The China Securities Regulatory Commission (CSRC) and the Securities and Futures Commission (SFC) have approved, in principle, the establishment of mutual stock market access between Shenzhen and Hong Kong, known as the Shenzhen-Hong Kong Stock Connect scheme.1
Charles Li Xiaojia, the chief executive of Hong Kong Exchanges and Clearing (HKEx), said that preparatory work for the program had basically been completed, and that it should take approximately four months from August 16, 2016 to complete the technical and operational preparations for the launch of Shenzhen-Hong Kong Stock Connect.
The long-awaited Shenzhen-Hong Kong stock connect scheme has been a hot topic for the last two years and the market has always been guessing its launch date. Before analyzing the prospect of the Shenzhen-Hong Kong Stock Connect, it would be better to go over the performance of the Shanghai-Hong Kong Stock Connect — which is what the Shenzhen trading link is being modeled after — since its establishment on November 17, 2014.
Investors from both sides of the mainland China border acted quite differently towards the Shanghai-Hong Kong Stock Connect. Mainland Chinese investors have shown far more interest than global investors in the trading link. Since the Stock Connect’s establishment, mainland Chinese have bought 81.92 percent of their aggregate quota of the RMB 250 billion allowed by Chinese regulators. But global investors outside mainland China have only used 50.09 percent of their total quota of RMB 300 billion. Until mid-August, mainland Chinese investors have bought RMB 204.8 billion worth of Hong Kong shares, while foreign investors have invested merely RMB 156.7 billion in Shanghai shares.
Besides the asymmetric responses of north-bound and south-bound trading, there has been shrinkage in the trading scale in both directions. The public has noticed that in the Shanghai-Hong Kong connect, both the north- and south-bound average daily turnover value (ADT) have dropped, and the revenue from the existing Shanghai-Hong Kong Stock Connect program has fallen about 38 percent year-on-year (from 2015 to 2016) to HKD 71 million (USD 9.2 million) in the six months to 30 June 2016. According to its half-yearly report, the HKEx reported a 27 percent year-on-year decline in net profits to HKD 3 billion, and said that average daily turnover almost halved in the same period to HKD 67.5 billion.2
The relatively lackluster demand by global investors for Chinese stocks listed in Shanghai, and the shrinkage in trading scales in both directions of the scheme so far have raised many questions about the success of the program. Does this bode well for the launch of the Shenzhen connect? What is the point of expanding the existing scheme, and will foreign demand for Shenzhen stocks be any greater? HKEx chief executive Charles Li Xiaojia said he is not really bothered by the trading statistics of the connect and he explained the future potential and benefits from the south-bound side. In his opinion, the connect is a very big thing for a long time to come.
Nowadays, the south-bound can only bring investment to listed companies in Hong Kong, which are largely still Chinese companies. It looks just like mainland Chinese investors are coming to Hong Kong to electronically buy merchandise packaged as foreign goods. Therefore, it is very important to understand that the potential of the connect is not fully developed yet, and the current function of the connect is not what the designers of the scheme really want. The Hong Kong side will bring more products to this platform once the link is formed.
Now we examine the prospects for both the south- and north-bound markets. For the south-bound, over time the Hong Kong side is hoping that Hong Kong as a platform will be able to bring a lot more truly international products, internationally listed companies, and international risk management instruments for Chinese investors to buy. Anyway, China is the last residual pool of capital in the world today that is yet to be globally deployed, so there will be huge potential to further develop the Chinese market in the future.
A big drawback of China’s stock markets has not been resolved, which is the domination of retail investors in the markets.
For the north-bound direction, the link gives foreign investors another trading channel linking to the world’s seventh-largest stock market. According to the World Federation of Exchanges, the Shenzhen Stock Exchange had a market capitalization of USD 3.16 trillion as of the end of May 2016. That’s an aggregate exchange scale between Hong Kong’s USD 3.10 trillion, and Shanghai’s USD 3.87 trillion.
Next we compare the Shenzhen stock market with the Shanghai market to see what makes the second connect scheme worthwhile. There are two aspects which could make the Shenzhen market more attractive than the Shanghai market to foreign investors. Firstly, the stock trading link between Shenzhen and Hong Kong will unlock access to a new territory of Chinese tech stocks that global investors can’t easily get anywhere else. The Shenzhen Stock Exchange has 1,790 listed companies, more than the 1,110 listings in Shanghai, and a bit less than the 2,330 listed companies in the New York Stock Exchange as of May 2016. Some foreign investors are hoping to invest in one of China’s hottest sectors: Chinese tech stocks. Around 20 percent of Shenzhen’s stock market consists of tech companies, a much bigger proportion than that of its Shanghai counterpart, where tech stocks just account for 4 percent of the whole market.
Secondly, in Shenzhen, the value of share trading was USD 1.2 trillion in July 2016. During the same month, the trading volume in the New York Stock Exchange is USD 1.27 trillion, while Shanghai’s was USD 713 billion. High volumes mean ample liquidity, making it easier for investors to make the trades at the prices they want, which also makes the Shenzhen stock market attractive.
Chinese officials, particularly Premier Li Keqiang, have stated that high-tech companies’ continued growth will help shift China’s economy from the old pattern economy led by debt-fueled investment spending, to the new pattern economy driven by consumption and the middle class. But under the inevitable trend of the economic slow-down and China’s very difficult economic transformation, investors may assume that good intentions from the top may not be delivered smoothly.
Until now, a big drawback of China’s stock markets has not been resolved, which is the domination of retail investors in the markets. Unlike more developed exchanges in Hong Kong and the US, where institutional investors comprise a much larger proportion of the market, individual investors comprise 80 percent of the market participants. Long-term investors and institutional investors such as pension funds usually tend to take more time to react to news and will always act as a stabilizing force in markets. Retail investors in China, on the other hand, tend to be more sensitive to speculation, which cause amplified fluctuations in mainland Chinese stock markets. Due to the unhealthy composition of the market participants, the Shenzhen market is also a very volatile market, which had been proved again by its astounding surge and tumble in 2015.
Under the background of China’s economic slow-down, the uncertainty of its economic transformation, the expectation of RMB depreciation, the reality of weak regulation, and the unhealthy composition of market participants, foreign investors will still be very hesitant to invest in mainland stock markets in large amounts. In contrast, Chinese domestic investors are relatively more willing to invest outside due to the lack of investment choices and the drawbacks of the mainland stock markets mentioned above. But in view of the south-bound threshold (RMB 500,000) for mainland Chinese investors, only relatively rich people can invest in the Hong Kong market. Rich people always tend to avoid risks when the economy is bad. So unless the Hong Kong exchange provides more financial instruments that can help investors reduce their risks, we will not see huge capital inflows going into the Hong Kong market.
Therefore, there is a very high chance that the response towards the Shenzhen-Hong Kong stock connect scheme will still be asymmetric and lacking in enthusiasm in the near future. Nowadays, both domestic and foreign investors are extremely cautious as the economy worldwide is still in a mist, and uncertainties remain everywhere. Therefore, there is no reason to expect much difference from what has been going on with the Shanghai-Hong Kong connect for the last 2 years, especially if the authorities do not upgrade the scheme to provide more varieties for investors.
1. Shenzhen-Hong Kong Stock Connect will be established by the Shenzhen Stock Exchange (SZSE), The Stock Exchange of Hong Kong Limited (SEHK), China Securities Depository and Clearing Corporation Limited (ChinaClear) and Hong Kong Securities Clearing Company Limited (HKSCC).
2. Hong Kong Exchanges and Clearing Limited (2016). 2016 interim results. Retrieved from