Green Light China: welcome to a new world of opportunities

Initially published on Wednesday 21 September 2016

China's financial market opening continues at pace, with the widely anticipated Hong Kong-Shenzhen Stock Connect now slated for implementation around December 2016.


China sceptics should take note, the dumping of aggregate quotas means the Hong Kong-Shenzhen Stock-Connect scheme, together with Shanghai-Hong Kong Stock-Connect and the recent opening of the China Interbank Bond Market (CIBM) will leave a sizeable 85%1 of China's capital markets (including fixed income and equities) accessible quota-free.
IN A CHANGING WORLD
OPPORTUNITIES IN CHINA ARE RIGHT AHEAD

Shenzhen - shinier than Shanghai?


International investors could find Shenzhen has some appealing features compared with the more well-known Shanghai market. The Shenzhen scheme not only offers an alternative to the Qualified Foreign Institutional Investor (QFII) in terms of participating without QFII quotas, it also opens the door to direct access to new growth areas in the Chinese economy because of the type of companies listed in Shenzhen.

With a market capitalisation of more than USD3 trillion2, Shenzhen is the world's seventh largest bourse. Around 880 stocks that are listed on the Shenzhen Stock Exchange (representing about 74% of the total capitalisation) are eligible for investment under the scheme by institutions or individuals who have accounts with registered brokers in Hong Kong.

What will no-doubt attract overseas investors1 interest and what makes the constituents of the Shenzhen Stock Exchange (SZSE) stand out is that these companies come from the sectors that are powering China's "new economy". While Shanghai is heavily weighted towards large caps and the more traditional industries, with a number of stocks already dual-listed in Hong Kong, SZSE has attracted many more small and medium-sized enterprises.

The initial attention is likely to centre on the "new economy" sectors, including IT, Industrials (focused in non-traditional areas), Consumer Discretionary and Healthcare, that will become more heavily emphasised as China moves away from its reliance on heavy industry and fixed asset investment-driven growth and toward a more consumption-driven model.

The Pearl River Delta has built a reputation for innovation and technology, and the investors  might be attracted to the Chinese tech stocks that will now be able to gain exposure to under the Shenzhen Connect. Indeed the ChiNext board, which is China's NASDAQ equivalent of high-growth stocks, will be available to institutional professional investors under the new scheme.

While analysts may be busying themselves to gather information on many of the lesser-known firms that will now enter their investable universe, there are also some big companies and familiar names within the top 10 most actively traded stocks that constitute 6.9 % of the average daily turnover of SZSE4.
Green light china 7 facts
  • Shenzhen world's 7th biggest bourse
  • 880 stocks open to international investors (73% of total) 
  • Chi-Next Board = China's Nasdaq equivalent
  • Shenzhen market cap USD3 trillion
  • With Shanghai Market cap USD4 trillion and China Interbank Bond Market USD7.3 trillion = USD14 trillion
  • 85% of China's capital markets now open quota-free (inbound)

Momentum is building

China's move in February to open its USD7.3 trillion onshore bond market to more foreign investors, through the China Interbank Bond Market (CIBM) Direct scheme, has already attracted international interest from yield-seekers.

Foreign bond buying has accelerated since the CIBM announcement, with foreign investor holdings up 15% between February and June 2016, according to the People's Bank of China. With negative European interest rates, Chinese bond yields are more attractive than those in many developed markets.

The speed at which China has moved to remove restrictions on inbound investment has surprised some, but market-watchers warn that outbound flows are still heavily regulated.

Small step or giant leap?

What are the implications of this new Connect and will it have a big impact beyond Hong Kong and China? BNP Paribas believes that it might in fact be a key factor in China A-shares being included in the MSCI global indices, and then in turn benefit from this move because of the resulting investment flows.

Since the formation of the MSCI-CSRC working group in June 2015, we have seen progressive steps being taken to comply with the MSCI requirements. Through a number of initiatives, China has been making significant progress on improving access to its capital markets for overseas investors. The Shenzhen-Hong Kong Stock Connect is the latest part of this overall policy. It enhances the existing Shanghai scheme and the removal of the aggregate quota could have wider implications.
Although MSCI in their recent review did not include A-shares in their global indices, it recognised that China has made significant steps toward this happening. The quota system was one of the stated hurdles and with the global index provider not ruling out a potential off-cycle announcement, there is a possibility of inclusion being re-evaluated.

If MSCI took the decision to include A-shares, this would lead to global benchmark trackers needing to make an allocation to Chinese stocks. The two Connect schemes would benefit from these subsequent flows, as would those stocks with larger market capitalisation. As Asset Managers look to make these investments into A-shares, they will benefit from the more cost-effective options offered by the Stock Connect when compared to QFII access.
Green Light China: the last decade
1 Sources: BNP Paribas; Hong Kong Stock Exchange; Bloomberg; BNP Paribas Research "SZ-HK Stock Connect: Small is beautiful" as of August 2016
2 Source: World Federation of Exchanges
3 Subject to announcement to be made by Hong Kong regulators. 
4 Source: SZSE, from 18 July 2016 - 15 August 2016

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