Is the Shanghai-London stock link a clear sign of genuine market reform in China?

Market regulators in China are working on a stock connect scheme that will link the exchanges in Shanghai and London. The scheme is expected to launch this year.

On Friday, the China Securities Regulatory Commission published draft rules governing the new trading system and invited the general public to express its opinion. The link scheme is part of efforts by Beijing aimed at opening up its capital markets, but its impact may be minimal.

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The link with London is being viewed as a symbolic move rather than a substantive measure aimed at inviting more foreign investment participation.

Fang Xinghai, vice-chairman of the China Securities Regulatory Commission, said in May Beijing was worried about capital outflows, and that any reform measure would be implemented keeping financial stability in mind.

Given this approach, it is certain the regulators will only gradually introduce Chinese depository receipts to domestic investors at this early stage.

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An influx of such shares will drain liquidity out of existing A-share holdings, exacerbating the bearish sentiment in the mainland equity markets. Indeed, the benchmark Shanghai Composite Index lost 0.94 per cent on Monday morning following the unveiling of the draft rules.

A different kind of link

The Shanghai-London link was proposed during a visit by Chinese President Xi Jinping to the UK in October 2015. The two countries decided to set up a system that would allow investors to trade shares on each others’ markets. The proposal came after Xi told a panel session of the National People’s Congress in March 2015 that Shanghai was being encouraged to open up its equity markets.

The stock connect with London will use the depository receipt system, and only depository receipt shares – part of a company’s shares transferred to a custodian bank – will be traded by investors.

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The new link will, therefore, be different from the stock links between Hong Kong and Shanghai, launched in 2014, and between Hong Kong and Shenzhen, launched in 2016, which let investors trade shares through local brokerages.

Moreover, the existing stock links with Hong Kong give investors access to a large number of stocks, while the Shanghai-London trading system will give investors access to only a limited number of shares.

The regulators have chosen depository receipts for the London link scheme because the time difference between mainland China and the UK will make it difficult for investors to trade shares directly in each others’ markets.

Beijing also wants to ensure the stability of the A-share market, and is wary of taking a drastic step in its liberalisation drive.

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The exchanges in Shanghai and London have been working on the stock link since 2017, and aim to kick off cross-border trading as soon as possible. The timing of the draft rules is in line with a timetable set earlier. In April, for instance, China’s central bank governor, Yi Gang, told the Boao Forum the Shanghai-London stock connect scheme would be launched this year.

Limited participation

It is believed only blue chip companies with the largest capitalisations and profits will be picked by the commission to issue depository receipts on the London Stock Exchange. UK companies will sell Chinese depository receipts on the Shanghai exchange, while mainland companies will issue global depository receipts in London.

As to who will be allowed to invest, the commission has not yet clarified who will be able to buy the Chinese depository receipts issued by companies listed in London. But it is believed that – apart from institutional investors – only those individual investors who have a capital base of at least 5 million yuan (US$732,032) will be allowed to buy these share.

This means, the threshold for individual investors will be much higher than that for retail investors allowed to buy Hong Kong-listed shares through the existing stock link schemes. Mainland investors with financial assets of no less than 500,000 yuan can buy designated Hong Kong-listed stocks through the stock connect systems.