Primer on Shenzhen–Hong Kong Connect
The Shenzhen–Hong Kong Connect (SZ Connect), which launched in late 2016, has just celebrated its two month anniversary. It follows the ground-breaking success of the Shanghai–Hong Kong Connect (SH Connect), which was launched in 2014, and adds to the menu of options available both to foreign investors interested in acquiring equity exposure in China and to Chinese investors interested in diversifying into shares listed in Hong Kong.
Access to China’s domestic exchanges is now greatly improved. Combined with the elimination of the maximum quota (see more in box at end), international funds now have increased flexibility in investing in the Chinese equities market. Together, the Connect schemes are an important step in the ongoing liberalization of China’s capital markets and the internationalization of the renminbi (RMB).
What Is the SZ Connect?
The SZ Connect is the mutual stock market access between the Shenzhen Stock Exchange (SZSE) and Stock Exchange of Hong Kong (SEHK), with order-routing connectivity to enable investors in one market to trade shares listed on the other market. For northbound investments (i.e., into China), investors in Hong Kong and overseas can now invest in China’s highly liquid onshore A-share market through participating brokers in the SEHK. For southbound investments (i.e., into Hong Kong), only mainland institutional investors and individual investors with an aggregate balance of not less than RMB500 thousand (USD72.5 thousand) are allowed to invest in SEHK securities.
Greater China Stock Exchanges
Hong Kong | Shanghai | Shenzhen |
|
|---|---|---|---|
| Market cap (USD billion) | 3,135 | 4,080 | 3,197 |
| Turnover (USD million) | 6.9 | 22.0 | 27.9 |
| Number of listed companies | 1,713 | 1,175 | 1,859 |
| Constituents | • Wide range of large, liquid blue chips and mid- to small-cap companies • Traditionally dominated by properties and banks • One in five companies listed on the Main Board is a red chip or an H-share | • Large, traditional blue chip companies, such as banks, financial services, and manufacturing • Many state-owned enterprises (SOEs) | • Dominated by smaller, fast growing, and innovative private sector companies • Many new economy stocks active in such sectors as IT, consumer, and healthcare |
Note: All figures as of 30 December 2016
Source: Hong Kong Stock Exchange
As the table shows, despite being a smaller market in value terms, SZSE has more listings and is more actively traded with significantly higher liquidity. This strength is in part attributable to the preference for small-cap and high-growth stocks among domestic retail investors. The addition of SZ Connect is thus complementary to SH Connect, and together they provide access for foreign investors to an estimated 80% of the A-share markets in China, which is an unprecedented level.
Implications of the Connect Schemes
For investors in mainland China, the Connect schemes provide a channel for currency hedging in addition to market and stock diversification. When buying SEHK listed securities, mainland investors would convert their onshore RMB into offshore Hong Kong dollars (HKD) for settlement purposes. Upon the sale of such securities, the HKD are then converted back into RMB and are not allowed to leave the system. Even though the Connect schemes are designed as a closed-loop system, because the HKD is pegged to the USD, the schemes allow mainland investors the additional benefit of currency diversification.
Of course, the significance of the Connect schemes does not end with better market access, more liberalization, and diversification, even though individually and collectively these are important and worthwhile objectives. Importantly, the success of the Connect schemes could be leveraged and further developed to cover other products, including IPOs, exchange-traded funds, REITS, bonds, and commodities. There has also been speculation that at some point, A-shares will finally be included in MSCI indexes.
From the perspective of market integrity, we are optimistic that the Connect schemes will bring additional benefits in terms of improved standards in corporate governance, better transparency and accountability, and more timely disclosure as well as more effective regulation, all of which will contribute to a healthier, more sustainable market.
A Note on Quota
At the time of launch in 2014, trading under the SH Connect was subject to a maximum cross-boundary investment quota:
- Aggregate northbound quota: RMB300 billion
- Aggregate southbound quota: RMB250 billion
- Daily northbound quota: RMB13 billion
- Daily southbound quota: RMB10.5 billion
In anticipation of SZ Connect, the aggregate quotas (Item 1 and 2) were eliminated in August 2016 although the daily quota remains and applies to both Connect schemes. The daily quota is computed on a “net buy” basis and limits the maximum net buy value of cross-boundary trades each day. It is reset each day and any unused amount of the quota is not carried over to the next day. For investors who are already invested, they will always be allowed to sell their cross-boundary securities regardless of the quota balance.
If you liked this post, consider subscribing to Market Integrity Insights.
Image Credit: ©Getty Images/Kanmu
