Approval of Shenzhen-Hong Kong Connect removes a barrier to China A-Shares inclusion

Aug 17th, 2016 | By | Category: ETF and Index News

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The Shenzhen-Hong Kong Connect, a programme linking the Shenzhen and Hong Kong stock exchanges, has been given the green light to launch in December, four months from now.

Share trading through Shenzhen Connect approved for December launch: ETFs to follow shortly after

The Shenzhen-Hong Kong Connect will allow investors to trade stocks and ETFs between both exchanges in Hong Kong and Shenzhen (pictured).

The venture follows the successful launch of the Shanghai-Hong Kong Connect programme in November 2014, but will be the first of the two programmes to offer investors access to exchange-traded funds (ETFs).

Limits or quotas on how much foreigners can invest have also been lifted, thereby removing an important obstacle to the inclusion of China A-Shares in benchmark indices from MSCI and FTSE Russell – a move which would impact some major ETF allocations.

The programme allows Hong Kong-based investors to trade stocks listed on the Shenzhen Stock Exchange (northbound transactions), and similarly grants access to Hong Kong-listed shares to Chinese investors through trading on the Shenzhen Stock Exchange (southbound transactions).

Speaking in an interview with Bloomberg Television, Charles Li, chief executive officer of Hong Kong Exchanges & Clearing said the establishment of the southbound link is of far greater importance than the northbound in enhancing Hong Kong’s position as a leading financial centre: “The long-term significance of the Connect is the southbound…Hong Kong’s job is to bring the world to Hong Kong, so China can invest in the world at this full stop in Hong Kong.”

The China Securities Regulatory Commission and Hong Kong’s Securities and Futures Commission have stated that the four month delay was chosen to allow securities firms time to prepare for the expected increase in trading activity.

Showing greater confidence in the new programme, Chinese mutual funds will be allowed to trade Hong Kong stocks through the Shenzhen link immediately after launch, a move that was only permitted with the Shanghai Connect four months into its infancy. The Shenzhen connect will also differ from its Shanghai counterpart in that no aggregate volume limit will be set. Daily volume limits will be set however at RMB13bn and RMB10.5bn for northbound and southbound trading links respectively.

ETFs will not be immediately available for trading as regulators wish to monitor share trading activity through the Stock Connect, ensuring trading is orderly, certain conditions are met, and the registration and settlement processes are refined, before progressing to other investment vehicles.

The Shenzhen exchange tends to host smaller and less liquid stocks compared to the Shanghai exchange; however, with both programmes operational, investors will finally be able to access a broader profile of investments that better reflects the entire Chinese investable universe.

The two programmes aim to open up China’s A-Shares market to foreign investors and have been touted as significant steps forward in lifting the restriction on A-Shares inclusion in widely tracked indices. Perhaps the most important of which is the MSCI Emerging Markets Index.

It has been estimated that the inclusion of A-Shares may result in the proportion of the MSCI EM Index assigned to China increase from its current level of 24.8% (30 July 2016) to approximately 40%. When this does occur, it will result in significant buying and selling activity in a wide range of ETFs tracking the index. The largest of these is the iShares MSCI Emerging Markets ETF (NYSE Arca: EEM) with over $31bn in assets under management. In the UK, iShares offer a UCITS-compliant version of the fund, the iShares MSCI Emerging Markets UCITS ETF (LSE: IEEM), which has $4.9bn in AUM.

Other European-listed ETFs to cover the index include the $2.7bn UBS ETF MSCI Emerging Markets UCITS ETF (LSE: UC27); the $2.0bn Lyxor MSCI Emerging Markets UCITS ETF (LSE: LEMD); the $162m Source MSCI Emerging Markets UCITS ETF (LSE: MXFS); and the $138m SPDR MSCI Emerging Markets UCITS ETF (LSE: EMRD).

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