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Shenzhen-Hong Kong Stock Connect finally gets green light for this year

Hong Kong Exchanges CEO Charles Li explains the long-awaited stock connect arrangement with Shenzhen. (Photo by Kenji Kawase)

HONG KONG -- An investment channel linking the stock exchanges in Shenzhen and Hong Kong is slated to open in the coming months, nearly two years after the launch of a similar link between Shanghai and Hong Kong.

China's State Council gave the nod to the long-awaited Shenzhen-Hong Kong Stock Connect program on Tuesday. In a notice posted on a government website, Chinese Premier Li Keqiang said that preparatory work had been completed.

"The launch of the program is a solid step for China's capital markets to move toward better legal structure, marketization and internationalization. It carries a wide range of positive significance," Li said.

The connect program will give international traders a new direct channel other than the limited paths designated by Beijing, such as the qualified foreign institutional investor scheme, to buy stocks on mainland China's second-largest stock exchange in the southern city of Shenzhen. The bourse is home to higher-growth startups and tech companies like smartphone maker ZTE and electronics producer TCL. Shanghai's bourse is dominated by larger-cap state-owned companies.

For Chairman Chow Chung-Kong of Hong Kong Exchanges & Clearing, this marked "another milestone" for the bourse operator. He told reporters on Tuesday evening that the new trading channel "reflects further opening up of mainland capital market for international and Hong Kong investors" and will further "strengthen Hong Kong's position as international financial center."

The new trade window is expected to be ready in about four months, keeping in line with Beijing's earlier promise to launch it by year-end.

According to the announcement, global investors will be able to trade 880 Shenzhen-listed stocks that are components of major local indexes with market capitalization of at least 6 billion yuan ($906 million) through Hong Kong. But the Chinext market, consisting of mainly startups, will be open only to professional institutional investors for the time being.

On the other hand, mainland investors will be eligible to invest in another 99 Hong Kong-listed stocks included in the small-cap index with market cap of at least 5 billion Hong Kong dollars ($645 million) over a certain period. As most mainland investors hold accounts at both bourses, the new arrangement will expand their tradeable Hong Kong shares to 417 from the current 318 via Shanghai.

The dual-listed shares, or so-called "A+H shares," will also become eligible for investors on both sides.

Exchange-traded funds, or ETFs, will be added to the trading list as well. But trading will begin only sometime next year, given the differing rules and systems with regard to clearing and other trading details among the three bourses involved.

Daily trading quotas from either side will remain the same as the existing Shanghai-Hong Kong link, with "northbound" trading initiated from Hong Kong at 13 billion yuan while "southbound," or mainlanders investing in Hong Kong assets, stays at 10.5 billion yuan.

The maximum cross-border investment quota, or aggregate quota, will not be introduced and will be abolished for the Shanghai-Hong Kong arrangement as well. HKEx CEO Charles Li Xiaojia explained keeping the daily quota while getting rid of the aggregate quota as an "ultimate contingency" plan. It seems far from happening now under the existing scheme, where trading between Hong Kong and Shanghai is limited, but "to leave a stabilizing mechanism" in place for when liquidity gets out of control.

"From the perspective of portfolio managers, Shenzhen stocks provide significant diversification benefits as well as stock-picking opportunities and give ... investors the means to achieve broader exposure to the entire Chinese economy," said the Asia Securities Industry and Financial Markets Association in a statement.

The new Shenzhen arrangement may also enhance the prospects of yuan-denominated A-shares in mainland China finally joining the MSCI Emerging Markets Index after having been rejected again in an annual evaluation this June. HKEx chief Li stressed that the new stock connect will be "an important component of MSCI, [and] we are absolutely on the right direction, on the right track."

Some said the timing of the launch was strategic, given that this announcement came just weeks before the Group of 20 meeting to be held in the Chinese city of Hangzhou this September. This move "not only allows the government to demonstrate a continuous commitment to financial reforms, but also leaves enough time for the launch before seasonally quiet December," said Aidan Yao, a senior emerging Asia economist at AXA Investment Managers.

Hong Kong and mainland stocks have rallied in recent days buoyed by hopes of a formal announcement of the connect program. Hong Kong's benchmark Hang Seng Index reached a nine-month high on Monday but softened by 0.1% on Tuesday, while the Shenzhen Composite Index closed 0.56% higher. The news also sent the Shanghai Composite Index to its highest level since January on Monday.

HKEx's Li seemed quite reluctant to discuss the timing of the move. He initially dodged despite answering other questions in detail, saying that "when you have a baby, just celebrate" and do not try tally up days. Only when pressed further did he admit learning of Beijing's decision Tuesday. "I could not have known earlier than I needed to in order to make this public announcement," he said.

But others are less bullish, noting that investor interest for mainland Chinese shares is likely to wane over time. Data from HKEx showed that the first-half average daily turnover for the Shanghai-Hong Kong Stock Connect was down for both southbound and northbound trading, with the latter falling 60% on the year to only 3 billion yuan ($452 million).

One reason is the valuation difference between markets. AXA's Yao estimates that shares in Hong Kong are trading at 12 times earnings compared with 17 times for Shanghai and 46 times for Shenzhen. "The hefty valuation of the Shenzhen market may be a big hurdle for offshore institutional investors to overcome, constraining the northbound flows in the Shenzhen-Hong Kong Connect," he added.

Nonetheless, Fraser Howie, a long-time observer of China's capital markets, said: "Hopefully this expansion of the [connect] program will mark a new chapter in the market development. But no one should relax, there is lots that China needs to do to build trustworthy and efficient markets."

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