China’s Changing Scope
With Stephane Loiseau, Head of Cash Equities and Global Execution Services, Societe Generale, Asia Pacific
International investors have differing views and impressions as to China’s development among global equity markets. Following the MSCI decision process, perceptions among European and US investors differ widely from regional investors in Asia.
Asian investors are more open to the Chinese market, both in terms of market structure and investment opportunity, than their European and American peers. US investors, hurt by the 2015 equity turbulence, are skeptical to engage again with China.
Asian investors are more open to trading China first because they benefit from the location and second, because they likely have less choices: as a firm in Asia, ignoring Chinese equities’ size and influence on other markets would be imprudent. Asian investors are also growing more comfortable with China’s microstructure improvements.
Such improvements weighed heavily on MSCI’s decision not to include A-shares in its Asia index yet. For international investors, MSCI inclusion is a proxy for institutionalised accessibility to Chinese markets. Over the years and certainly in the last two reviews, MSCI were evaluating accessibility and microstructure in A-shares. While much has been done already, there is a roadmap for realising further gains.
The Shanghai-Hong Kong Stock Connect for example, has technically been a success. Progress has been slow at the beginning, but the enhanced SPSA enhanced model announced in April has resolutely expanded accessibility to additional investors.
Stock Connect is a material improvement for access to the A-share market. However, macroeconomic trends in China have hindered an increase in accounts from translating into increased volumes. Investors appear to be gearing up for increased interest in China, therefore they want to be ready for any sudden influx.
The Chinese regulators have also recently clarified beneficial ownership rules, which has been a legal barrier for many international investors. Finally, the rules about suspensions of individual names has also been clarified, adding another productive market structure improvement.
Shanghai and Shenzhen have revisited their suspension rules to avoid the mass suspensions international investors and MSCI specifically highlighted as a hindrance to investability. This change brings the Chinese market closer to par with most global markets or at least similar to Hong Kong, which is familiar to many investors.
The Hong Kong Exchange has actively educated international investors about the strengths of the Chinese markets. The Hong Kong Exchange has a significant part to play in communicating the latest updates from China, including the regulatory changes.
Hong Kong’s position as an entrepôt for Chinese markets remains attractive because it is still seen as having privileged access. Yet the interest in H- and A-shares is spread across pockets of assets.
However, investors will judge the market on the experience of trading in that market. Unfortunately, a number of investors were intimidated by last year’s turbulence. Overcoming this sentiment will likely be the biggest challenge.
Concerns about the Chinese economy and markets are only one part of the equation. Education on trading microstructure can be the easiest to address because there is investment interest, provided investors find the right vehicle.
Broadening the range of investment ideas in Hong Kong, Shanghai and Shenzhen will also deepen the number of constituents and instruments, easing trading impact.
The impact of retail
In 2015’s volatile Chinese markets, retail trading played a significant role spreading news and company information and the corresponding over-focus on retail investors by certain listed firms. On the back of the so-called national team’s involvement, it is clear larger investors have now a more prominent role in A-shares compared to past years. As a result, retail trading’s importance faded after the June decline began. China is not alone among Asian markets with high levels of retail participation, meaning those firms with experience in the region were able to trade with greater confidence. Hong Kong’s newly minted circuit breakers, locally referred to as a Volatility Control Mechanism (VCM), is an attempt to taper volatility spikes, particularly those driven by retail reactions to company news.
Given the close levels of coordination, after Hong Kong implements the VCM, China is likely to revisit their retail markets afterwards. After China’s difficulty with circuit breakers in January of 2016, Shanghai and Shenzhen will aim to improve on their original implementation.
Future of Connect
Even more important as a driver of market structure change may be MSCI’s 2017 A-share inclusion ruling. In an attempt to pre-empt challenges from MSCI, China and Hong Kong may accelerate Stock Connect’s Shenzhen launch and expansion.
The technical specifications for Shenzhen connect were recently published by the Hong Kong Exchange signalling the high priority given to Shenzhen readiness. Meanwhile, the Chinese regulators wait for the right time to make the announcement.
The A50 and the CSI300 indices, used both regionally and domestically, contain a large number of Shenzhen stocks which today cannot be traded on Shanghai- Hong Kong Stock Connect.
Expectations are that the Connect scheme will add more Shanghai stocks to cover a larger percentage of the market capitalisation.
Even though the daily quotas have not always been filled, they may be raised to make the Connect more credible and attractive for institutional investors, relative to QFII and RQFII. While the CSRC has not indicated an intention to offer unrestricted access at this stage, raising the quota would give investors greater comfort and flexibility.
Packaging with the other Stock Connect improvements, the Shenzhen announcement may be followed by a bond connect, and an ETF Connect.
Hong Kong’s role
Despite the considerable column space devoted to UK-China bilateral discussions, we believe the Hong Kong Exchange will remain the privileged hub for access to China.
Even in the sibling rivalry between Shanghai and Hong Kong, when it comes to international expansion, Hong Kong seems to be the chosen gateway. If the initiatives discussed earlier are delivered soon, Hong Kong’s status may be bolstered by additional capabilities authorised by the mainland.
Hong Kong’s secondary competition with Singapore seems focused on derivative products as Singapore has some of the largest derivative contracts on the Chinese domestic A50 index. However, if Hong Kong has the ambition to close this gap, it is expected to create competing derivative products to track Chinese indices in particular.
Until MSCI decides to include A-shares in its Asia index, Hong Kong is China’s main access point. After MSCI inclusion, an expanded Stock Connect will still channel flows through Hong Kong.
In the long term, the real question may be whether an open China will need any gateway at all.
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