Stock Connect: Money Flows from Hong Kong to Shanghai

Bizback_14Nov

Investors located in Hong Kong as of today are allowed to place a maximum of €39 billion at the Shanghai Stock Exchange, with a ceiling of €1.7 billion of daily movement. Mainland China financists will not be able to transfer more than €33 billion towards the Hong Kong Stock Exchange.

Today’s opening happened after a brief delay, very political, when Beijing announced on Monday, 10 November, that the connection between the stock exchanges in Shanghai and Hong Kong will be operational on November 17.

Chinese Premier, Li Keqiang, had cited that measure in April as an example of the will of the government to open up the financial system. The program should have been then be introduced within six months. But, having failed to obtain approval from the executive in Beijing, the Hong Kong Stock Exchange had to announce a delay, on October 26, while pledging to be ready technically. The wording suggested that Beijing was punishing the former British colony for the sit-in student strike demanding more democracy.

The Shanghai Stock Exchange closed on Monday up 2.30% and that of Shenzhen up 0.83%, buoyed by the announcement of this platform for joint exchange that will provide unprecedented access of the Chinese financial market to foreign investors.

China’s trade operations with the rest of the world are still tightly controlled by Beijing. Trade flows are indeed open, which allowed the People’s Republic to position itself as the world’s largest exporter and the first to raise foreign exchange reserves in the world. In contrast, capital flows, including foreign access to China’s stock market, remain very limited.

Opening gages

Opening gages

But Chinese President Xi Jinping is willing to provide guarantees of openness. Especially since he received the heads of the Asia-Pacific states at the APEC summit in the capital on Monday 10 and Tuesday 11 November.

Only a limited number of foreign banks and funds can, to this day, invest in yuan to the Shanghai Stock Exchange. They must be screened by the Chinese regulator, and investments are limited by an individual quota set by Beijing called a “qualified foreign institutional investors” program, or QFII for the acronym.

In this context, Chinese companies wishing to receive foreign funding blocked by the border prefer to be listed on the Hong Kong Island. The financial sector is consistently recognized by the American conservative Heritage Foundation as the most open in the world over the last twenty years.

The new program, whose approval was announced on Monday by Beijing, is sometimes called “direct train”; banks and funds of the Shanghai Exchange will be allowed to invest in yuan in Hong Kong-listed shares, and vice versa.

It allows the Chinese government to progressively open the lock between the stock market of mainland China to the Hong Kong, as well as the rest of the world.

This is part of the commitment of the authorities to promote the use of the Chinese currency abroad. “This facilitates the flow of renminbi (RMB) between the two places, supports the development of the offshore yuan market and thus accelerate the internationalization of the RMB, decisive movement in the opening of the capital account in China,” says the research Director of the Bank of China in Hong Kong.

Such a program was mentioned as early as 2007, but it remained in the drawers as the global financial crisis prompted China to exert the utmost caution. However, this new opening phase will also controlled by quotas, according to the strategy, now classic, consisting of “crossing the river by feeling the stones”, in the words of the late father of reforms, Deng Xiaoping.

Investors based in Hong Kong are allowed to place up to 300 billion yuan (39 billion euros) in total to the Shanghai Stock Exchange, with a ceiling of 13 billion yuan daily movement. Financial mainland China, meanwhile, cannot get 250 billion yuan in the direction of the Hong Kong Stock Exchange. “Even with these quotas to abide by, it is a significant step in the trend of controlled liberalization,” said John Zhu, an economist at HSBC in Hong Kong.

On Monday, at the opening of the APEC summit in Beijing, US President Barack Obama, however, called on China to accelerate the liberalization of markets and the conversion of its currency.

Much agiotage around stock connect

The stock market of mainland China is attracting strong interest. To prove this point, on Monday, Nov. 17, during the first day of connection between the financial centers of Hong Kong and Shanghai, investors based on the island soon exhausted the quota of daily cash flow available for the continent.

