While the newly announced Shanghai-Hong Kong Stock Connect Program provides short-term positive momentum in the Shanghai and Hong Kong market sentiments, the benefits of the program is far more significant and prosperous in the long term. Financial sector reform has always been a priority of the Chinese government, while this program plays an important role in widening China’s capital market and internationalization of RMB. The new scheme allows institutional and individual investors in Mainland China and Hong Kong to cross trade via the exchange and clearing house in their local markets, creating a presence in Hong Kong becoming the world’s primary offshore RMB center.
Widening China’s Capital Market
H-share was first introduced in 1993, and it has been contributed massively to Hong Kong’s capital market over the past 20 years. The Shanghai-Hong Kong Stock Connect sets important milestone in the development of capital markets in China. This scheme is an endorsement of the China government building Shanghai as a financial hub for Asia. It opens an accessible, comprehensive, and scalable cross trading system with minimum incremental costs and no impact on RMB exchange rate or China’s foreign exchange reserve. The closer the integration of the Hong Kong and China market, the narrower the valuation discount between A and H shares. It is likely to see liquidity improve and the valuation gap between A-H shares will be arbitraged. In the long run, the scheme will improve A-share market fundamentals with a more balance investor base and aim to be included into a global index, such as the closely monitored MSCI Emerging Markets Index, in order to boost liquidity flow into the A-share market substantially.
Internationalization of RMB
Since 2009, the use of RMB in cross-border transactions has expanded significantly and it is a crucial part of the International Monetary System reform to reflect a more diverse and inter-connected economy. Hong Kong acts as a gateway for trade settlement, financing, asset management, and a wide range of RMB products for financial institutions and individual investors. Mainland investors can now directly invest in shares listed on the Hong Kong Stock Exchange, created a new channel for cross-border uses and circulation of RMB where investors directly participate using RMB for trades. Investors are allowed to cross-trade up to 550 billion yuan (US $88.96 billion), while the quota of funds is expected to adjust upward in the future based on the demand of the markets.
Growth Potential
The Shanghai-Hong Kong Stock Connect offers a wider range of equity products to investors, with the potential of attracting a larger new customer base. The A-share market offers segments that the H-share market doesn’t have, including national defense, automotive, travel and tourism, increasing diversification and the willingness for investors to hold stocks.