A historical opening of China’s equity market to foreign individual investors

On Monday 17 November the long awaited Shanghai-Hong Kong Stock Connect link (“Stock Connect”) opened for trading. 

What is Stock Connect?
The Stock Connect is a pilot program which enables foreign investors, both institutional and individual, to trade shares listed on the Shanghai Stock Exchange (“SSE”) and Chinese mainland investors to trade shares on the Hong Kong Stock Exchange (“HKSE”).

How does Stock Connect work?
In brief, the SSE has established a subsidiary in Hong Kong and the HKSE has established a subsidiary in mainland China, both of which have been granted permission to participate on the SSE and HKSE, respectively. In respect of trading on the SSE, foreign individual and institutional investors may trade shares listed on the SSE by placing buying or selling orders with a Hong Kong securities firm, which then forwards the buying or selling order to the HKSE subsidiary in mainland China. The HKSE subsidiary places the order on the SSE and also handles the subsequent settlement and clearing.

Are there any limitations?
As was (and still is) the case with the Shanghai Free Trade Zone and other attempts at liberalizing trade and investment in mainland China, there are naturally certain limitations in place to ensure that the Stock Connect will not result in an uncontrolled opening of China’s capital markets. The most significant limitations for trading on the SSE through the Stock Connect are the following:

First, only specifically approved shares may be traded through the Stock Connect. At present, there are approximately 570 SSE listed shares that are approved for trading, all of which are so-called A-shares, meaning they are RMB denominated.

Secondly, buy trades of SSE listed shares through the Stock Connect is upwards limited by fixed daily and annual quotas. The total initial buying quotas for all aggregated trading through the Stock Connect are RMB 13 billion per day and RMB 300 billion per year. Importantly, the quotas are calculated on a net basis – sell orders will be deducted.

Thirdly, day trading is not allowed, meaning that an SSE listed share bought through the Stock Connect can at the earliest be resold the day after it is bought.

An historical opening of investment opportunities in China
Foreign access to trade A-shares listed on the SSE is not an entirely new concept. This has to some extent already been possible through China’s RMB Qualified Foreign Institutional Investor (RQFII) program. However, only certain institutional investors have been eligible for such program, leaving most foreign individual investors without direct access to trade on the SSE. The Stock Connect therefore represents an historical opening of the Chinese equity market for individual investors. The reported interest among foreign investors for trading on the SSE through the Stock Connect is high. Although the program comes with some limitations it may prove to be a major step towards the full opening of China as a sought after and easily accessible investment destination.