China’s unstoppable 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. 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.