China’s unstoppable market liberalisation
Ben Hung says the Shanghai-Hong Kong 'through train' share-dealing scheme, while not perfect, is a big step in the opening up of China's capital account, part of the irreversible journey of market liberalisation
I was surprised to hear the positive news first hand from Premier Li Keqiang at the Boao Forum last week that investors on the mainland and in Hong Kong will soon be able to trade shares on each other's exchanges. It is not common for such policies to come from the premier himself. The announcement goes beyond adding weight to the importance of the scheme; it underscores Beijing's strong determination for reform.
The Shanghai-Hong Kong Stock Connect programme, or so-called "through train" scheme - is set to be launched in six months, and is a significant step in the opening up of China's capital account.
Enabling cross-border two-way capital flows, the programme is a long-awaited, missing ingredient in the internationalisation of the renminbi
Enabling cross-border two-way capital flows, the programme is a long-awaited, missing ingredient in the internationalisation of the renminbi. Up to this point, the liberalisation of China's currency has primarily been focused on the economy's current account and, in particular, on trade and direct investments. Since last year's change in leadership, there has been a noticeable step up in the pace of reform. This latest Shanghai-Hong Kong linkage is one of a plethora of new measures rolled out by the Chinese government at a breathtaking pace. In the past months, we have seen a widening of the renminbi trading band, the end of the People's Bank of China's control on bank lending rates, as well as the launch of Shanghai's pilot free-trade zone, which opens up two-way corporate payment flows.
The programme is also a first step to quench the thirst of investors for Chinese assets, which have hitherto been inaccessible. Hong Kong, the leading offshore renminbi centre, will soon become the choice connector to bridge, on one side, global investors, who will gain direct access to China's stock market and, on the other, tens of millions of mainland savers keen to diversify their assets.
The "through train" scheme allows mainland investors to trade up to a quota of 250 billion yuan (HK$314 billion) of Hong Kong shares, and Hong Kong investors to trade up to 300 billion yuan of Shanghai-listed shares. Up to now, access to China's A-share market has been limited to licensed institutional investors going through the Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor quota schemes. The new programme provides a more direct and flexible means for investors, including retail investors, to trade Shanghai-listed shares without having to go through fund managers.
Like most reforms, every change will bring knock-on effects. As a start, the programme may narrow valuation gaps between the Shanghai and Hong Kong equity markets. The daily 20,000 yuan conversion cap for Hong Kong residents may become the next regulatory consideration in China's pipeline. Listing in Hong Kong may present a fresh appeal to foreign issuers. And, given that the scheme is denominated in renminbi, the implicit convertibility of the yuan has never been clearer. These are all plausible suppositions for all to bear in mind.
Sceptics may argue that the quotas set by Beijing limit the scale and relevance of the "through train" programme. But it is important to note that the quotas are net amounts, not gross, and that underlying trading value can be many times greater.
For policymakers, it is more straightforward to bring about changes when a market is either all open or closed. It is a different matter when a market is trying to move from one spectrum to the other, where far more risk considerations need to be taken. It is true that by imposing quotas, China has stopped short of a complete opening of its capital account.
Yet, quotas are absolutely necessary to manage the transition from a closed economy to an open one - not to mention this is an economy worth 57 trillion yuan and second in size only to the US. Even the smallest degree of change in China's policy could cause tectonic shifts on the mainland, and send ripple effects across global markets.
China always moves one step at a time, starting new programmes small and expanding them in an orderly manner only when the time is right. To be successful, the "through train" scheme will need expanding and it may prove difficult to achieve the desired results without going all the way.
The opening of stock trading will bring about a different approach to qualified foreign and domestic institutional investor schemes. The former offers a new avenue to directly invest in China and Hong Kong stocks, whilst the latter still has its intrinsic portfolio value as it spans a wider spectrum of investment alternatives, including bonds and futures. The introduction of a "mutual recognition" programme is also on the horizon. This will allow Hong Kong-based mutual funds to raise money from mainland investors and vice versa. All these are progressive examples of China's willingness to experiment with different policy variations in the journey to open up its economy.
The "through train" scheme is part of China's bigger reform train which has strong forward momentum and no reverse gear. It should be clear that the opening of China's capital account is an irreversible journey, just like the internationalisation of the renminbi, which has taken place at breakneck speed in the past few years.
This programme is not perfect. There will be questions and concerns over the quota application, and what happens when quotas are reached. Inevitably, any quota system will create distortions and may induce unnecessary problems.
Investors should brace themselves for bumps along the way, but they should not be put off participating in this significant step in China's market liberalisation. What lies ahead will be well worth the ride.
