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How To Gain From The Hong Kong-Shanghai Link Up
Perspective | 10 October 2014
By: Shane Goh
Articles (99) Profile

Hong Kong is facing its worst political crisis since its return to Chinese rule in 1997. Since 22 September, student protestors have filled the streets following China central government’s decision on electoral reform regarding future Hong Kong chief executive and legislative council. The latter’s stance is seen as effectively screening out any pro-democracy candidate.

The protest has impacted the city’s economy and its stock market. After hitting a six-year intra-day high of 25,362.98 on 4 September, Hong Kong’s Hang Seng Index has tumbled 7.2 percent to close at 23,534.53 on 9 October.

Amid the backdrop of the political protest and market rout, one upcoming major development is the potential link up between the stock exchanges of Shanghai, China, and Hong Kong.

Apart from the potential increase in trading volume and reduction of arbitrage opportunities, the proposal would widen investors’ equity choices, particularly for Chinese investors who were previously unable to get their hands on Hong Kong-listed companies.

What does the tie-up mean for investors? Find out more at the Shares Investment Conference 2014 on 18 October 2014. Visit for more information.

The Stock Connect
The Shanghai-Hong Kong Stock Connect establishes mutual stock market access between mainland China and Hong Kong.

In total, 568 Shanghai-listed stocks (A-shares) will be available through Hong Kong while 266 Hong Kong-listed stocks (H-shares) will be accessible by mainland investors.

Both exchanges will impose a daily quota of Rmb13 billion (A-shares) and Rmb10.5 billion (H-shares) respectively.

Share prices and trading of A-shares will be in Chinese Yuan while share prices of H-shares will be quoted in Hong Kong Dollars and settled in Chinese Yuan.

Chinese institution and investors with a minimum Rmb0.5 million in their securities accounts will be granted access to Hong Kong shares through mainland brokerages.

Potential Volume Increase
Expected to be launched in late October, the link up is set to lift the trading volume of certain Hong Kong and Shanghai shares.

Out of the 266 H-shares, about 70 of these companies are dual-listed in Shanghai and Hong Kong. The remaining 190 firms could see an increase in trading volume due to pent up Southbound demand for the equity of these previously inaccessible companies.

However, the Northbound interest might be far greater as the link, which allows a net Rmb23.5 billion of daily cross-border purchases, would provide foreign investors unprecedented access to Shanghai-listed companies.

Since 2003, selected large institutions have been granted entry to A-shares under China’s “Qualified Foreign Institutional Investor” programme, but the Stock Connect is set to enhance the accessibility.

Despite representing about half of the total number of stocks listed on the Shanghai Exchange, the firms involved in the link up represent 90 percent of the exchange’s market capitalisation.

Narrowing Arbitrage Opportunities
Although Shanghai shares tend to trade at cheaper valuations than those listed in Hong Kong, the Hang Seng China AH Premium Index, which measures the weighted average gap between the largest dual-listed shares, has risen to close at 98.92 on 9 October, shy of its 52-week high of 102.22 set on 5 February.

A level of 100 means H-shares in Hong Kong trade at the same price as A-shares on the mainland. It has been trading below 100 since March and hit a low of 88.72 on 24 July.

The surge in the past few months has been supported by an influx of funds into exchange-traded funds (ETF) tracking Chinese equities this year. Investors have channelled US$3.6 billion into such ETFs, larger than three times more than the amount placed with Hong Kong ETFs.

To take advantage of any further arbitrage opportunities, one may choose to short the stock in Hong Kong, which has richer valuations, and long its counterpart in Shanghai.

Key Risks
With every development that receives much fan-fare, there will be cracks that may trip its success. In August, a CLSA survey found that 77 percent of mainland investors did not intend to participate in the planned exchange link up. Reasons for shunning away include rules on the minimum account size and the exclusion of small-cap stocks.

Additionally, the Stock Connect will not allow intra-day trading while investors are required predeliver their orders. This means that purchases and disposals of A-shares must occur over separate trading sessions. This could render foreign investors powerless over their holdings through market gyrations.

The link up will aid in China aim to boost the use of the Chinese Yuan in global trade. However, as share transactions are executed in Chinese Yuan, this poses a currency risk to overseas investors, who must choose to pay a fee to hedge their translation exposure or be subjected to foreign exchange fluctuations.

Reclusive Gaming/Technology stocks
Two sectors of interest which were previously unavailable to mainland investors are gaming and technology. These include Macau casino operators such as SJM Holdings (HK:0880), Sands China (HK:1928) and Galaxy Entertainment Group (HK:0027) as well as technology company, Tencent Holdings (HK:0700).

According to China National Tourism Administration, travel agencies arranged trips for 3.1 million mainland tourists to Macau in 2013, the fourth largest outbound destination of the Chinese.

Tencent Holdings is the owner of Tencent QQ, an instant messaging software service that also offers online social games, music and shopping services. As of 31 March 2014, QQ’s aggregate monthly-active-users hit 848 million. According Enfodesk, QQ’s mobile instant messenger was the largest in China with 39.9 percent of the market share.

The familiarity of these sectors could potentially aid to shore up interests in their stocks once the link up goes online. Apart from the two sectors, we’ve sought to uncover stocks across various industries that may be of interest to the mainland investment community.

Look out for our selection next Monday!

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

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