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Chinese connection: the new Shenzhen-Hong Kong Stock Connect
Chinese connection: the new Shenzhen-Hong Kong Stock Connect
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Chinese connection: the new Shenzhen-Hong Kong Stock Connect

05/12/2016

Live since 5 December 2016, the Shenzhen-Hong Kong Connect has extended foreign investors' quota-free access to almost 85% of China's capital markets

The joint launch announcement, on 16 August 2016, from the China Security Regulatory Commission (CSRC) and the Securities and Futures Commission of Hong Kong (SFC) about the establishment of a mutual stock market access between Shenzhen and Hong Kong, came as no surprise: China has continuously strived to open its capital markets to foreign investment. This new Connect offers investors an alternative to the Qualified Foreign Institutional Investor (QFII) in terms of participation in the Chinese markets without quotas, while granting access to new growth assets.

Much of the technical setup is similar to the Shanghai – Hong Kong Stock Connect’s framework, making Shenzhen’s implementation an easier project for investors and providers. Some changes are worth noting though, such as the removal of aggregate quota across both Connect schemes. While the daily trading volume limits remain, they are segregated between north and southbound trading with a daily quota of RMB 13 billion and 10.5 billion respectively.

A new doorway to china

With a market capitalisation of more than USD 3 trillion, Shenzhen is the world’s seventh largest stock market. Around 880 listed stocks are eligible for investment under the new Shenzhen Connect scheme. This alone should raise overseas interest.

By comparison with Shanghai, Shenzhen has attracted more small- and medium-sized firms and has a reputation for growth companies. Foreign investors are likely to prioritise “new economy” sectors - including information technology, industrials[1], consumer discretionary and healthcare - and large corporations. 

Under the Shenzhen Connect, the investment community thus gains exposure to technology stocks. Indeed, the ChiNext board, China’s NASDAQ equivalent of high-growth stocks, is available to institutional professional investors[2] at the initial stage and will be opened to other investors later, subject to regulator’s further announcement.

Soon, a must have?

Since the formation in June 2015 of the Morgan Stanley Capital International (MSCI) - China Securities Regulatory Commission (CSRC) working group - China has been making significant progress to comply with the MSCI requirements: improved access to its capital markets to overseas investors; the internationalisation of the RMB now included in the International Monetary Fund (IMF)’s Special Drawing Rights (SDR) basket (October 2016); the Shenzhen-Hong Kong Stock Connect (December 2016) removal of aggregate quota; and the exchange-traded funds (ETFs) slated to be available in 2017.

The MSCI decision to eventually include Chinese A-shares, leading to global benchmark trackers needing to make an allocation to Chinese stocks, will make the two Connect schemes benefit from these investment flows. As asset managers look to invest into these A-shares, the two Stock Connects should soon become their preferred route as they represent an easier, quicker and more cost-effective option than the QFII access.

All that glitters

However, the creation of this fresh direct access to new stocks has made some analysts raise concerns as to the valuations of the stocks listed in Shenzhen. By way of example, the Shanghai Composite Index (SHCOMP Index) currently trades at approximately 15.2x 2016E PEi (and 13.4x 2017E PE), a little higher than other emerging markets. But the Shenzhen Composite (SZCOMP Index) has much higher multiples (31.5x 2016E and 24.6x 2017E)[3].

Nonetheless, interesting prospects are still to be found in mainland China, including in technology, automobile, capital goods and airports sectors. But this requires access to the high expertise and on-the-ground teams of research analysts provided by some banks, like BNP Paribas.

Seize the investment opportunities

The Shenzhen-Hong Kong Stock Connect gives investors the option to use special segregated sub-accounts (SPSA) through approved brokers and custodians. With a proven track record on clearing management, settlement, and custody, BNP Paribas is one of the few foreign banks currently offering SPSA custody. Our clients were able to hit the ground running and start trading on this new Connect from day 1.

 


[1] Industrial stocks in Shenzhen should also qualify as “new economy” - most of them don’t operate in the traditional areas.

[2] Definition according to SFC: means a person falling under paragraphs (a) to (i) of the definition of “professional investors” in section 1 of Part 1 of Schedule 1 in Securities and Futures Ordinance.

[3] Source: Bloomberg consensus, November 2016

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