Stock Connect scheme has faced low turnover, volatility and regulatory challenges
Turnover from the scheme’s northbound route represented only 2 per cent of the Shanghai market at its peak
The Shanghai-Hong Kong Stock Connect scheme was billed as a breakthrough in mainland market reform, but on the eve of its first anniversary it has failed to live up to expectations.
And, what is more, it has also raised new challenges for local regulators and brokers that need to be addressed.
The scheme, launched a year ago tomorrow, has already entered the history books for allowing foreign and mainland retail investors to freely conduct cross-border trading in selected stocks in Hong Kong and Shanghai, subject to quotas.
However, despite running smoothly, turnover is low and many brokers and investors ignore it.
“It was bad timing as the scheme was launched in a year when China’s economic growth slowed down and overseas markets also have faced uncertainties such as the US interest rate rise,” said Ben Kwong Man-bun, executive director and head of research of KGI Asia, adding that trading was not as active as initially expected.
“The benefits for local brokers are not high and it has not brought too much commission income,” he said.
Turnover from the scheme’s northbound route – international investors buying Shanghai stock via Hong Kong – represented only 2 per cent of the Shanghai market at its peak in April and has since fallen to around 0.6 per cent.
The southbound route – mainlanders buying Hong Kong stocks from Shanghai – represented only about 5 per cent of Hong Kong market turnover at its peak in April and has since fallen to 1 per cent.
HKEx chief executive Charles Li Xiaojia played down the low turnover factor.
“The focus shouldn’t be on statistics because stock connect is a catalyst, and a model, for the future,” Li wrote in his blog. “It shows us what’s possible when we innovate and exploit the great advantages Hong Kong has under ‘One Country, Two Systems’, and the benefits we can earn by working alongside mainland China as it grows and internationalises.”
Local broker Christopher Cheung Wah-fung, who represents the financial sector in the legislature, said the scheme only appealed to big banks and large brokers, with many local stockbrokers opting out. Only 110 out of the 450 local stock brokerage firms joined the scheme.
“The majority of the local brokers are serving local retail investors, who are not that interested and know too little about many A shares,” Cheung said. “ Likewise, many mainland retail investors know too little about Hong Kong stocks.”
Despite the low turnover, Joseph Tong Tang, executive director of Sun Hung Kai Financial, said the connect scheme had opened up a new investment channel.
“It takes time for investors on both sides to learn about the different market practices and companies listed in another exchange,” he said. “It is more the synchronisation of market trading rules that is the key for future developments, for example it is extremely difficult for Hong Kong investors to get used to the ‘daily trading limits’ rules in mainland markets.”
Keith Pogson, a senior partner at accounting firm EY, said the scheme had to deal with the questions such as the importing of volatility into the Hong Kong market, which had led the local market to think about whether it needed to introduce circuit breakers.
After Beijing allowed mutual funds to invest in Hong Kong stocks, the Hong Kong market’s turnover tripled to a record high of HK$293.91 billion on April 9. Both Hong Kong and Shanghai markets rose to seven year highs, but the mainland market rout from June saw Shanghai’s benchmark index fall by as much as 30 per cent, with the Hong Kong market down 20 per cent in the third quarter.
Brett Mcgonegal, chief executive of Reorient Group, said: “the connect has certainly had its hand in some of the volatility we saw this summer in both A and H shares. I think that as the mainland investor begins to be more fundamentally driven in investment themes we will see the volatility come down and a broader field of names gaining attention.”
The stock connect introduced new regulatory challenges in preventing potential cross-border market malpractices. Securities and Futures Commission chief executive Ashley Alder told a seminar recently that it had enjoyed “a very good experience under our new cooperative arrangements” with the mainland’s China Securities Regulatory Commission.
“First, whilst for obvious reasons the details have to remain confidential, I can say that we have experienced consistently rapid responses from the mainland to our requests for surveillance information about dealings in our market,” Alder said. “These ranged from inquires about potential insider dealing to market manipulation and unexplained movements in prices or turnover.”