Cross-border arbitrage arrangement blocked by controls on capital

The mainland's capital controls and lack of a fully convertible currency will hamper the establishment of an arbitrage arrangement between the Hong Kong and Shanghai stock markets, brokers and fund managers said.

The proposal for such an arrangement was raised by Chief Executive Donald Tsang Yam-kuen in an interview with the Financial Times, after similar calls by Financial Secretary Henry Tang Ying-yen and Hong Kong Monetary Authority chief executive Joseph Yam Chi-kwong.

Mr Tsang suggested bringing in some financial instruments to aid trading of Hong Kong and Shanghai-listed shares in each market. The move could narrow the valuation gap between Shanghai and Shenzhen A shares and Hong Kong H shares.

'The yuan is not yet fully convertible and China has not yet relaxed capital controls. How can we introduce an arbitrage arrangement that effectively would lead to capital outflow from the mainland,' said Christopher Cheung Wah-fung, chairman of the Hong Kong Securities Professionals Association.

Without a fully convertible yuan, foreign investors including those in Hong Kong have limited access to the mainland stock market via channels such as the qualified foreign institutional investor scheme, while the country's capital controls restrict mainland investors from directly buying Hong Kong-listed shares.

This has resulted in a significant price gap for 42 companies that are listed in both markets with their mainland-traded A shares selling at a premium to their H shares.