China shares: joined up thinking

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Hong Kong is fighting for its future. In part, this entails maintaining its relevance as China’s conduit to international finance. In that regard it is still on form. Hong Kong’s stock market is part of global benchmarks; Chinese companies use it to access global capital. So Stock Connect, a tie-up between the Shanghai and Hong Kong exchanges, makes sense.

In concept, at least. Subject to quotas, international investors will be able to buy shares in some China-listed companies (A-shares), routing their trades through Hong Kong. Mainland investors will have access to certain Hong Kong-listed shares.

Thus Hong Kong links up with China’s larger trading pool (Shanghai and Shenzhen have traded an average of $20bn a day this year versus Hong Kong’s $8bn), and China takes a baby step towards freer capital flows. But the system must also work for investors. A-shares bought through the scheme will be held in China in the name of the Hong Kong Stock Exchange’s clearing entity. China does not recognise ownership behind nominee accounts. So in the event the Hong Kong Securities Clearing Company goes bust, creditors in China could claim nominee holdings – though unlikely, the risk is a deterrent for institutional long-only investors. Hedge funds, used to instruments that provide performance without ownership, will cope better.

But exclusion of foreigners from A-share rights issues, uncertainty over taxation and pre-trade delivery of stock are additional niggles. The latter prevents short selling and inhibits unplanned sales in response to market conditions. At a cost of up to 1 per cent to deliver stock and return it unsold, “just in case” planning is prohibitively expensive.

Stock Connect is a welcome step towards integration of China into global markets. But more must be done before long-term capital can feel safe enough to play.

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