2016 December
“Shenzhen-Hong Kong Stock Connect” Strengthens Hong Kong as International Financial Hub

What major implications can the financial industries of the Mainland and Hong Kong expect with the launch of “Shenzhen-Hong Kong Stock Connect”? Tse Yung-hoi, the Chamber’s Standing Committee Member and Chairman of BOCI-Prudential Asset Management Limited, provides us with his analysis, offering his insights into the anticipated market response during the initial stage of this trade link, as well as what’s next along the path of implementation.


“The first and foremost significance for the launch of ‘Shenzhen-Hong Kong Stock Connect’ is how it symbolizes the further opening up of China’s capital market.” Tse pointed out that China primarily opened up to developed markets in the past; yet, under the “Belt and Road” framework, emerging countries are becoming just as important.


“Shenzhen-Hong Kong Stock Connect” extends its reach to “Belt and Road” countries

According to Tse, the “Belt and Road initiative” is basically a circle surrounding China. “It is expected that the financial interaction within this circle will be increasing and settlement amount in RMB will be growing over time.” He foresees that both “Shenzhen-Hong Kong Stock Connect” and “Shanghai-Hong Kong Stock Connect” will provide RMB-dominated investment products and services for countries along the “Belt and Road”.


Hong Kong, Shenzhen and Shanghai to play unique financial roles

As the three major financial centers of China, Hong Kong, Shenzhen and Shanghai are often regarded as competitors and frequently compared. Tse, however, sees unique fortes in the three markets. “In fact, each of them has their specialties and serves different purposes as far as the Central Government is concerned. None of the three can replace one another; otherwise, the direction for development would deviate from how it should be.”


Tse elaborated further that Hong Kong, Shenzhen and Shanghai have three main functions: internationalization, innovative development and financial reform respectively. “Hong Kong is the most liberal and internationalized city in China. With its sound legal system and international reputation, Hong Kong is more than qualified to shoulder the important task of facilitating the internationalization of China.” For a very long time, Hong Kong is a major stronghold for opening up the Mainland’s capital market. No matter whether it is QFII (Qualified Foreign Institutional Investor), RQFII (RMB Qualified Foreign Institutional Investor), or “Shanghai-Hong Kong Stock Connect” and “Shenzhen-Hong Kong Stock Connect” that followed, Hong Kong has been integral in the role it plays and the functions it exerted in these measures, which have further reaffirmed its position as China’s international financial center.


Constituent stocks in “Shenzhen-Hong Kong Stock Connect” appealing to global investors

During the early days of the launch of “Shanghai-Hong Kong Stock Connect”, Hong Kong investors were enthusiastic about how the mechanism could play a part in transferring northern capital southwards. Yet, unexpectedly, Hong Kong stocks went downwards on the launch date of “Shanghai-Hong Kong Stock Connect”, and many shareholders were deeply disappointed. Before “Shenzhen-Hong Kong Stock Connect” goes live this year, the market is generally unruffled. There are views that the trade link would not be too strong a magnet to attract capital inflow. Tse, however, pointed out that there are obvious differences between the constituent stocks in “Shenzhen-Hong Kong Stock Connect” and “Shanghai-Hong Kong Stock Connect”, and that shares eligible for trading under “Shenzhen-Hong Kong Stock Connect” are much more enticing to Hong Kong and global investors. He expected the market would eventually set eyes on “Shenzhen-Hong Kong Stock Connect”.


Tse further mentioned that “the shares listed in the Shanghai Stock Exchange Composite Index are mostly sizeable Mainland companies, with many of them already listed in Hong Kong for quite some time. The situation is rather different for the Shenzhen Stock Exchange Component index, which mainly comprises of small to medium cap shares, with many start-ups, which are uncommon in the Hong Kong market.” He added that “Shenzhen-Hong Kong Stock Connect” covers about 880 shares from the Shenzhen market, about 200 of which comes from ChiNext. As these shares are fundamentally different from those available through “Shanghai-Hong Kong Stock Connect”, the two markets can complement each other to offer Hong Kong and overseas investors with a more diversified selection of investment options. “The enriched investment options may stimulate capital flow across the border, just as there will be south-going capital. All in all, the market can expect north-bound and south-bound capital flowing back and forth between Hong Kong and Shenzhen.”


Furthermore, the proximity and the relatively free information flow between the two cities will be favorable for the implementation of “Shenzhen-Hong Kong Stock Connect”. “Confidence is crucial to investment and confidence comes from information.” As Tse put it, Shenzhen residents are watching Hong Kong television every day, meaning information exchange between the two cities are quick and in high volumes. This is what Shanghai-Hong Kong trade link cannot match.


“Shenzhen-Hong Kong Stock Connect” exhibits strengths in capital allocation

Amongst the Hong Kong shares tradeable under the “Shenzhen-Hong Kong Stock Connect” framework, which types are particularly attractive to Mainland investors? Tse said that three types of shares are especially charming, namely dual-listed Mainland stocks with price differentials on the A-share and H-share markets; stocks that are unique to Hong Kong, and stocks that are substantially held by fund houses. “Retail investors with herd behavior dominate the Mainland stock market. For example, when they note a certain type of shares is substantially held by fund houses, they would follow suit and purchase the same. In terms of the ability to distribute capital southwards and northwards, ‘Shenzhen-Hong Kong Stock Connect’ outplays ‘Shanghai-Hong Kong Stock Connect’ by far.”


Opportunity for reinforcing financial regulation in the Mainland

According to Tse, both “Shenzhen-Hong Kong Stock Connect” and “Shanghai-Hong Kong Stock Connect” are probes that may prove to be highly favorable for the process of internationalization in the future. “Take the interest rates for cross-border capital as an example. As the stock-connect mechanism promotes capital flow between Mainland and Hong Kong, the capital demand and supply between the two cities are affected and result in variable interest rates – this is in fact water testing in disguise.”


At the same time, the stock-connect mechanism offers the opportunity for further reinforcing financial regulation in the mainland. Tse explained that the Mainland places a stronger focus on regulating investors and securities firm; the Hong Kong tradition, on the other hand, relies on discipline and disclosure. Hong Kong is also stronger in enforcing laws against financial crimes. He reckoned that over the course of implementing the stock trade link, the Mainland may take reference from Hong Kong’s practices on the regulatory aspect and accelerate its alignment with the international market.