Tightly controlled scheme may see more than just a slow start
Beijing-imposed currency controls mean that mainlanders will need to brave the costs and risks in order to get the through train moving ahead
"A quiet start [ to the Shanghai-Hong Kong Stock Connect scheme] will not bother me. The ultimate victory lies in the creation of a long-term, stable and vibrant market."
Charles Li Xiaojia,
HKEx chief executive
Read that as an attempt at expectation management. A quiet start, if not a longer-term spell in the doldrums, looks increasingly likely after the local bourse recently revealed more details about the through train investment scheme.
Stock trading is all about risk and reward. Yet, under the tightly controlled scheme, a mainland investor trading a Hong Kong stock will have no idea of those factors until the very end.
How eager they will be to trade in the Hong Kong stock market via the scheme is anyone's guess.
It all stems from currency controls. To reassure Beijing that the new scheme won't hurt, three gates have been put in place.
The first is that while all the buying and selling of stocks will be routed to Hong Kong on a gross basis, the money will be transferred here on a net basis.
The second caps the net money flow in and out of the mainland, with no more than 10.5 billion yuan (HK$13.2 billion) allowed to leave and no more than 13 billion yuan allowed to enter on a single day.
So if mainland investors do 100 billion yuan of buying and 90 billion yuan of selling on a particular day, only 10 billion yuan will get into Hong Kong.
For this to be possible, the money has to circulate in a closed loop.
Once investors sell their stocks, the money will flow back to their home market bank accounts. This also makes sure there is no funny playing around with the money.
But for a mainland investor, it means costs and risks.
Imagine you're a newly rich mainlander sitting in Chengdu who wants to buy HK$10 million worth of Cheung Kong. You will have no idea exactly how much it will cost in yuan terms until the end of the day.
The rate will be agreed between central government-owned China Clear and banks in Hong Kong on a daily basis. If it is HK$1.25 to the yuan, you'd end up paying eight million yuan.
A day later, Cheung Kong gains 2 per cent and you sell. How much you get depends on the exchange rate that day, because the money has to come home and be changed into yuan.
If the yuan goes up to 1.30, you will lose about 2 per cent despite the 2 per cent rise in the stock price. If the yuan goes down, you get more than the stock price appreciation.
And that's before accounting for the exchange spread charged by the bank.
If this doesn't sound too painful, imagine you want to switch your investment from Cheung Kong into underperforming New World Development. In a free market, it is just a click away.
Yet, under the through train arrangement, you cannot. This is because you don't have Hong Kong dollars sitting in your account. Remember, all the Cheung Kong proceeds have already gone home.
To make the new bet, you have to put in a new pile of yuan and start the above process all over again, accepting another round of costs and uncertainty.
It is true that every investment in a foreign market involves exchange risk. The problem here is that you don't have a choice on when to do the currency exchange.
In a real market, there will be some sort of currency hedge between you and your broker. However, in this case, that will be very challenging, if not impossible.
According to HKEx, it is China Clear and not mainland brokers who will have access to the Hong Kong dollars. China Clear will negotiate with Hong Kong banks on the exchange rate and distribute the costs to investors.
The cost allocation formula is still under discussion. With no access to foreign currency and no control over the cost, how can anyone provide any hedging?
The fundamental question is why bother if you can open a stock account in Hong Kong while shopping for a Gucci handbag over a weekend, smuggle big bucks here and trade Hong Kong stocks freely at your Chengdu home.
Why invest under the through train scheme which will incur expensive exchange costs and risks, allows no day trade, bars margin finance and risks the possibility of trading bans in case quotas are exceeded?
And you've read about an HKEx official telling a press briefing that the stock connect conduit could be closed down in the event of a Lehman Brothers-like market meltdown for the sake of the country's financial stability.
Well, how interested are you now?
Sure, many don't have the connection to send money here in suitcases on speedboats. But are we seriously counting on such unsophisticated mainlanders to brave the costs and risks and get the through train steaming ahead?
Let's get real.