Across The Border

Shenzhen-Hong Kong Stock Connect to see warmer investor response if yuan stabilises

More mainland capital has flowed south to Hong Kong than north, with annual southbound fund flows expected to reach between 200 billion to 400 billion yuan

PUBLISHED : Monday, 23 January, 2017, 4:13pm
UPDATED : Monday, 23 January, 2017, 9:55pm

Since its launch on December 5, the Shenzhen-Hong Kong Stock Connect has seen a relatively lacklustre response from investors compared with the Shanghai-Hong Kong Stock Connect, but analysts expect trading volumes to pick up later this year if the yuan stabilises and concerns ease about China’s economy.

The Shenzhen-Hong Kong Stock Connect (SZ Connect), which allows individual investors from overseas to directly buy stocks in Shenzhen and vice versa, had a slow start in December.

Statistics from Hong Kong Exchanges and Clearing showed that only 7 per cent of the northbound daily quota, which was set at 13 billion yuan, was used in the first month after its launch. In the meantime, only 4 per cent of the southbound daily quota, which was set at 10.5 billion yuan, was used.

In contrast, the Shanghai-Hong Kong Stock Connect (SH Connect), a similar scheme that allows direct cross-border stock trading, saw a daily average of 12 per cent of the northbound daily quota used in December.

According to the latest statistics, as of January 20, 843 million yuan or 7 per cent of the SZ Connect’s northbound daily quota was used, still lower than the 8 per cent used in the northbound quota under the SH Connect.

Investors were also less enthusiastic over the start of SZ Connect compared with when SH Connect kicked off in November 2014. In the first month after the SH Connect’s launch, about 25 per cent of northbound daily quota was used on average, and 5 per cent of southbound daily quota was used.

SH Connect even ignited the A shares boom that began in November 2014, with the Shanghai Composite Index up 11 per cent during that month. In the following seven months through June 2015, the benchmark Shanghai Composite surged more than 60 per cent.

However, since SZ Connect’s launch on December 5, the Shenzhen Composite Index had fallen a combined 9 per cent as of Monday. The benchmark Shanghai Composite had also dropped 3 per cent.

“The SZ Connect has seen a more calm response from the market, which was partly due to different timing,” said Li Kongyi, an analyst from Fortune Securities.

Although SZ Connect expands the stock universe for international investors and allows them to tap into China’s “new economy” stocks, the market sentiment is subdued due to concerns about China’s debt risks and the yuan’s depreciation, he said.

The yuan accelerated its pace of depreciation in the fourth quarter of last year. For 2016, the currency declined 6.6 per cent against the US dollar, the biggest annual drop in 14 years.

A cheaper yuan will make investment returns of A shares less appealing.

“International investors are less interested in A shares now,” Li said.

Another reason was that SZ Connect was launched in December, usually a time when investors choose to stay on the sidelines, said Ronald Wan, chief executive for Partners Capital International.

“Investors are usually cautious at the end of the year,” he said.

“Given the yuan’s recent sharp declines against the US dollar, investors may also want to wait for more clear signals from the Federal Reserve and the Trump administration to assess the direction of the dollar,” he added.

In addition, it also takes some time for investors to become familiar with SZ Connect, which has a different stock universe than SH Connect, Wan said.

Mainland investors buy Hong Kong stocks mainly to hedge the yuan risks, as the Hong Kong dollar is pegged to the US dollar
Li Kongyi, analyst from Fortune Securities

Wan expects trading volumes for SZ Connect to pick up in the longer term when concerns ease about China’s economy and currency and capital flows back to the region from the US.

Meanwhile, there have been more funds flowing south to Hong Kong than funds flowing north to the mainland under SZ Connect.

Data from HKEX showed that daily turnover for southbound SZ Connect reached an average of 26.2 billion yuan in December, while northbound daily turnover was only HK$9.2 billion.

Analysts said the flows are within market expectations.

“Mainland investors buy Hong Kong stocks mainly to hedge the yuan risks, as the Hong Kong dollar is pegged to the US dollar,” said Li.

China has tightened capital controls to stem outflows since the end of last year, imposing more restrictions on individuals who want to convert the yuan to foreign currencies.

However, it has worsened expectations for further yuan depreciation and failed to curb capital outflows, Li said.

Wang Hanfeng, chief strategy analyst for China Capital International Corp, said in a recent research note that mainland capital has flowed into Hong Kong “on a large scale” since late December, with daily buying of Hong Kong stocks representing as much as 20 per cent of the market’s daily turnover.

However, northbound fund flows were weaker, with international investors’ daily buying of mainland stocks usually accounting for less than 1 per cent of the total turnover of the Shanghai and Shenzhen markets.

Wang also attributed the difference mainly to the yuan’s depreciation.

“After the overall limit was removed [for equity trades through the SH Connect scheme] the annual southbound fund flows from the mainland will reach between 200 billion to 400 billion every year,” Wang said, adding that 25 per cent to 30 per cent will be from insurance companies.

China announced last August that the overall quota of 550 billion yuan for SH Connect would be removed and it would not impose any aggregate quota for SZ Connect.