Stock Connect: 5 years on, how did linking the mainland-Hong Kong exchanges become a success after launching during Occupy Central?
- Programme was launched during Occupy Central protests, then dealt with China market meltdown
- Platform gives mainlanders access to home-grown stars like Tencent, while northbound traders can buy high fliers like Kweichow Moutai
After a rocky start, the Stock Connect is now heralded as a great success, giving mainland Chinese investors access to such home-grown stars as Tencent Holdings and at some point e-commerce giant Alibaba Group Holding while giving Hong Kong and global investors the ability to buy such high fliers as liquor giant Kweichow Moutai.
On Sunday, the programme turned 5 years old. Trading began on the Connect first in the Shanghai and Hong Kong exchanges. Shenzhen joined two years later. In 2017, the Bond Connect was launched.
The Connect had some tough moments early on: It was launched during Hong Kong’s Occupy Central demonstrations, had weak traffic, then suffered through the Chinese market meltdown in 2015, which wiped out US$5 trillion in market cap and raised alarms among foreign investors about the stability of the country’s equities.
In June 2018, global index provider MSCI first included stocks on the mainland’s A-share market in its benchmarks, a huge endorsement that had previously been denied three times. The step is accelerating trading of China’s so-called A shares.
“The introduction of the Connect scheme was a significant breakthrough and marked a major opening up of the mainland capital market. All brokers and investors were excited about the new scheme because we knew it would give the markets a big boost,” said Edmond Hui, chief executive of Bright Smart Securities.
The Connect opened a floodgate into what had been an almost entirely closed off stock market for global investors hoping to profit from China’s economic growth.
“The stock connection scheme enables us to own shares in companies like Tencent,” said Ivan Li, an asset manager at hedge fund Loyal Wealth Management. “We think it’s necessary to allocate some assets to own shares in those bellwether technology stars.”
When trading kicked off in November of 2014, the average daily turnover for “northbound” trading – buying by Hong Kong and international investors of select Shanghai-listed companies – was valued at 5.84 billion yuan (US$834.3 million), while “southbound” trading, in which mainlanders were allowed to buy Hong Kong-listed stocks, was much lower, averaging just 757 million yuan a day.
Northbound trading of eligible shares has increased mightily: Total turnover over the past five years topped 16.5 trillion yuan by the end of August.
And now southbound trading averages HK$5.3 billion a day. That represents about 8.4 per cent of the total daily trading value at the Hong Kong exchange.
“Put simply, China A shares would not have been included by (global index provider) MSCI for the first time last year if not for Stock Connect and the resulting ease of access provided for global investors. The door now opened has led FTSE and S&P to follow suit, and global investors now account for 1.6 trillion yuan in China’s A share market. But this is just the beginning,” said Lyndon Chao, the managing director and head of equities at ASIFMA, the regional financial industry association which represents over 125 member firms.
Success has brought new problems, though, Chao notes.
“As portfolio sizes and trading activities increase, the industry will need to work with regulators to further strengthen the trading channels to accommodate large size transactions via block trading, securities lending for risk management and to develop a more diversified investment ecosystem via derivatives, both listed and (over the counter). Chinese regulators have been very proactive in market reforms to grow the market and we expect such reforms to continue,” Chao added.
There are peculiarities that traders venturing into unfamiliar markets must learn.
Not all holidays are not the same on the mainland and in Hong Kong, for example, which adds to how many days the markets are closed and can lengthen the time it takes for transactions to become final.
Traders need to consider currency fluctuations, which can impact gains or losses when converted to another currency.
Also, there is a one-day requirement to hold a newly bought stock in China, meaning no day trading.
And northbound traders face the 10 per cent daily limit for up or down price movement in the mainland’s main exchanges after stocks have debuted, limiting upside gains. (China’s securities regulator says it is increasing the limit to 20 per cent and will allow new stocks to gain or lose without curbs during their first week. The timing of those changes is unclear.)
Meanwhile, northbound traders cannot buy Chinese stocks on their debut, when it is fairly common for them to shoot up to the limit of 44 per cent. And stocks on the new tech Star board, where there is no cap on gains or losses the first week, are not listed on the Connect.
China also limits the percentage of foreign ownership of its stocks, which has prompted some hot stocks to be removed temporarily from the Connect.
Issues like these need to be addressed, says Brock Silvers, managing director of Adamas Asset Management in Hong Kong.
He points out that any retail investor can buy mainland stocks on the Connect programme. But in mainland China, trading on the Connect is restricted to those with at least 500,000 yuan (about US$71,000) to invest, putting Hong Kong-listed stocks out of reach of smaller traders.
“Only larger, approved institutions and wealthy individuals may participate in the scheme, as Beijing knows that a mere circular from regulators can control their trading activities,” Silvers said.
“The financial market is really waiting for a more robust Chinese integration, and not a grudging allowance of controlled outflows in exchange for larger inflows. The Southbound Connect may gain added relevance as Alibaba and others repatriate to Hong Kong,” Silvers said.
Investors from Europe, including Britain, and the United States usually trade on the Connect through the Hong Kong subsidiaries of big banks or international brokers while many Southeast Asian investors like to trade through local brokers in Hong Kong.
“We can see that the foreign ownership is increasing, the investor composition is improving and the concept of value investing has taken hold among local investors,” said Chen Hao, a strategist at KGI Securities in Shanghai. “The blue-chip companies with stable earnings growth do outperform those with poor profitability track records now, which is a goal the Chinese regulator has long wanted to achieve.”
On October 28, select Hong Kong-listed stocks that have so-called weighted voting rights – giving founders and others more control over a company – became available to mainland Chinese traders.
Smartphone maker Xiaomi and online food delivery-to-ticketing firm Meituan Dianping were the first such companies to benefit.
Mainland investors have been piling into Meituan Dianping ever since.
On the Shanghai-Hong Kong Stock Connect, it has been on the top 10 list of the most heavily traded stocks by Hong Kong dollar terms on 13 of the 15 trading sessions, according to traffic data available at the Hong Kong exchange.
In Shenzhen, which accounts for less traffic in Hong Kong dollar terms, Meituan Dianping has been in first place on six of those 15 trading days. It has never been lower than the seventh most traded stock in terms of turnover by value.
In just under three weeks of trading on the Connect, Meituan Dianping had gained 7 per cent as of Friday’s close at HK$96.85 (US$12.38).
“The Stock Connect has brought in much higher turnover in Hong Kong,” said Christopher Cheung Wah-fung, the lawmaker of the securities industry who is also the founding chairman of Christfund Securities. “For the local brokerage houses, it helps bring in international clients as under the Connect schemes, the international investors need to trade through Hong Kong brokers.”
The daily trading quota of the included stocks – 52 billion yuan for northbound and 42 billion yuan for southbound – may not be enough because trading is expected to grow due to China shares being included on the global indexes.
“After five years of running, regulators are encouraged to mull over a plan to revise the trading rules to push further internationalisation of the A-share market, although we cannot expect it to happen overnight,” said Wang Feng, chairman of Shanghai-based financial services firm Ye Lang Capital.
“It is not time to relish its success. It is instead a new start to make the market more transparent and investor-friendly to match China’s economic power.”