the bounce in volumes anticipated for the markets, the announcement marks another key milestone for China on its gradual but steady trek to capital account liberalization. The country’s economic czars are still crossing the river by feeling the stones, developing schemes to allow qualified domestic institutional investors to test foreign markets, widening the trading bands on the renminbi against the US dollar and other means as incremental steps towards eventual renminbi internationalization.

At the same time, however, the International Monetary Fund and other global institutions are warning that China must tread carefully in opening up the capital markets because of the danger of hot money flows in both directions that could destabilize the economy.

According to the mainland securities regulator, the cross-border equity trading scheme is expected to begin on Oct. 8. There is still room for numerology in the Chinese lexicon. 8 is the luckiest number because of its auditory resemblance to the word that means “prosperity” or “wealth.” It is also a day when the skies over Hong Kong’s Victoria Harbor explode into a massive fireworks display.

Stocks expected to be included in the first stage of the trading trial are to include large cap and mid cap stocks on both exchanges, as well as A and H dual-listed equities. A-shares are listed on the Shanghai exchange and are largely available only to domestic investors. H-shares are listed on the Hong Kong Stock Exchange and are available to international investors. In both cases, the origin of business should be the mainland.

Specifically, that includes member stocks on the Shanghai Stock Exchange list of 180 shares and the SSE380 Index, which will be open for Hong Kong-based investors. In Hong Kong, the Hang Seng Composite Large Cap Index) and the Hang Seng Composite MidCap Index) constituents will be available for onshore investors.

Permitted quotas in the initial phase are set at Rmb300 billion for the “southbound train” and Rmb250 billion for the northbound one, with daily quotas limited to Rmb10.5 billion and Rmb13 billion respectively.. While a simple calculation implies that the total quota would be exhausted in just a month, the CSRC has left the door open to make adjustments “according to the trial’s progress.” Hence, the policy impact is sure to be more profound than initially thought.

Stocks with large A and H-share spread discrepancies reacted strongly in the afternoon session on Thursday. Any premium and discount of effectively the same unit of shareholding across the two markets will quickly become a thing of the past as arbitrage moves in to close the gap. Many other businesses listed in Hong Kong but not in the mainland will be certain to attract strong interest from PRC investors, such as for those sectors with large PRC patronage such as Gaming and E-Commerce.

There are no qualification criteria specified for Hong Kong-based investors looking to invest in onshore Shanghai. In the other direction, the Hong Kong regulator has requested restricting mainland participants to either institutional investors or individuals with securities account asset holdings of over RMB500,000. There are no specific restrictions in regard to the location of the individual investor, which is much more flexible than originally anticipated.

Steve Wang is Chief China Economist and Head of China Research for the Hong Kong-based REORIENT Group. He is a regular contributor to Asia Sentinel