Opening the Trade Valve

By+Deng+Yaqing

Two years after the launch of the Shanghai-Hong Kong Stock Connect program， China introduced another stock trading link between the Chinese mainland and Hong Kong. This move serves to further push forward the yuans internationalization and cements Hong Kongs status as an offshore yuan hub.

“Only by opening wider to the outside world and constantly advancing the marketization， legalization and internationalization of Chinas capital market can the real economy be better served， making the capital market more competitive，” said Liu Shiyu， Chairman of China Securities Regulatory Commission（CSRC）， in his speech at the launch ceremony of the Shenzhen-Hong Kong Stock Connect program on December 5.

His view echoed that of Wu Lijun， Chairman of Shenzhen Stock Exchange， who believes that with the Shenzhen-HK program in place， the Chinese mainland and Hong Kong will cooperate with each other on a larger scale and at a higher level， which will elevate the international competitiveness of the two markets and increase their capability to serve the real economy.

As statistics have shown， within the first week of the launch， blue chip companies listed on the Shenzhen Stock Exchange attracted the most northbound orders， such as Midea Group， Gree Electric Appliances Inc.， Wuliangye and Vanke. On the other hand， southbound orders took a fancy to small and medium-sized hi-tech stocks such as BYD， ChinaSoft International and Fullshare Holdings Ltd.

“There is definitely interest among foreign investors in Chinese mainland shares， but valuation levels among those companiesShenzhen shares may cause them to be more selective. We are seeing interest in high quality companies which are attractively valued，” Sandy Mehta， CEO of Hong Kong-based Value Investment Principals Ltd.， told Beijing Review.

Lukewarm reactions

China launched the Shanghai-HK Stock Connect program in November 2014 to link the two cities stock markets under an aggregate quota of 550 billion yuan （$82.4 billion）. But， following the announcement of the Shenzhen links approval， both programs will operate quota-free.

Despite that， both schemes will operate under the daily limits currently in place for Shanghais program—13 billion yuan （$1.95 billion） for orders going north to Chinese mainland stocks and 10.5 billion yuan （$1.57 billion） for southbound orders.

According to statistics from the Shenzhen Stock Exchange， from December 5 to 9， the first five trading days of the Shenzhen-HK Stock Connect program， southbound orders registered 851 million yuan （$122.71 million）， 520 million yuan（$74.98 million）， 356 million yuan （$51.33 million）， 412 million yuan （$59.41 million） and 371 million yuan （$53.5 million） respectively—far below the daily limit of 10.5 billion yuan. Meanwhile， northbound orders registered 2.71 billion yuan （$390.77 million）， 1.94 billion yuan （$279.74 million）， 1.78 billion yuan （$256.67 million）， 1.71 billion yuan （$246.58 million） and 3.61 billion yuan （$520.55 million） respectively—also far below the daily limit of 13 billion yuan. However， northbound stock trading is generally more popular than southbound transactions.

There are 881 stocks that foreign investors can choose to trade from in the Shenzhen Stock Exchange through the Shenzhen-HK program， while Chinese mainland investors have only 102 stocks available for southbound orders， said Liao Liao， Vice General Manager of CES Capital International（Hong Kong） Co. Ltd.， a subsidiary of China Eastern Airlines.

Given the size of the Chinese mainland stock market and the investment opportunities it can provide， its reasonable to expect more northbound traffic， said Mehta， who also noted that the recent rise in the U.S. Federal Reserve interest rate is a short-term concern for the HK market.

In the short term， investors tend to be cautious with the HK stock market， because the robust economic recovery in the United States has made interest rate hikes more likely in 2017， which will further shore up the U.S. dollar index， said Yang Lingxiu， Chief Hong Kong Stock Strategy Analyst of Citic Securities.

The expectation of reflation and a stronger U.S. dollar will neutralize investorsenthusiasm to put their money into the HK market and will therefore affect liquidity. Aside from that， stringent regulation and tight liquidity control on the Chinese mainland also block the flow of capital into the HK market， Yang noted.

Since the Shanghai-HK Stock Connect was put in place two years ago， a lot of Chinese mainland funds have been invested in Hong Kong， which also explains the lackluster amount of southbound orders after the launch of the Shenzhen link， said Xu Zhaozhong， Chairman of Luk Fook Financial Services.

According to Gu Lei， a professor of finance and securities with Renmin University of China， to some extent， investors in Hong Kong and other countries are reluctant to promptly step into the Chinese mainland market because valuation levels among Shenzhen shares are conspicuously higher than those listed in Hong Kong， the United States and the European Union.

Furthermore， some chronic structural problems haunting the Chinese mainland capital market also result in investors reluctance to enter the market， said Gu.

Gu also attributed the lukewarm reactions to recent exchange rate fluctuations.

As the U.S. dollar rallies， the United States has gradually regained confidence in rebuilding its manufacturing industry， and the yuan is depreciating against the dollar. Given that， investors in HK and other countries are less willing to buy assets denominated in a depreciating currency， said Gu.

However， Gu said hes optimistic on the prospect.

Overestimated value does not necessarily mean inactive transactions. As long as Chinas economy continues to maintain medium-high-speed growth and its capital market develops steadily， HK and foreign investors will be likely to invest heavily in the Chinese mainland capital market， Gu forecasted.

Far-reaching significance

The launch of the Shenzhen-HK stock link has further advanced interconnection between the Chinese mainland and the HK markets， allowing foreign capital to have full access to the Chinese mainland stock market， said Gui Haoming， Chief Market Analyst of SWS Research Co. Ltd.

With the launch of the Shenzhen-HK program， Chinese authorities removed annual quotas for stock trading. That way， Chinese investors have found it more convenient to purchase foreign assets， and both foreign and domestic investors have had more investment options and dont have to consider quantity limits， said Gui.

Since the flow of funds has become smoother on a global scale， the interaction between the Chinese mainland and the global markets has been strengthened， Gui noted.

CSRC Chairman Liu said the ShanghaiHK and Shenzhen-HK links are just like two rivers concentrating the capital， technology， information， intellect and culture of the Chinese mainland， HK and global markets which will benefit the Chinese mainland， HK and the global economy in the long run， Liu said.

“Financial regulatory authorities of the Chinese mainland and Hong Kong will reinforce cooperation and market supervision and jointly crack down on illegal activities and behaviors such as cross-border market manipulation， in order to better protect legitimate interests of investors，” said Liu.

Mehta told Beijing Review that lessons learnt from the Shanghai connect program will help the Shenzhen link better cope with potential problems.

“Authorities， brokers， and investors all have learned a lot with the Shanghai connect， and they are better prepared and more experienced now，” he said.

“The Chinese Government has clearly fulfilled its promise and goal of increasing opening up its market and economy to allow international investors to participate. We would expect more foreign investors to directly own Chinese mainland shares through the link，” said Mehta.