Shanghai and Hong Kong investors can cross buy on both stock markets, which is set to begin on Nov. 17th, 2014. The Shanghai-Hong Kong Stock Connect Program experienced very intensive preparations and finally was approved by regulators after a month’s delay. “The tie up is seen as a key milestone in the capital market liberalization of China – the world’s second largest economy – where authorities keep a strong grip on the Yuan currency”, reported by BBC News.
Below is a video clip providing an overview of Shanghai-Hong Kong Stock Connect Pilot Program.
This is the first time that Shanghai and Hong Kong stock market connect. How will this program impact the market? From my point of view, this pilot program is a landmark for openness to global capital market, a test for capital control and a good scheme for sophisticated long-term investment.
Shanghai will receive more capital inflow from foreign investors. Dating back to 2002, the China Securities Regulatory Commission(SCRC) and the People’s Bank of China (PBOC) launched the QFII pilot scheme by jointly issuing the so-called “Provisional Measures on Administration of Domestic Securities Investment of Qualified Foreign Institutional Investors(QFII).” The system launched with a quota of $350 million and has grown to more then 112 billion. Before, foreign investors who want to get exposure to Shanghai A-share market can only do so through very limited quota of QFII. Now Shanghai-Hong Kong Connect Program will enable foreign investors to gain more quota to invest. The new plan will start with $49billion and will probably increase from there.
More foreign institutional investors will bring sophisticated experiences to shanghai A-share market. For current shareholder composition of the Shanghai A-share market, individuals who hold merely 26% of total market capitalization, account for around 80% of daily trade volume in the stock market. QFIIs take up only 1% of total market cap. In Shanghai A-share market right now, retail investors are most active while domestic institutions often make short-term speculation. There’s lack of investment philosophy to support equity investment. Sophisticated foreign investors will bring long-term view of investment and urge companies to better their cash flow management, dividend policy and transparency.
The Shanghai-Hong Kong link will help the stock market become more reflective of real economic fundamentals and make the price gap closer. Historically, the stock prices listed for the same companies on A share and H share stock markets are different. Shanghai A-share market has long been blamed of underperformance. The Shanghai Stock Exchange (SEE) Commodity Index reached 6000 in 2007 and sparked on a downward trajectory since then. The connect will attract capital inflows and push the price higher. Since the program’s announcement in April, the SEE index has gone up 15%. Before, Shanaghai A share stocks traded at a discount with Hong Kong H share stocks. Recently the price differentials reversed and saw positive in Shanghai A share market.
The Connect Program makes Hong Kong the access point for foreign investors to buy into China’s domestic market and enables China to gain control over how foreigners will spend their investment. “Funds going into Shanghai are limited to 300 billion yuan daily, or 1.7 per cent of the Shanghai A-share capitalization. Foreign investors will be limited to 13 billion yuan daily – just over 5 per cent of daily turnover, much less than Hong Kong”, reported by South China Morning Post. This is a modest limit of volatile hot money but still investable. Currently, China has foreign reserve of $4 trillion and sees hot money continuously flow in. The program provides an alternative channel to examine hot money. The capital from foreign investors can be monitored and controlled. The plan will also seek a bigger role for Yuan as an international reserve currency and push it for trade.
To conclude, the Shanghai-Hong Kong Stock Market Connect Program will further liberalize China’s capital account in a controlled manner. The program has more impact on Shanghai market and makes companies more reflective of its fundamental value. Foreign investors will bring in long-term investment experiences and help make the Shanghai A-share market more sophisticated.