News Analysis: New stock link upgrades opening up of mainland's capital market

A new cross-border stock link between Hong Kong and neighbouring Shenzhen will upgrade opening-up of Chinese mainland's capital market.

The Shenzhen-Hong Kong Stock Connect opened on Monday, offering 881 stocks listed on the tech-heavy Shenzhen stock market to global investors via the Hong Kong bourse. It came after a similar link, Shanghai-Hong Kong Stock Connect, which was launched two years ago to provide 567 stocks on the Shanghai bourse.

A most important point of the Shenzhen-Hong Kong Stock Connect is that it has offered China's most innovative industries and enterprises to global investors, said Charles Li, Hong Kong Exchanges and Clearing Limited chief executive.

The new trading link helps double the daily turnover quota of the entire stock connect program to 26 billion yuan (3.77 billion U.S. dollars) for overseas investors.

NEW MILESTONE IN OPENING UP CAPITAL MARKET

It was only in 1993 that the first enterprise from the mainland got listed overseas, namely Tsingtao Brewery listed in Hong Kong. Twenty-three years later, three bourses in Shanghai, Shenzhen and Hong Kong have been connected in a certain way, ushering in a new era of opening up on the mainland.

Steven Sun, head of HSBC Global Research, said the long-awaited Shenzhen-Hong Kong Stock Connect is another milestone in opening up of mainland's capital market, giving investors access to previously unavailable opportunities to invest in the mainland's future growth.

Bloomberg economist Fielding Chen said in the 1980s when the mainland started opening up, most policies were designed to attract investment, but this time it is not about money.

The bigger end of the stock connect mechanism is to attract institutional investors, for example overseas banks, to change the investment landscape of the mainland's stock market, he added.

Chen added that Hong Kong in essence represents the global market, as international funds can flow freely into or out of Hong Kong, and connecting to the Hong Kong is connecting to the global market.

Dr. E Zhihuan, chief economist at the Bank of China (Hong Kong), expected the stock connects to change investment habits of the mainland investors, but "changes will be gradual."

Unlike many of the world's stock markets, the Shenzhen market is dominated by retail investors rather than institutional investors, who make up more than 80 percent of the trades on the Chinese mainland's stock exchanges, according to an HSBC report.

The market of A-shares, or mainland's local currency shares, has been characterized by frequent trading and high velocity, but a market driven by institutional investors would be more rational and less volatile, the report said.

According to the China Securities Regulatory Commission and the Shenzhen Stock Exchange, overseas ownership of Shenzhen-listed A-share companies was less than 1.2 percent in early 2016, far below 46 percent in China's Hong Kong stock market, 26 percent in Japan, 30 percent in the Republic of Korea, 30 percent in Brazil and 23 percent in Russia.

"That's why the Shenzhen stock market represents the largest untapped investment opportunity in the world," Sun said.

The new link has demonstrated that the mainland is committed to bringing accessibility of the A-share market closer to international standards, he said.

A CATALYST FOR MSCI INDEX INCLUSION

Global index provider Morgan Stanley Capital International (MSCI) announced in June that it was delaying the inclusion of A-shares in the MSCI Emerging Markets Index for the third time following its 2016 market classification review. As a result, A-shares will remain on the review list for potential inclusion into the emerging markets index next year.

Sun believes the Shenzhen-Hong Kong link will be a "catalyst" for the long-awaited inclusion of A-shares into MSCI's Emerging Markets Index.

He forecast the longer MSCI waits, the more likely it is to have to substantially increase the inclusion factor for A-shares and "the time pressure is on the MSCI side, not on the Chinese mainland's side."

He believed the new link should relieve MSCI's concerns over market accessibility and capital mobility in the A-share market. It is worth noting that through the stock connect schemes, the A-share and Hong Kong markets together would form the second largest equity market in the world by market capitalization.

Before the two links, overseas investors can only have access to A-shares via Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) channels, which are restricted by license and quota approvals.

Sun said theoretically, investors can buy or sell 1 trillion U.S. dollars of A-shares over 260 trading days, which means the 20 percent monthly fund repatriation limit for QFII, a key reason for not including A share into MSCI index, is much less of a constraint in terms of capital mobility.

Jeremy Cook, Chief Economist at London-based World First, a foreign exchange company, said many global investors had little access to A-share market before, but the two new stock trading links provide new channels, and once A-shares are added to the MSCI index, overseas investors' demand for A shares will grow remarkably.

BETTER A-SHARE MARKET

In the past two decades the A-share market has been growing mature significantly.

The Shenzhen and Shanghai bourses are substantially more liquid, offer greater transparency and require higher quality standards for listing, disclosures and auditing of financial statements than many of their global competitors, according to the HSBC report.

With the launch of the new stock link, a full set of long-promised major financial reforms or changes on the mainland has been delivered.

They include interest rate liberalization, capital account opening, inclusion of Renminbi in the IMF's Special Drawing Rights basket, and the further opening of financial markets.

The Shenzhen-Hong Kong stock link is riding the tide of mainland's financial system modernization, it said.

Serving companies at different stages of growth, the mainland has built a multi-tiered capital market over the past quarter century.

On the Shenzhen bourse, around 480 competitive blue chips are listed on the mainboard, over 800 niche market leaders on the small and medium enterprises board, and over 550 innovative and entrepreneurial high-growth companies on the ChiNext Board.

The duo links are under Mutual Market Access, a mechanism for capital market cooperation between the mainland and Hong Kong.

The Mutual Market Access will further expand the range of securities eligible for trading under the mechanism to exchange-traded funds (ETFs) and to cover initial public offerings (IPOs), commodities and bonds into the mechanism is also under study, according to the Hong Kong bourse. Endit