According to Philip Erhmann, fund manager of Jupiter China Select Fund, the launch of Shanghai-Hong Kong Connect promises a sea change in the way domestic and foreign equity investors operate in the country.
The scheme commonly referred to as the ‘through train’ signals, in our view, a clear commitment by Chinese authorities to capital market reform, but also promises a sea change in the way domestic and foreign equity investors operate in the country.
Major reform
For overseas investors, the ‘through train’ will mark the biggest easing of restrictions on the purchase of mainland-listed, or so called ‘A’ shares of Chinese companies since the introduction of investment quotas in 2002.
Whereas hitherto they had to seek pre-approval from Chinese authorities to buy these shares on domestic stock markets such as the Shanghai Stock Exchange, they can now buy them via the Hong Kong exchange.
Investors, in our view, are likely to take full advantage of this newfound freedom although it may take a year or so for them to really get on board. We believe the market capitalisation of stocks held by foreign capital in China could rise to as much as 10% of all ‘A’ share free float, up from around 4% now.
Such an increase would arguably boost the influence of foreign investors, especially when it concerns issues such as corporate governance, a notorious weak spot for some Chinese firms.
Having easier access to ‘A’ shares also opens up a broader swathe of companies to foreign investment; ‘A’ shares are issued by a much larger number of Chinese companies than ‘H’ shares, which are traded on the Hong Kong Exchange. The scheme, in fact, will allow trading in the ‘A’ shares of 568 stocks, which represents about 90% of Shanghai’s ‘A’ share capitalisation.
Domestic interest
While Hong Kong-based investors will have a daily quota of CNY13bn, or $2.1bn (£1.36bn)to place on the Shanghai Stock Exchange under the new scheme, it is important to remember mainland Chinese investors will also be able to buy up to CNY10.5bn worth of securities on the Hong Kong Stock Exchange. Mainland Chinese fund managers, in our view, will seek to access a number of sectors and stocks, such as large-cap internet and technology-related companies that have been unavailable to them in the past because they were not listed in the ‘A’ share market.
Open-ended mutual funds have been restricted in their ability to participate in the ‘A’ share market via the Qualified Foreign Institutional Investor programme – up to now the only way along with the Renminbi Qualified Foreign Institutional Investor to invest in ‘A’ shares – owing to onerous capital and settlement issues.
What is more, there has been uncertainty about the tax treatment of capital gains and income. The rules and regulations of the ‘through train’, although not uncomplicated, go a long way to addressing the problems that we, and others, have encountered.
There remain outstanding questions relating to taxation, which we believe are close to being resolved.
There is also the challenging issue of needing to deliver stock settlement before payment, although even here there appears to be recognition by the Chinese authorities that changes are needed and should reflect best practice. As much as the ‘through train’ offers very real benefits to all investors, its real importance, in our view, may simply lie as an expression of the Beijing Government’s deep seated desire to continue to implement reforms that will bring its capital markets closer to the standards and practices found in other developed markets.
The fact the Hong Kong and Shanghai stock exchanges have been working on this tie-up for more than nine months is encouraging. It suggests that it is not, as in the past, a short-term fix to stimulate interest in languishing ‘A’ shares but rather a meaningful reform to drive deeper institutional involvement in equities – a necessary push in China in our view, where pension funds and other institutional players have shown some reluctance to invest in stocks.
Looking forward, the scheme also has huge implications for the development of a properly functioning bond market in China.
This is critical if China is ever to migrate its local governments and state-owned enterprises off the unsustainable recipe of cheap bank loans that effectively shut out the important private sector.
A commitment to reform and sustainable economic growth for the future remain central to our constructive view on China.
