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Shanghai-HK stock link: instant windfall?

2014-09-22 08:21 Shanghai Daily Web Editor: Qin Dexing
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Eepections are running high that Chinese mainland's sluggish stock market will get a big boost from a pilot program linking the Shanghai and Hong Kong exchanges.

The benchmark Shanghai Composite Index has been on rise for five consecutive months since the project was announced in April. The linkup is designed to open up a new channel for international investors to tap the A-share market.

But Chen Li, chief China equity strategist at UBS, said optimism may be running ahead of reality. Capital inflows are likely to be smaller than expected in the early stages of the program because of differences in the way the two exchanges operate. He sat down to discuss those ideas with a group of journalists in a recent interview.

Q: What are the differences between the new project and the existing quota system for foreign institutions?

A: Both of them allow foreign investors to buy A shares, but they are different in many ways. The connect program to some extent is more transparent than the quota system. With a daily trading cap, the connect program is administrated on a first-in, first-served basis. It treats every investor equally. For the quota system, although there are specified rules on investor qualification, the application progress varies in different cases. It might take only three months for an institution to get a quota approval, but in other cases, it could be nine months or even longer.

Moreover, the connect system is more flexible in that it will allow investors to enter and exit a share market at any time. By contract, the market exit mechanism for investors under the quota system is more complicated. Therefore, I think foreign investors planning to invest in the A-share market will prefer the connect program.

Q: Will the new program eventually replace the quota system?

A: For now, that's unlikely. The two are very different in investment scope. The connect program will enable foreign investors to trade only 568 designated shares on the Shanghai market, while investors under the Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor programs are allowed to invest in all A shares in both Shanghai and Shenzhen, as well as in the bond and interbank markets. But we can't rule out the likelihood that the two systems will be merged sometime in the future. Actually, there will be no need to have such systems when China's capital market becomes fully open.

Q: What impact do you think the Shanghai-Hong Kong linkup will have on the A-share market?

A: In the long term, it will strengthen foreign investors' pricing power on certain shares. The quota for Hong Kong investment in the mainland market is 300 billion yuan (US$49 billion). Add to that investment through QFII and RQFII programs, and foreign holdings of A shares will likely reach 850 billion yuan to 900 billion yuan by the end of 2015. That would account for around 9 percent of the total free-float market capitalization. Since foreign investors prefer large-cap shares, it will definitely boost the pricing power of those shares.

Although there is strong interest among foreign investors in the A-share market, I think the short-term capital inflows may be less than expected. Differences between the Shanghai and Hong Kong markets in terms of trading mechanisms, settlement systems and trading times will hold back some investors. For example, the connection will be closed when the Hong Kong market is closed due to local holidays. But the A-share market will remain in normal trading. When there is turbulence in the Shanghai market due to some big events, such as an interest rate cut, investors in Hong Kong will not be able to do anything about their shares. That kind of risk needs to be considered. There are also issues regarding taxation and differences between the exchange rates regarding onshore yuan and offshore yuan that will add to investment risk.

Q: Does the new program change your outlook for the A-share market?

A: No. We remain cautious. Allowing mutual access between Shanghai and Hong Kong exchanges is a big event. It may increase market preference for the main board rather than the ChiNext board. However, it won't change economic fundamentals, the policy environment or corporate profitability. We maintain our forecast that China's economic growth will slow from 7.5 percent this year to 6.8 percent in 2015.

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