The first week of Shanghai-Hong Kong Stock Connect is now in the books. Ordinarily, one week would be too soon to assess the performance of a major new market infrastructure project such as this. But given the substantial market focus and interest, I thought it might be helpful if I answered a few common questions we've received to date.
Are you satisfied with the performance in the first week? Or are you disappointed?
The most important measures of success for any major market infrastructure project are safety, stability and smooth operations. On that score, I am completely satisfied. I am therefore grateful to our colleagues, our partners and market participants.
Anticipating the flow of funds across the boundary was a bit trickier for us. We all shared in the collective enthusiasm prior to launch, so when we see the volume drop we're obviously a bit disappointed. But even if the market had rallied substantially in the first few days, it wouldn't have been sustainable in our view. Short term rallies usually happen when there are clear short-term trading profits to be gained; in this case, it's been seven months since the stock connect was announced, leaving plenty of time for A and H share prices to converge and for the scheme to be priced into the market. So there wasn't much of a "rush" to get into the scheme.
As I've said before, how much traffic travels across the bridge is a secondary consideration for us. As bridge builders, our biggest concern is that the bridge is built, it is safe and sound, and it is ready for traffic. As people become more familiar with it and have more reasons to cross, traffic will inevitably increase. Overall, this is a long-term scheme and we shouldn't get too hung up on the initial numbers.
What is your assessment of Northbound trading?
On the first day when the Northbound quota was used up, we saw a lot of swapping from the QFII scheme. As for the declining volume for the rest of the week, some have speculated the late clarification on taxes or challenges with pre-trade checking may have been factors. In other words, many participants are still going through their internal onboarding processes while others might be waiting for us to finish our central pre-checking enhancement on delivery. With the pending holiday season and year-end processes, we expect the whole market to be a bit quiet in the coming weeks.
Why has Southbound trading been so light? Are Mainland investors just not interested in Hong Kong stocks?
This is probably the most common question I've received since the scheme started. Southbound trading has been less than most market people anticipated. When we take a closer look at the reasons behind it, we've come up with a few potential factors:
Absence of short-term arbitrage gains. Unlike 2007, the valuation gap between the A share and H share markets is no longer there and some of the gap is actually the other way around.
Mainland institutions are not yet permitted to invest offshore. This issue is being resolved as the CSRC is already preparing the approval process. Over time, these institutions are expected to provide Mainland investors with more research coverage, product offerings, and promotional efforts to encourage more Southbound trading.
The RMB500,000 investor eligibility requirement. Investors with an account balance below RMB500,000 contribute significantly to A share market turnover. Whether we are able to lower or eliminate this barrier is something we will work on with our regulators.
Absence of small-cap eligible stocks. Mainland retail investors favour small cap stocks which were not included in the list of eligible stocks for Shanghai-Hong Stock Connect. While more stocks in both markets will likely be included in the scheme over time, we need to give the regulators more time to get used to the new joint regulatory and enforcement regime to protect investors against market misconduct, which tends to have a disproportional impact on small-cap stocks.
Lack of familiarity with the Hong Kong market. The biggest factor is still Mainland investors' knowledge and familiarity with the Hong Kong market. The A share market is a very unique market and A share investors are used to an investment and regulatory environment that is very different from Hong Kong and other international markets. So it's understandable some of them may dip a toe in the water before deciding to jump in. The broker-dealer community will continue doing its part to promote the scheme and we fully expect more Mainland investors to gain confidence and become more active over time.
Did you launch stock connect too soon? Should you have waited longer to give the market more time to prepare?
This is really a chicken-and-egg question. The impending launch of the scheme is what allowed us to get the tax situation resolved and the market infrastructure upgraded. If we had called for this prior to the scheme being announced or a firm launch date, it would have been very difficult for market players to get on board and commit to making the necessary investments without knowing when or even if the scheme would ever happen.
I spoke to the media last week and said the launch of Shanghai-Hong Kong Stock Connect is like a baby being born. Maybe the parents haven't decorated the nursery yet or purchased all the baby clothes, but that can be done later. When the baby is ready to be born, we can't make it wait. So let's welcome it into the world and then make sure we take good care of it and help it grow.
What is HKEx doing to help promote the scheme so we see increased volumes in both directions?
Continuing with my analogy, the baby has been born so now we can look at ways to make sure it is as healthy and happy as possible. Northbound, we are working hard on pre-trade checking to find a solution that works for institutional investors. We hope this can be done by May next year, but there's a possibility we can even get it done sooner on a trial basis if the industry is willing to work with us more closely.
Southbound, we will work with regulators to allow more investors to take part while working with the broker community to help promote the scheme, understand Hong Kong better, and get more research going. Perhaps we can consider expanding the scheme to smaller stocks initially through index products like ETFs. This will all help.
Do you think the slow take-up of the Stock Connect will impact other links or "bridges" to the Mainland market?
I truly don't know the answer to this question. The slower take-up may give people pause to think about the next move, or it might make people less worried about the risks of financial stability that are typically created by fast and excessive cross-boundary fund flows. If I had to guess, the reaction is more likely to be the latter as the first week of the Stock Connect gave a positive sign that the market has been calm and investors have been rational and sophisticated.
Do you still think you're on the right path? How will this end up?
Without a doubt we are on the right path. In all of this punditry and early obsession with the numbers, we should not lose sight of what the scheme represents. It's an historic opening of the Mainland's market that will grow and get better as China accelerates its strategic goal of reallocating its massive domestic national wealth beyond its own domestic markets. We have a strong conviction that Southbound flows will arrive en masse over time. What happens this week, this year, or next year will probably be forgotten in the future when we look back at the importance of the scheme to Mainland China and Hong Kong.
When the H share listing regime began in 1993, few companies in the Mainland used the scheme years after it was announced. It wasn't until the late 1990s that more companies listed in Hong Kong as H shares, and it really began to take off in the early 2000s. Now, we couldn't imagine not having H share companies listed in Hong Kong.
We have built the first bridge for mutual market connectivity. Now, as bridge builders, we will start looking for the next place to build a bridge and continue our mission as we help unlock China's potential and bring more benefits to Hong Kong, securing our role as a trusted partner to China and the world.