A Financial Milestone

By Helena Pozniak

The launch of an unprecedented cross-border joint exchange signals a new era of capital market expansion for China and may open a floodgate of wealth for both the Mainland and Hong Kong, says Charles Li, Chief Executive of the Hong Kong Stock Exchanges and Clearing Limited.

Both Mainland China and Hong Kong stand to reap huge benefits from a new stock market partnership between the Shanghai and Hong Kong exchanges, but more work is needed to perfect the machine so that capital will flow easily in both directions, said Charles Li, Chief Executive of the Hong Kong Stock Exchanges and Clearing Limited.

Speaking to more than 300 business executives, as well as current students and alumni of the Chinese University of Hong Kong Business School, Li said there is a huge amount of money within China that needs to find a home. “The Stock Connect is the beginning of that journey.”

Launched on November 17, the Shanghai-Hong Kong Stock Connect allows foreign investors to trade stocks in Shanghai’s market directly for the first time, and Chinese mainland investors to trade shares on Hong Kong’s market. Analysts believe this is one of the most significant openings in China’s capital markets in recent years. “We are talking about opening two fundamentally different markets,” said Li. “It’s like fitting a round pipe into a square hole. But how to make this work is the very spirit of Stock Connect–it puts the two clearing houses together and allows them to work out the differences between the two markets.”

Speaking during the first week of trading for the Stock Connect, Li said he was unperturbed by low volumes of trading, especially from mainland investors. Daily and aggregate limits are placed on how much money can flow from the mainland to Hong Kong and vice versa, which may limit enthusiasm for trading in the short term. “There was a lot of hype and excitement before the opening, but these levels of trading are exactly what I expected,” said Li. “From the perspective of someone who’s built the infrastructure, we want this to be relatively noise free. I think it will take years to fully appreciate what we have witnessed.”

“The launch of an unprecedented cross-border joint exchange signals a new era of capital market expansion for China and may open a floodgate of wealth for both the Mainland and Hong Kong.” – Charles Li, Hong Kong Stock Exchanges and Clearing Ltd

Under the system, which has overcome many complex technical and legal hurdles, Hong Kong investors’ trades are channelled through Hong Kong Stock Exchange and likewise mainland investors’ money is channelled solely through the Shanghai Stock exchange. “We’ve created a pipeline, so the only investor money actually crossing the water comes from the respective exchanges.”

This is a perfect solution for China, where economic reform is desired and essential, said Li. While Mainland China’s economy inevitably moves in line with global trends, its capital markets have remained completely closed at an increasing cost to the Chinese people.

This reciprocal system allows China a degree of control over capital flows in and out of the country, said Li, as funds are obliged to pass through the two exchanges. “When you buy in Shanghai, you won’t be able to use [your profits] to speculate on property or anything else within China,” said Li. And if Mainland investors wish to sell stocks in Hong Kong, their [profits] will return to the Mainland.

For the first time, said Li, the RMB will be used for investment as well as trade settlements. Funds from the Mainland are converted into RMB in Hong Kong before they are being invested in the Hong Kong financial market. “The exchange is not making a dime out of this [exchange],” said Li. As all trades are logged and visible, this gives China an extra level of reassurance.

While Hong Kong Stock Exchange is not directly responsible for regulating companies eligible for investment on the Shanghai Stock Exchange, it is now in the interests of both authorities to work together to protect investors, said Li. In fact, the mutual system offers international investors far more security than if they would invest in China via other international bourses, he said, where some mainland companies are listed, he said.

After a period of reform due to financial upheavals in the last decade, China’s stock market has leapfrogged other international markets to adopt the most up-to-date technology and regulations, said Li. “They’ve built the best risk-managed, the easiest-to-regulate and the most transparent market in the world.”

Currently only equity can be traded through the Stock Connect, but Li hopes the system will eventually extend to incorporate other markets such as derivatives, commodities and more. “In two to five years, this thing could be massive,” he said. “This convergence of two markets, with all the different appetites for risk, could create a much more diverse environment.” Think of the investment opportunities created by the Stock Connect as a “specialist mall,” which has access to the huge customer base of the domestic market in China, he said, adding that it is in the interests of Hong Kong to diversify and expand investment opportunities on offer. “This is only the beginning–it could take years to materialize but Hong Kong could potentially be the beginning of receiving a massive amount of investment.”

Currently Chinese investors are sitting on US$22 trillion’s worth of savings, with limited options to invest, said Li. “There’s a large amount of money in China which hasn’t been deployed efficiently at all. Within five to 15 years, that US$22 trillion will find its way into the capital markets if there is enough potential for that national wealth to be deployed.” While Hong Kong’s market has enjoyed spectacular financial success over the past 20 years, growing from US$3 trillion to US$25 trillion today largely by raising money for Chinese enterprises, that model now needs to change, he said.And Hong Kong is secure in its position as the gateway to China.

In Li’s opinion, Hong Kong should remain “strategically arrogant but tactically humble” in dealing with mainland authorities. “We’re a small city, with seven million people. We don’t grow anything. The only thing we have is a great economic system. This system not only guarantees our prosperity but also our very survival,” he said. As such, Hong Kong investors need to quell their fears that China might eventually benefit more from the Stock Connect than Hong Kong would. “As long as we are engaged, as long as we are part of the solution and connected with this massive machine, we will all benefit—just in different ways.”