Shanghai-London Stock Connect will allow international investors to access China A-Shares via Global Depository Receipts (GDRs) traded on the London Stock Exchange, and London-traded firms to list Chinese Depositary Receipts (CDRs) in Shanghai. This Stock Connect scheme differs from the existing ones between Hong Kong and Shanghai or Shenzhen in important ways, promising to give London a head start over rival financial centres in New York and Europe. All indications from both London and Shanghai are that the scheme will launch in December 2018.
An opportunity for Chinese corporates to list in London
Until now, Chinese companies listed domestically cannot list outside of China, excluding Hong Kong. Shanghai-London Stock Connect will allow Chinese companies listed on the Shanghai Stock Exchange to launch offerings/IPOs overseas in an exclusive agreement with the LSE. The hitherto ‘either-or’ rule has meant that many corporates, particularly tech companies seeking to build global brands and attract a wide investor base, have opted to list in the US (on the Nasdaq or NYSE) - which are now home to around 160 Chinese companies.
Stanislas Beneteau, Regional Head of Financial Intermediaries & Corporate Client Line at BNP Paribas Securities Services, points to China’s most valuable listed company to illustrate the point: tech giant Alibaba’s 2014 USD 25 billion float on the New York stock exchange. “Although Alibaba is a Chinese company, it is not actually listed in China. Its only traded stock is as American Depositary Receipts (ADRs) in the US.”
A simpler setup to invest in A-shares
As London’s LSE is the first and only option for Chinese companies seeking to list at home and overseas, the initiative will also open China’s locally listed companies, so-called A Shares, to a broader pool of international investors, including mid-tier, less sophisticated foreign investors for the first time. Huatai Securities will be the first issuer of GDRs and four other Chinese Companies have already disclosed their plans to issue GDRs sooner rather than later. Large pension funds, asset managers and hedge funds already invest in China A Shares in active strategies or via indices like MSCI Emerging Markets index. Yet investment in Chinese stocks can be perceived as complex and risky for managers without teams on the ground in Asia.
In contrast, Shanghai-London Stock Connect will allow investors to hold Chinese securities through London, free from the bespoke or unique structures needed by foreign investors in China. GDRs are simple, well known instruments; investors will be able to trade Chinese shares in UK hours and familiar currencies, as easily as if they were trading UK shares. “It gives access to China for small organisations that haven’t had a way into China before. China represents 15-20% of the world’s GDP, yet its weighting in key indices is in the low single digits,” says Gary O'Brien, Head of Custody Product, BNP Paribas, Asia Pacific.
Leveraging the differences in settlement cycles and time zones
The different settlement cycles and time zones between the UK and China, once perceived as a key challenge to the initiative, could in fact fuel its success. They will give London an advantage over a sister scheme, the 2014 Shanghai-Hong Kong Stock Connect which does not permit IPOs, but allows investors in Hong Kong and Shanghai to trade stocks from their respective markets.
Shanghai-Hong Kong Stock Connect follows the same investment model and rules as onshore China, which means that investors in Chinese securities must settle on the same day. That doesn’t leave much time for European or US investors without operations on the ground in Asia to complete all the processes associated with buying and selling shares such as arranging funding, validating the middle office process and ensuring the custodian matches in the market. If trades haven’t matched, investors are stung with buying costs, says O'Brien. “Some mid-size managers or banks who aren’t operating teams in Asia have steered away from the Shanghai-Hong Kong scheme for these reasons.”
In contrast, the London scheme will allow GDR buyers to follow London’s longer settlement rules. “London has a clear advantage for investors based in Europe and US,” says O'Brien. He also believes that the mismatch in settlement cycles and different time zones between London and China offers opportunities for London’s financial service providers. Brokers will be left with a funding gap that promises opportunities for liquidity providers like banks to bridge, he says. “Expect an increase in securities lending and securities borrowing activity in London to facilitate the complex back-to-back nature of trading shares in these capital markets.”
Shanghai-London Stock Connect will also allow buyers and sellers to use US dollars, pounds, euros or renminbi, depending on the currencies supported by the issuer. In contrast, under Shanghai or Shenzhen-Hong Kong Stock Connect, investors must settle in offshore renminbi (CNH) or onshore currency (CNY), Hong Kong dollars or US dollars. Yet settling in US dollars results in a mark-up in foreign exchange and settling in illiquid renminbi can also bring high funding costs.
Access to Chinese investors for UK issuers
The benefits of the initiative are just as significant for London-listed firms venturing East. They benefit from the opportunity to list in China for the first time, tapping China’s institutional investor base for whom investing overseas is difficult and expensive. According to consultancy Casey Quirk, assets under management in China’s investment management sectors’ is set to reach USD 17 trillion by 2030, up from USD 2.8 trillion in 2017. The banking group HSBC has already revealed it plans to issue CDRs in China, and Beneteau predicts that luxury and consumer brands for whom China is an important market could be other first movers.
His advice to UK companies thinking of listing is to examine the rules with a fine toothcomb (which is easier said than done since some are still being written), and evaluate the cost benefits. Progress might be slow: only a handful of securities will IPO in London and China in the short-term, predict Beneteau and O’Brien. But they point to Hong Kong Stock Connect’s 3-4,000 investor accounts today from humble beginnings four years ago as a sign of the potential. “This is a big deal for the UK, but don’t expect the Bloomberg screen to show huge trading volumes on day one. Success should be measured over several years, given the moving parts: primary issuance and supporting market conditions, secondary market mechanics, as well as rules and regulations evolving over time.” says Beneteau.
It also means it will take a while to nurture an investable index for passive investors seeking exposure to China. London Connect will only offer exposure to individual securities in the short term and is best viewed as a first-step, or a way to dip a toe in the market for investors new to China. “Until the number of securities grows, it won’t be a solution for those wanting true access to a range of securities in China, but it is a big step in the right direction” says Beneteau. The medium term ambition stated by the respective stock exchanges is that they expect tens, if not over a hundred securities over time.
Nevertheless, Shanghai -London Connect sets the LSE up to compete with New York and attract China’s most exciting companies seeking to IPO at home - and abroad. “Even though the US has the largest Depositary Receipt market in the world, Chinese authorities picked the UK,” said Beneteau.
What is Shanghai-London Stock Connect?
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China: Five questions raised by foreign investors about Stock Connect, Bond Connect and more
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