Mutual market access plan a key step for China

A move to allow mutual market access between stock exchanges in Hong Kong and Shanghai will narrow the valuation gap between the two.

A move to allow Hong Kong investors the ability to buy shares on the Shanghai stock exchange and vice versa is being hailed as a big step forward in the opening up of China.

The mutual market access plan was reported by mainland newspaper 21st Century Business Herald, while another local newspaper said the first quota of the mutual investment could be $50 billion.

A source close to one of the stock exchanges confirmed the plan to FinanceAsia and said it could come to fruition this year. The details of the scheme, however, have not been settled, said the source.

The Chinese side of the move – a qualified domestic individual investor program (QDII2) – will allow mainland individual investors to invest in Hong Kong by passing stock orders to the Shanghai exchange for execution.

Investors are currently not allowed to invest in overseas stock markets directly because of the country’s control of foreign exchange and are compelled to use domestic qualified brokerages to do that.

Equally, the flipside of the scheme will allow non-mainland investors to directly buy A-share stocks by placing orders with the Hong Kong exchange.

“This is a big step in China opening up,” said Candy Ho, global head of RMB business development with HSBC. “It allows mainland Chinese to access directly for the first time the Hong Kong stock market,” said Ho.

The move, a part of China’s bigger plan to make the renminbi fully convertible, will open up domestic capital markets to freer flow of foreign capital and vice versa, said Uwe Parpart, chief strategist and head of research with Reorient Group.

It should also allow China’s government to more easily prevent illegal capital outflow by some Chinese high-net-worth-individuals looking for overseas investments, as well as inflow of arbitrage capital, said Uwe.

Analysts believe that the mutual market access arrangement can reduce the difference in valuation between the two markets, which in the long run may change issuers’ choices in financing places.

“Blue chip stocks will trade in more reasonable valuation once the market is open for overseas investors,” said one investment banker with a large securities house headquartered in Beijing. 

The banker said shares of some mainland blue chip companies have been long undervalued, especially those in the financial and real estate sectors - which are traded in the A-share market much lower than the H-share market.

“Foreign investors [in mainland stocks] will favor those blue chip stocks with which they are more familiar with due to lack of knowledge and understanding in smaller businesses,” said the banker.

Conversely, some small-sized companies would like to list on the Shenzhen stock exchange rather than in Hong Kong because of over-valuation. For example, technology groups are traded at an average price-to-earnings ratio of 50 times compared to Hong Kong’s average of less than 10 times.

If the valuation gap closes, more such companies may come to Hong Kong for IPOs.

As such, valuation is set to drop down the list of considerations for issuers when they choose where to raise new equities.

In this case the other factors, like market efficiency, liquidity and regulation, will be more important for issuers.

Mutual market access will boost the business of some securities houses that have extensive presence in both markets and high exposure to brokerage businesses.

The securities sector rebounded upon the news. Galaxy Securities, Guotai Junan International, Shenyin Wanguo Hong Kong and Haitong International surged by 7%, 11%, 10.8% and 7%, respectively.

Among mainland securities firms, brokerage commission accounts for 48% of Galaxy’s revenue, the highest exposure to brokerage business. 33% and 59% of Guotai Junan and Shengyin Wanguo’s revenue came from fees last year, according to a report by Haitong International.

To be sure, the process of loosening China’s capital controls entirely is bound to be gradual, and more direct market access for mainland and foreign investors into each other depends on the will of government.

Investors may also recall events in 2007 when Beijing planned to allow mainland investors to invest in Hong Kong’s stock market through a “through train” programme. However, the plan was cancelled due to the worsening global market situation and the protectionism of the central government.

This time conditions are ripe. The People’s Bank of China announced in January that preparation for the implementation of QDII2 has started, with the government keen to experiment with capital free flow in the Shanghai free trade zone and the other special economic zones.

“The trend of mutual connectivity and openness is irreversible, although it is unlikely to happen in one go,” said Hu Yifan, chief economist with Haitong International Securities.

¬ Haymarket Media Limited. All rights reserved.

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