Through Stock Connect, the cross-border investment channel that began operating in November 2014, investors outside China are able to trade in shares listed on the Hong Kong and Shanghai stock exchanges. Some minor restrictions remain; for instance, Hong Kong investors trading Shanghai stocks are limited to a daily quota of RMB13m. However, before the launch investors outside China faced lengthy application processes to acquire the required approvals from the Chinese Securities Regulatory Commission (CSRC). Now, to a great extent, if you can deal on one exchange you can deal on them both.
These are two of the world’s busiest exchanges. The Hong Kong Stock Exchange (HKEx) ranks sixth in the world, with Shanghai Stock Exchange a close seventh. As of October 2014, their respective market capitalisations were US$3.3 trillion and US$3 trillion, giving a combined total of US$6.3 trillion to rival some of Europe’s long-established exchanges.
Of course international investors have long sought opportunities to participate in the China growth story. At the same time, China’s investors have been seeking more direct access to well-regulated markets such as Hong Kong’s to create new avenues for capital and to diversify their portfolios. It might also provide them with an alternative to real estate, a long-favoured investment target in China but one which has been seeing recent declines.
China benefits too from growing its influential role in Asia’s capital markets. Hong Kong gains from providing new investment opportunities in a new market for overseas investors, Shanghai from elevating its status as a regional financial centre (RFC). Both benefit from the necessary deepening of the relationships between the regulatory authorities – principally the CSRC and Hong Kong’s Securities and Futures Commission (SFC). Stock Connect has required them to collaborate to an unprecedented level on market surveillance, enforcement and information sharing.
In launching Stock Connect, China is embarking on the second stage of a process to further internationalise its markets. The first step involved the creation of some offshore RMB markets and comparatively small-scale testing of investor appetite for trading; this next stage capitalises on that experience and brings a much more concerted push.
The further RMB internationalisation continues elsewhere is part of the process of China’s integration into the global economy. The further opening of the country’s capital account, a steady rise in the use of RMB as an investment currency by international investors and the International Monetary Fund’s (IMF) expected recognition of RMB as a potential reserve currency via inclusion in its special drawing rights (SDRs) are all critical steps towards the greater internationalisation of the currency and the liberalisation of China’s financial markets. Stock Connect can be viewed as part of this wider process.
Corporations Gaining Confidence
The established RMB centres around the world are leading corporations to become more confident about using the RMB as a transaction currency, and holding it outside China. Investors currently seeking RMB-denominated investments currently do so via offshore “dim sum” bonds. Just as these offer international investors access to RMB-denominated bonds, Stock Connect will enable them to invest in RMB-denominated equities.
It is worth noting, however, that when SSE shares are sold via Stock Connect, settlement is in Hong Kong dollars (HKD). This rule is in place to ensure that RMB used to buy shares via Stock Connect is not then used for other purposes.
Thomson Reuters’ recent white paper The Through Train, co-produced by trade body the Asia Securities Industry & Financial Markets Association (ASIFMA) looked at how the Stock Connect model might develop and be extended to other stock markets and beyond equities into other asset classes such as exchange traded funds (ETFs) and futures contracts. A Bond Connect, for instance, would help to lower Chinese corporates’ funding costs at a time when their cost of capital is increasing.
It now looks as if some of these hopes will be fulfilled – and soon. Last month Chinese premier Li Keqiang announced the next stage of the liberalisation of China’s financial markets with a planned second Stock Connect, this time linking the Shenzhen and Hong Kong exchanges.
This new facility will enable investors outside China to invest in some of the country’s rapidly growing businesses and sectors. Many Shenzhen-listed companies, which include China’s leading residential property developer Vanke and traditional medicine producer Tibet Cheezheng, have consistently outperformed many of the major state-backed enterprises listed in Shanghai. There will be considerable interest in this Shenzhen connection from investors outside China who want to participate in the country’s long-term growth trajectory.
The fact that premier Li made his announcement so soon after the first Stock Connect initiative is a strong indication that China is accelerating efforts to open its markets to the world’s investors. The challenge for the financial services industry worldwide is now to ensure investors’ customers have the information and insight to make maximum use of these opportunities to integrate China further into the global economy.
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