While China has experienced tremendous economic growth over the past several decades, its financial markets have remained relatively closed. Given the limited investment universe and high household saving rate, we have seen problematic signs emerge from time to time, e.g. high inflation in property prices and an epidemic in shadow banking and trust products. The government has carried out various measures to tackle some of these issues in the past, but they have tended to address symptoms rather than resolve root causes. However, a new program called Shanghai–Hong Kong Connect, also known as the "through train," is scheduled to launch in two months.
The through train program is designed to provide mutual access to both stock markets of Shanghai and Hong Kong. Historically, overseas investors could access China's domestic A-share markets only through programs such as the Qualified Foreign Institutional Investor ("QFII") and the Renminbi Qualified Foreign Institutional Investor ("RQFII") schemes, which have granted a combined total quota of about US$90 billion.
Aside from stringent qualification requirements, one major issue with the QFII and RQFII programs is a capital mobility constraint, primarily due to various lock-up periods and the repatriation restrictions (in terms of frequency) imposed by Chinese regulators. The through train program aims to eliminate those drawbacks, as institutional or individual investors that can trade in Hong Kong, will be able to access such investments as China's A-shares* without the usual restrictions.
Similar to QFII and RQFII, mainland investors may invest in foreign securities through the Qualified Domestic Institutional Investor ("QDII") program, where investors must select from different financial products offered by around 150 licensed financial institutions. The through train takes a step in loosening the eligibility requirements, as mainland institutional or individual investors with over RMB 500,000 (or about US$81,000) can invest in Hong Kong securities directly.
Although its actual impact on the markets may be very limited, the through train serves an important pilot program for opening China's financial market. Under the current program’s design, the investment universe for the through train includes 568 Shanghai listed A-shares and 266 Hong Kong stocks—all relatively large and liquid. The aggregate quota for overseas investors is set at RMB300 billion (or about US$49 billion), while the quota cap for domestic investors is RMB 250 billion (or US$41 billion). Given the total capitalization of about US$2.7 trillion for China's domestic stock markets and about US$3.1 trillion for the Hong Kong-listed stocks, the through train's initial impact on the markets as a whole may be fairly incremental.
The through train represents a significant step in China's financial reform and builds easy and mutual access between two important investment universes.
The program will also further facilitate renminbi circulation and internationalization, as more foreign investors may seek attractive investment opportunities in China's stock markets. While gaining access to such a broad new stock universe can be exciting, foreign investors should be mindful that the trading volume in China's A-share markets is largely dominated by retail investors. As a result, A-share markets can be highly volatile.
Henry Zhang, CFA
* China’s domestic A-share market is comprised of domestic Chinese stocks listed in Shanghai and Shenzhen. Note, this does not represent a new asset class but a growing opportunity to access what represents the fifth largest public equity market in the world. According to FactSet and Bloomberg, A-shares consist of more than 2,300 companies totaling approximately US$2.7 trillion in market capitalization.
The information contained in this article does not, in any way, constitute investment advice. It should not be assumed that any investment will be profitable or will equal the performance of any securities mentioned herein. The information does not constitute a recommendation to buy or sell any securities mentioned.