Slow start for Shanghai-Hong Kong Stock Connect is no indicator of its true potential

The recent link-up between the stock exchanges of Shanghai and Hong Kong marks another milestone in China's drive to reintegrate with the international financial system and transform its currency into a global investment medium.

The Shanghai-Hong Kong Stock Connect is a key element in the bridgework being built between China's huge but relatively isolated domestic markets and international investors, and will become increasingly important as more supporting financial infrastructure is created.

Having grown at a breakneck pace for more than three decades, China's economy is now the second-largest in the world. Likewise, its financial markets have grown: it has recently overtaken Japan to become the world's second-largest equities market and has the third-largest bond market.

But China's 60 trillion yuan (HK$76 trillion) debt and equity capital markets are an anomaly: despite their size, they have been largely out of reach to global portfolio investors.

Years of capital restrictions have isolated China's financial markets. Outward portfolio investment (domestic investment in foreign securities) amounted to just 3 per cent of gross domestic product in China, compared with 49 per cent in the US. The contrast is even starker for inward portfolio investment (foreign investment in domestic securities): 4 per cent of GDP in China versus 86 per cent in the US.

But China is opening up. Since 2009, Chinese regulators have made a concerted effort to make renminbi and renminbi-denominated products more accessible. They started by opening the trade account, and then moved on to encouraging the establishment of an offshore pool of renminbi liquidity.

For overseas investors interested in domestic assets, the People's Bank of China established quota-capped channels like the Qualified Foreign Institutional Investor scheme, which allows foreign institutions to buy into the bond and equities markets.