November saw the launch of the Shanghai-Hong Kong (SH-HK) Stock Connect, a programme that allows foreign investors access to the Shanghai stock market (A shares) via the Hong Kong stock market, an access that had been severely restricted for international investors until now.1 The programme also allows investors from mainland China to easily trade on the Hong Kong stock market via the Shanghai market. This reform has taken place within the overall liberalisation and modernisation of China's finance and capital markets which, in turn, forms part of a broader mission towards a «more market-oriented» economy. This scheme has aroused huge expectations as it could become one of the biggest steps taken by the Asian giant in opening up its capital account.
This mechanism for mutual access connects two of the world's most important stock markets (namely Hong Kong and Shanghai): their union would produce the third largest market in stock capitalisation terms, smaller than just the NYSE and NASDAQ. As in all actions carried out by China to open up its economy, at present substantial controls remain in place, both regarding the products traded and their quantity, but this is still the most important step taken to date in the liberalisation of the Chinese equity market.2 Previously foreign investors could only invest in the bond and stock markets of mainland China via the Qualified Foreign Institutional Investor (QFII) programme and the Renminbi Qualified Foreign Institutional Investor (R-QFII) programme, started up in January 2003 and December 2011 respectively, which not only have very strict quotas on the amounts that can be invested (representing less than 3% of China's stock market) but also require investor approval by the Chinese authorities. However, through the SH-HK Stock Connect all kinds of foreign investors (institutions and individuals) can invest in Shanghai and, in spite of the quotas set, their daily trading could reach 20% of the business volume of Shanghai's stock market (the seventh largest in stock capitalisation terms). This percentage might even increase as the programme finds its feet and quotas are enlarged. In all actions taken to open up its economy, China has acted first by setting up small, controlled pilot trials that have gradually been extended.
Without doubt this greater access to the Chinese stock market will increase the country's share in the portfolios of international investors in the world equity market. At present it is clearly under-represented: it share of the MSCI AC World stock market index is just 2.2%, far below the importance of China's GDP in the world's total, which is just over 13% (see the graph).3 This will help international investors to diversify their portfolios as well as possibly increase their returns thanks to the Asian giant's growth potential.
From the point of view of Chinese households, the start-up of the SH-HK Stock Connect provides a very important alternative route to channel their savings. The limited development and depth of the Chinese finance and capital markets has made it more difficult for them to difersify. A very large proportion of household savings has been invested in real estate (72%) while cash also accounts for a notable 20% of their total assets. This new scheme will also increase the number of Chinese firms that can take advantage of the inflow of global funds, previously highly restricted by the QFII and R-QFII programmes.
Lastly, in strategic terms China's more open capital account via the SH-HK Stock Connect should considerably increase the use of the renminbi (or yuan) at an international level. This internationalisation of the country's currency
is an objective pursued intensively by the Chinese government over the last few years. In short, as China's economy becomes more liberalised, the omnipresent greenback may have to gradually make way for a new rival, the red note.
1. Numerous Chinese companies are listed on the Hong Kong stock exchange via H shares, and on the Shanghai stock exchange via A shares. As a result of the limitations in place until now for foreign investors wishing to trade on the Shanghai stock exchange, in practice A shares were restricted to domestic investors (from mainland China).
2. There is a daily limit of RMB 13 billion (2.1 billion dollars) for northbound purchases (from Hong Kong to Shanghai), and RMB 10.5 billion (1.7 billion dollars) southbound. Similarly, the securities that are eligible to be traded in mainland China total 568 (90% of the Shanghai stock market capitalisation), and 266 in Hong Kong (82% of the Hong Kong stock market capitalisation).
3. The MSCI AC index attempts to reproduce the yield from the global market (advanced + emerging) available for global investors. In addition to stock market capitalisation, to determine the share of each market within the index it also takes liquidity measures into account.