Teething problems as a Chinese bourse opens up

The Chinese stock market has opened to business from foreign investors — but overseas buyers are staying away.

Last year, the Chinese government announced it would open a link between the Hong Kong and Shanghai stock exchanges to allow foreign investors to buy Shanghai-listed shares with much less stringent controls than before. By the time Stock Connect opened in mid-November, the excitement was palpable.

The only conditions for investing northwards — from Hong Kong to Shanghai — was that a Hong Kong registered broker must be used and there was a daily limit to the total net flows. There was speculation this limit would be too low, and on the opening day it was reached by lunchtime.

Since then, however, the amount of capital flowing into Shanghai has hovered around a fifth of the limit, and the net money going south has been much lower — less than 5 per cent of the maximum in the first four weeks.

“The market built up a lot of expectation that the daily limit would be insufficient very quickly,” says Lawrence Au, head of Asia Pacific at BNP Paribas Securities Services. “Now it is rising gradually and that is probably healthier.”

Stock Connect is not the only way foreign asset managers can access shares listed on the Chinese mainland. The qualified foreign institutional investor and the renminbi qualified foreign institutional investor schemes (QFII and RQFII) have allowed managers to apply for quotas to invest in Chinese stocks for some years, and have recently been expanded significantly. Many established managers of China or Asia funds are continuing to access the market through these more established channels while Stock Connect’s teething troubles are sorted out.

“It is still early days for Stock Connect and we are waiting for any glitches to be resolved,” says Nicholas Yeo, head of Chinese equities at Aberdeen Asset Management. “In any case, we are able to access the local market using our QF quotas.”

In a sign of how slow managers are to exploit Stock Connect, Axa Investment Managers launched a new China A-shares fund at the end of January using its QFII quota rather than the new link.

Many of the glitches are administrative or regulatory, but there are some tweaks the Chinese administration needs to make to ensure the scheme is more attractive to foreign investors. Currently, only the constituents of certain indices are eligible for the scheme, meaning just 80 per cent of companies listed on the stock exchange are available to foreign investors. Initial public offerings are also not currently eligible.

One unexpected problem is that public holidays on the two exchanges are out of sync, meaning there can be delays in implementing trades. All of these issues are to be addressed in the second phase announced in January.

There are plans under way to open a further link to the Shenzhen stock exchange. It has more stocks, many of them the technology and manufacturing stocks that represent some of China’s most attractive industries. “These kinks will be ironed out in time,” says Yeo.

Pat Lardner, chief executive of the Irish Funds Industry Association, agrees. “You have to remember it only went live on November 17, and it was brand-new infrastructure and a brand-new channel,” he says. He is confident the regulators in Shanghai and Hong Kong are keen to sort out the initial problems.

“Once this happens, I would imagine there will be a lot more interest from institutional investors,” says Au.

Managers of exchange traded funds, one of the fastest-growing groups in the market globally, have yet to approach Stock Connect, perhaps because of concerns about how the daily limit would be implemented and what impact it would have on their products.

In the meantime, applications to use Stock Connect are growing slowly, both from seasoned China investors looking to add another channel of access to their QFII or RQFII quotas, and from managers who never applied for a quota.

Regardless of the level of traffic on Stock Connect, it seems it is meeting at least some of its objectives, such as making the Chinese stock market more open and its functionaries more experienced in dealing with outside investors. “This is a pilot scheme as part of the internationalisation of the renminbi,” says Au. “It is all part of a much more strategic programme that the Chinese authorities are embarking on.”

The northbound traffic on Stock Connect may not have met expectations, but southbound, from Shanghai to Hong Kong is even lower. This is partly due to structural issues (the mainland market is mostly made up of retail investors who tend to have a strong domestic bias), and partly due to market movements.

The Shanghai index has jumped more than 30 per cent over the past three months, compared with the Hang Seng’s more moderate 4 per cent growth.

Luxembourg and Ireland Ucits access

When Ucits fund managers get access to Stock Connect, it will experience a big boost in traffic. This is the contention of Alfi, the Luxembourg fund association, and the Irish Funds Industry Association. The regulator in the grand duchy authorised a single Ucits fund to include stocks from the Shanghai index just before Christmas, having previously signalled it had reservations about the scheme.

The Irish regulator has not yet spoken publicly about it, but it has engaged in “very open and constructive discussion” with the IFIA, which has been working intensively with the Hong Kong regulator to establish a clear understanding of the investment and administrative process.

“There is an important meeting of two things,” says Pat Lardner, chief executive of the IFIA. “First is understanding and being respectful of the existing regulatory framework [in Asia], but we are also trying to put in place a bridge” between that and European regulatory requirements.

The salient issue is around depositary and custodian functions. The European Ucits structure places great emphasis on these, while they are less clearly defined in China. Some market participants are under the impression that the concept of beneficial ownership either does not exist or is unclear in China, making it uncertain whether shareholders would be able to prove ownership of a stock.

Patrick Rooney, regulatory affairs manager at the IFIA, says this is not the case. “The Hong Kong exchange has helped us get comfortable with this, supplying translations of documentation, showing it does exist and how it might be enforced. They have even indicated they might be willing to assist in enforcing it in some circumstances.”

“We think we are in a great position to support the [Irish] regulator in looking at these issues,” says Lardner.

— Financial Times