Practical analysis for investment professionals
22 April 2014

Investing in China May Just Get Easier

Investors frustrated about not getting access to local shares in China can now relax. Things are about to change for the better.

Hours after Premier Li Keqiang spoke at this year’s Boao Forum for Asia on 10 April about the Chinese government’s support for mutual access between the stock markets of Shanghai and Hong Kong, the securities regulators of China and Hong Kong announced guidelines for implementing this initiative.

So What’s New and Who Benefits?

Under this scheme, Hong Kong brokers will be able to place orders on the Shanghai Stock Exchange and Chinese brokers on the Hong Kong Stock Exchange on behalf of their clients.

But first, a little background if you are completely new to investing in China. Prior to 2002, foreign stock investors could only invest in Chinese companies listed in Hong Kong or on other overseas exchanges. The Qualified Foreign Investor Scheme (QFII) launched in 2002 was a game changer. For the first time, it allowed approved foreign institutional investors to invest in local Chinese stocks. Institutions soon made some of the stocks available to retail investors through funds either dedicated to China stocks or, more often, in international equity or Asian equity funds.

Although details are still sketchy, the recently announced guidelines promise three new developments for international investors:

  1. International investors, QFII or not, will have direct access to “eligible” individual stocks listed on the Shanghai Stock Exchange.
  2. Individual investors will have direct access through their brokers in Hong Kong.
  3. The suggested quota of 300 billion yuan, or about US$48 billion, which will effectively raise the current QFII quota by 50%, means greater access to China’s domestic stocks for overseas investors.

The same is true for Chinese investors, who currently are only able to access Hong Kong stocks via the Qualified Domestic Investors Program (QDII). This set of new guidelines would offer the same new developments as well, although the quota is slightly lower at 250 billion yuan, or US$40 billion.

The immediate beneficiaries are clearly the brokers in China and Hong Kong, as well as clearing companies for both exchanges. When all is said and done, investors globally will be the biggest beneficiaries. International investors will have better and greater access to the world’s fastest-growing major economy. Chinese investors will also gain important diversification benefits by being able to invest more assets outside of China.

This is also a major step toward the internationalization of the renminbi. Under the new arrangements, Chinese investors will be able to invest in Hong Kong stocks directly using the Chinese currency. The increased flow of renminbi to Hong Kong through official channels would bolster Hong Kong’s position as the leading offshore renminbi trading center.

Market efficiency should also improve. Although there are only a handful of stocks that trade on both exchanges, they tend to be popular stocks of large companies. For a long time, because of the constraints on foreign direct investment, some of these stocks have traded at significant discounts on the Shanghai Stock Exchange. The guidelines, once implemented, should eliminate that phenomenon.

A Cautionary Note and Who Doesn’t Benefit

A cautionary note is warranted as many of the details have yet to be worked out. For example, do international investors need to have the assets in their Hong Kong brokers’ accounts to invest in China’s local stocks, or will investors in other jurisdictions that have cross listing agreements with Hong Kong invest through their local brokers? Regulatory changes in China are not typically known to be expedient and smooth, and this one may prove no exception. The additional inflow from new international investors also may not prove sufficient to reverse the long slump in China’s local stock market.

In terms of what’s not included in the guidelines, we know this does not yet apply to individual investors in China with less than half a million yuan, or about US$80,000, in their trading account. It does not apply to all the stocks listed on the Shenzhen Stock Exchange or some stocks on the Shanghai and Hong Kong exchanges. Regulators on both sides have decided to restrict the “eligible” stocks in the trial stage to only the components of specific large and mid-cap indices and shares otherwise already traded on both exchanges.

Another group of stakeholders that have been anxiously watching on the sidelines are the brokers and fund managers in Taiwan. As this pilot program (Shanghai-Hong Kong Stock Connect) will certainly shore up both Hong Kong and Shanghai’s positions as major financial centers in Greater China, in Asia, and even worldwide, Taiwan is increasingly feeling marginalized.

Overall, this is a major step in the long-term opening of the Chinese financial markets. Although I would not necessarily call this a game changer, it is certainly a win-win for investors globally.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, Multi-Asset Strategies: The Future of Investment Management and AI Pioneers in Investment management. He is also a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

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