China’s historic stock opening to recast global investing

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If proxy indicators are to be trusted, investors will welcome a key further opening of China’s Shanghai stock market to foreigners next month with a bang. More important, though, are the ways in which the partial integration of the Shanghai and Hong Kong exchanges promise to recast the global investor landscape.

Several portents of a rousing reception await the launch of the “Shanghai-Hong Kong Stock Connect”, which is set to offer Hong Kong and foreign investors with offshore renminbi (CNH) the most unfettered access yet to the Shanghai market.

Investors availing themselves of CNH have helped drive the currency’s three-month interbank rate to a 2014 high of over 3 per cent in recent days, up from 1.5 per cent in June. The price gap between the Hong Kong-listed and Shanghai-listed shares of mainland companies with dual listings has narrowed sharply (see chart), as arbitrage intensifies. And some financial institutions, including Deutsche Bank, have had to shut Chinese exchange traded funds (ETFs) to new investment because of capacity constraints.

The chart below shows a narrowing gap between the share prices of the 47 mainland companies with listings in both Shanghai and Hong Kong. An index value of 100 denotes parity in pricing; at Wednesday’s close it stood at 97.

Source: Financial Times“Many investors take the view that the premium between (Shanghai’s) A-shares and (Hong Kong’s) H-shares will go away. I think there will be some differential but not much,” said Cindy Chen, country head, Hong Kong securities services at Citi.

Chen and several others have observed strong interest from investors around the world in the scheme, which is expected to be launched in October although Beijing has yet to fix a firm date. “We do expect the daily quota (on investment inflows) is likely to be fully taken up in the first few days and weeks,” Chen said.

Foreign and Hong Kong investors will be permitted to buy a net Rmb13bn ($2.1bn) in 568 selected Shanghai-listed stocks a day, up to an overall quota of Rmb300bn. Unlike previous partial openings of China’s domestic stock markets (the so-called QFII and RQFII schemes), there will be no lengthy “lock in” periods, allowing investors to sell their holdings without delay.

Changing the global investor landscape
But beyond the immediate prospects for Hong Kong and Shanghai stocks, the scheme creates pressures to reorganise global investing. A glance at the size of the two exchanges suggests that their linkage – which moves to create the third largest exchange in the world – could reverberate for years to come.

One pressure it exerts is upon the vendors of global stock indices, such as MSCI, which face a choice between diluting their influence if they do not accept A-shares into their indices and diluting their standards if they do.

MSCI has announced that it will continue to exclude A-shares from its emerging markets index, but it has acknowledged that it will review this decision in 2015, potentially opting for a phased inclusion schedule that prioritises better-run companies.

Turning the offshore renminbi into a portfolio currency
Another force to be unleashed by the Shanghai-Hong Kong link is for the further internationalisation of the offshore renminbi. The biggest inhibiting factor in the redback’s march toward acceptance as a global currency has been the paucity of investment opportunities.

Jonathan Anderson, economist at the Emerging Advisors Group, has estimated that in mid-2013, total capital market assets freely available to international investors in US dollars were worth $55tn; in euros, $29tn; in yen, $17tn; and, in sterling, $9tn. The renminbi offered a mere $250bn. “That is about 0.1 per cent of the global market, putting the renminbi on a par with the Philippine peso and just a bit higher than the Peruvian nuevo sol,” Anderson noted.

This could change significantly if, as is planned, the A-share market opens in stages to portfolio investors holding offshore renminbi. Chen said it is possible that within a few years the overall quota could rise from the current Rmb300bn to around Rmb1tn.

Chen also sees the potential for a stock connect scheme to be extended to markets other than Hong Kong, perhaps including Singapore and London. “But there needs to be close co-operation between the two regulators . You need a strong political will,” Chen said.

Financing Chinese companies with offshore money
The speed of China’s opening to offshore portfolio flows is accelerating. It took the QFII (Qualified Foreign Institutional Investor) scheme, through which selected financial institutions are permitted to invest in mainland assets under strict guidelines, over 12 years to reach its current quota of $150bn. The RQFII scheme, which sets out investment opportunities to approved foreign financial institutions as long as they own offshore renminbi, was launched three years ago and has a total quota of Rmb480bn.

By contrast the stock connect scheme is starting with an Rmb300bn quota, which analysts expect to be increased quickly in line with official policies on boosting the renminbi’s internationalisation and reforming China’s capital account.

At least as important as the size of the quota, though, are the investible assets under the scheme. Chen thinks that the scope is set to be broadened to include not only bonds issued by China’s finance ministry but also stocks listed on the Shenzhen stock market and equity derivatives.

Such moves, if they transpire, are set to increase pressure for corporate transparency and clear accounting, also elements of Beijing’s reform agenda.

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