Today marks the start of possibly the biggest day in China’s financial relations with the rest of the world in years with the start of direct trading links with the Shanghai stock exchange from the outside world.
In fact, if the new system succeeds, it could see the emergence, over time, of the world’s third major stockmarket.
It is something Australian fund managers and others in our $A1.8 trillion dollar superannuation industry will be looking to use over time to diversify away from Japan, the US and Europe.
It will be of greater importance to Australian investors than the weekend’s G20 murmurings.
The impending change, which kicks off later this morning, has boosted Chinese shares and the Shanghai market ended trading last week on Friday at its highest level since November, 2011.
A quiet start is expected – in fact it will be a quiet few weeks as investors work out how the system works and look for any kinks that need ironing out.
Certainly the Chinese government wants the system to succeed, on Friday leveling the tax playing field inside China for foreign investors for the next three years at least.
On Saturday a test was conducted to make sure the systems of the two stock exchanges are properly connected. The Shanghai exchange also ran the test on Saturday.
The Hong Kong Exchange said a total of 97 brokers and other exchange participants, accounting for about 80% Hong Kong market turnover joined Saturday trial run.
That was a day after China’s Finance Ministry said it would temporarily exempt taxes on profits made from the scheme.
But it left room to introduce taxes on foreign investors at a later date should the system prove to be a success.
Shares in Hong Kong and Shanghai have been slowly rising for much of the past couple of months as the link up became more real.
Interest from Chinese buyers looking to move into the Hong Hong market is expected to be much less than the interest from foreigners wanting to hold Chinese shares directly.
A final start date was revealed a week ago after it was delayed from the target date of last month.
While the program will be constrained by quotas initially, investors can buy a net total of $US2.1 billion shares a day without needing approval.
Reuters reports that Hong Kong analysts claim it could in time create the world’s third-largest stock market if the two markets are fully integrated.
And if successful, will offer hedge funds and other big investors a way of hedging their China exposures – at present the Aussie dollar is a favoured way of doing that.
Over time the Stock Connect could ease the pressures on the Aussie dollar from this hedging, allowing it to find its own level.
The changes mean that for the first time allow international investors direct access to Shanghai stocks while mainland investors will be able to buy those of Hong Kong-listed companies.
This should see the premiums on some Chinese shares listed in Hong Kong and elsewhere (such as the US) eliminated over time.
Stock Connect is the name of the new buying system and it will limit the amount of shares to be held by foreign buyers to set amounts (which are expected to be increased over time as the system settles down).
Northbound (into China) and southbound investors (into Hong Kong) will have to abide by the rules of the market into which they are buying and selling.
Fund managers, their custodians and brokers will have to adapt to the differing systems (such as China’s very short settlement system), but again this is expected to happen slowly as investors and their advisors get more experience of each other’s markets and systems.
At the moment China does not allow brokers to sell shares for clients without first checking themselves that customers hold the stocks – potentially forcing international investors to sell shares a day later than they planned to allow time for brokers to check.
This guide from Forbes contains a lot of additional good detail (http://www.forbes.com/sites/chriswright/2014/11/11/one-country-one-market-making-money-from-shanghai-hong-kong-stock-connect/)
The scheme is the first to allow institutional investors into mainland markets without requiring each to be individually approved, as they are now via the Qualified Foreign Institutional Investor scheme.
If Stock Connect becomes a success, it is expected to be expanded to the Shenzhen market (where more small and medium companies are listed).
The Financial Times points out that there is a bonus for regulators, who will work more closely in market surveillance and data sharing.
Investors on both sides will be liable for stamp duties, and Hong Kong investors will be taxed 10% on dividends earned from mainland investments, according to Friday’s announcement from the Finance Ministry.
