Beijing appears ready to approve a long-awaited “south through-train” program allowing qualified domestic individual investors unfettered access to Hong Kong’s stock market, with the possibility that it will be followed by a “north through train” in the near future allowing Hong Kong residents into the Shanghai market.
Although no official announcement has been made, it appears the decision to get the trains moving will come around the time of the Communist Party’s Third Plenum, at which time Chinese Prime Minister Li Keqiang has vowed to make the country’s economy more market-oriented.
The southbound scheme will have an initial quota of US$50 billion, delivering additional depth and liquidity to Hong Kong’s stock exchange, whose daily trading volume in 2012 ranged from US$4.02 billion to US$16.38 billion, as Chinese investors buy into the market. The same thing should be true as Hong Kong investors later are allowed to invest in the China market. We anticipate that these decisions will boost markets in both China and Hong Kong and provide substantial opportunities for stocks with large A-share vs. H-share price discrepancies.
The decision to go ahead has been triggered by the great success of an experiment starting last April 1 in which Taiwanese, Hong Kong and Macau 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 suggests that Beijing could extend the program to all Hong Kong residents in reciprocity for the outward investment scheme.
There are three compelling reasons for the State Council to launch the cross-border investment program in conjunction with the reforms that are expected to be presented at the plenum, which we regard as the most critical event for the Chinese Communist Party since 1978.
First, China has displayed strong confidence in its capital account position by permitting the renminbi to appreciate to new highs against the US dollar, simply by refraining from forex intervention. This highlights that the People’s Bank of China and the State Administration of Foreign Exchange are ready to take on further capital account liberalization as part of the ongoing financial reform package. Introducing an onshore-offshore investment scheme with balanced outward and inward counterparts is a logical progression of capital account reform.
Second, the PBOC’s current public stance basically agrees with HKMA Chief Executive Norman Chan’s proposal to completely remove Hong Kong residents’ daily yuan conversion limit of RMB20,000. The PBOC terms the idea “feasible,” as a precondition to accelerating the development of RMB-based wealth management products, suggesting more proposals are in the works to stimulate the time deposit-driven RMB retail scene in Hong Kong. The ensuing relaxation could also revive Dim Sum bond issuance in the SAR, which stagnated in the third quarterQ (RMB2.53 bn) after a strong first half (RMB34.85 bn).
Third, for such a “through train” scheme to roll, it is generally agreed that pricing of stocks with listings in both Shanghai/Shenzhen and Hong Kong should be as close as possible to minimize arbitrage opportunities and keep market disturbances to a minimum. The Hang Seng China AH Premium index has homed in towards 100 since early October from over 112 in late June, indicating nearly zero average price differences for the largest 53 such dual-listed stocks. Nevertheless, investors can still take advantage of the discrepancies among some of the more significant outliers.
Under the current market system, the two balancing parts of the cross-border investment equation would probably be labeled “QDII2” and “RQFII2,” representing Qualified Domestic Individual Investors and Renminbi Qualified Foreign Individual Investors, respectively. Perhaps Northbound and Southbound Through Trains would be easier to remember. But regardless of the name, we think there could be material changes to the initial assumption of the QDII2 on the back of the rise of Shanghai as the chosen test bed for reform.
The choice of Shanghai as the destination for China’s first pilot free trade zone is no coincidence. Its rapid progress can be measured in light years as compared to the subdued momentum in Shenzhen’s Qianhai zone, which also promises trials of yuan convertibility among other financial innovations. Hence we expect QDII2 – the Southbound Through Train – may be first opened to Shanghai residents as opposed to those in Guangdong. The prominence of the Shanghai Stock Exchange gives its local investors a natural advantage in investing in Hong Kong.
There had been abundant speculation that only high-net-worth individuals with certain wealth thresholds and/or years of investment experiences could be ‘qualified’ for such cross-border investment trials in order to ‘protect’ small investors. That is actually quite debatable, and with Premier Li stressing fairness as a core value for the current reform push, we expect such professional investor-type requirements to be dropped and for regulatory restrictions to be determined by location of residency and the overall permitted quota at the given time. Equally, we do not expect the Hong Kong Monetary Authority to impose such qualifications under which Hong Kong residents could purchase renminbi and get on board the Northbound Through Train.
(Steve Wang is chief China economist and research director for the Hong Kong-based REORIENT Securities Ltd.)