For this first day of laid-back Monday morning, the President of the Commission of Chinese stock market regulation, Xiao Gang, welcomed a “major institutional innovation,” accelerating the international role of the platform and consolidating the Shanghai Hong Kong

“The link foreshadows a new model – in which operations are convenient and risks are controllable – for investments in cross-border securities” Mr. Xiao said, adding that it also contributes to the internationalization of the yuan.

Quota reached by mid-day in Shanghai

On the first session, the opening of this valve has essentially generated flows to Shanghai, reflecting the attractiveness of the outside world to the Chinese stock market, which was still very far off.

At 13 pm local time, the ceiling of 13 billion yuan (1.7 billion euros) that can now enter every day Shanghai Stock Exchange from Hong Kong had been reached, in fact closing exchange for the end of the day in this direction.

However, the flow moving from mainland China to the former British colony has exceeded about one-fifth of the daily limit set by the authorities.

Index drop

The day did not see the market rise. The Hong Kong Stock Exchange ended up with 1.21% drop, while Shanghai lost 0.19% on the session, after gains early in the session.

The announcement on Monday morning of the counter-performance of the Japanese economy entered into recession (with GDP down 1.6% year on year in the third quarter), sealing all Asian markets.

The director of the Hong Kong Stock Exchange, Charles Li, had anticipated disappointing debut two days before the opening.

“Whether the first trains are crowded with people left out on the station or they leave with empty seats, it is not important. What matters to us is the long-term scheme and its success will be measured in years, not days or weeks,” Mr. Li wrote on Saturday.

These markets will gradually merge

In fact, the recent value of quantity of shares also reflected hope generated by the influx of new investors. “The anticipation was already fully perceived in prices on the market in recent weeks,” said Xu Gao, chief economist at Everbright Securities.

According to Xu, the long-term effect is significant, however. China has promised to make Shanghai an unavoidable financial center by 2020, a project that was lying because of the closure of capital flows on the outskirts of mainland China.

For its part, the island of Hong Kong is concerned to see its key role in Asia if threatened by Beijing promoting Shanghai.

The government has to provide an initial response. “This is the beginning of creating a key market for the world. In fact, these markets will gradually merge in the coming decade,” assumes Xu Gao.

New perspectives for China-Australia relationships

China is already the largest market for exports from Australia in 2013, it bought almost a third of Australian goods, at $101 billion. This will be even more so after the free trade agreement on which Canberra and Beijing have agreed on Monday, November 17, after nine years of negotiations, which should be signed in 2015.

“Australian companies will have unprecedented access to the second global economy,” praised the Australian Prime Minister Tony Abbott. The agreement “will bring billions to the economy and will create jobs,” he added.

Chinese President Xi Jinping, visiting Australia for Saturday and Sunday for the G20 welcomed the relations between the two countries, in a speech to parliament in Canberra.

All the details of the agreement have not yet been made public, but according to the Australian Government, over 90% of Australian exports will no longer be taxed on entry to China within four years.

Agriculture is presented as the winner. Australia wants to intensify export of agricultural products and China wants to secure supplies to meet its growing needs.

This is the case for milk, on which tariffs will be eliminated. The industrialists are eagerly awaiting a bilateral agreement, in order to further penetrate the Chinese market, the world largest importer of milk, which is supplied mainly to New Zealand.

Customs duties on exports of cattle will not exist in four years. Taxes will also disappear for fruit, vegetables, wine, etc.

Less tension for Chinese investments regulations

Australia will also have easier access to the services market in China. Xi Jinping put forward, in his speech to Parliament, the quality of Australian universities. The stakeholders in education, health, insurance should see their access to China simplified.

Restrictions on Chinese investment in Australia, which have long blocked the free trade agreement, will be relaxed. China will be able to more easily invest in the iron and coal industry, including those of Australia. Raw materials should also enjoy better export conditions.

This agreement is timely for Australia, which this year has already negotiated free trade agreements with Japan and South Korea. The country is in its 24th consecutive year of growth, but suffers an economic downturn and seeks to reduce its dependence on mining. The government wants to develop other sources of growth, including agriculture and services sectors.

After Canberra, the Chinese president is scheduled to visit Tasmania, an island in southern Australia, on Tuesday. Appointments have already been made to start investing in agriculture.

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