adminLondon. — China is about to set another milestone in its long journey of financial market liberalisation. The Shanghai-Hong Kong Stock Connect, to be launched on November 17 will for the first time allow international investors to trade shares directly in China’s stock market without applying for an individual quota.
Although the programme will initially cover select stocks listed on the Shanghai exchange, its implications are significant.
By providing direct access to the Chinese market, it essentially knocks a hole in the Great Wall that has historically separated shares for domestic investors and shares made available to international investors. More importantly, Stock Connect paves the way for China’s stock market to debut on the stage of international relevance, something that has eluded it despite its massive $4,8 trillion market capitalisation.
Locally listed stocks quoted in renminbi, or A shares, may soon be included in key global indices, which means foreign investors will be able to gain direct exposure to China’s growth story through direct ownership. Equity fund flows into the world’s second-largest economy will receive a sizeable boost.
Since the early days of China’s monumental growth story, global investors eager to tap the China theme have done so through Chinese stocks listed in Hong Kong and other markets. Some have access to domestic A shares through programmes for qualified foreign institutional investors, which have set limited quotas.
Since 2002, China has granted numerous quotas totalling a combined $112 billion to foreign investors under the QFII and RQFII programmes but that represents only 5 percent of the A share market capitalisation in free float (tradable on the exchange as opposed to locked up by majority shareholders). The QFII and RQFII programmes have both expanded in size and scope in the past few years.
Accessibility issues have precluded the inclusion of A shares into global indices. In June, MSCI announced that, following consultations with investors, A shares would not be added to its emerging markets benchmark, highlighting constraints linked to the quota systems.
China’s share of the MSCI Emerging Markets Index, at about 19 per cent, comprises stocks listed in Hong Kong, or those listed in China but denominated in US or Hong Kong dollars.
To prepare market participants for the future inclusion of A shares in standard indices, FTSE launched in June its Global R/QFII Series to provide access to Chinese shares in the transition period, noting that China has made efforts in further liberalising its market.
Stock Connect will take access to the A share market to another level. At its launch, foreign investors will be able to trade 568 Shanghai-listed A shares with a combined market value of $2,6 trillion through Hong Kong brokers. Even though a quota is in place, the financial industry expects the program to be expanded — like QFII and RQFII — after the initial phase, boosting investment choices available to overseas investors.
With Stock Connect in place, it is only a matter of time before A shares become a mainstream investment opportunity for global investors. Based on the experience of Korea and Taiwan, A shares are not that far from being included in global benchmarks, given the progress China has made in financial market liberalisation. The announcement could happen as soon as next year.
The long-term implications for the Chinese market are tremendous. Foreign ownership of A shares, which stands at less than 5 percent of free float through the current quota systems, will increase as these stocks are added to global equity indices.
There will also be changes to fund allocations, as China is under-represented in global equity benchmarks. It contributes more than 12 percent of global GDP and a similar share of world trade, but has a weighting of just over 2 percent in the MSCI All Country World Index. The inclusion of A shares in global equity benchmarks could trigger as much as $21 billion of incremental fund allocations to China by 2016.
In the long term, Stock Connect will integrate A shares with Hong Kong shares to create the world’s second-largest market by value. Size aside, it is a market of increased relevance to global investors who are seeking more exposure to China.
The integration of A shares into global indices will allow investors to capture China’s growth more broadly and access opportunities that are only available in domestic markets at present.
It will also allow international investors to refine their exposure from large-cap oil, telecom and banks towards sectors offering more focused exposure to domestic consumption such as health care and media.
Stock Connect is a big step forwards in further liberalising China’s A share market, creating unprecedented opportunities for investors worldwide.
It is also an important component of China’s market reforms including renminbi internationalisation, which will elevate the country’s standing in the global economy — Financial Times
Online Reporter