Shenzhen-Hong Kong a “Game Changer” for ETFs

Shanny Basar

The long-awaited link between the Hong Kong and Shenzhen stock exchanges will be launched next week and although it applies to equities, it will also benefit exchange-traded fund issuers who will find it easier and more efficient to access index constituents.

Shanghai-Hong Kong Stock Connect was launched in November 2014 and the Shenzhen link will begin next week on 5 December. The Stock Connect schemes allow any investors to trade mainland Chinese stocks via Hong Kong, and vice versa, without needing a license or an approved quota.

Danny Dolan, managing director of fund manager China Post Global (UK), told Markets Media: “Completion of Stock Connect is a game changer as ETF issuers can trade more cheaply and efficiently. It is already a big plus.”

He added that as a result of Shenzhen-Hong Kong, some indices will have 98% of their constituents covered by the Connect scheme. BNP Paribas said in a note that removal of aggregate quotas from the two Stock Connect schemes, together the recent opening of onshore China Interbank Bond Market (CIBM), means that 85% of China’s capital markets are accessible quota-free.

The French bank added that Shenzhen is the world’s seventh largest bourse with a market capitalisation of more than $3 (€2.8) trillion from around 880 listed companies. Many stocks are from high-growth sectors and so will be attractive to international investors.

“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,” added BNP Paribas. “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.”

Cindy Chen, country head, securities services, Hong Kong at Citi said at an Accessing China seminar at the London Stock Exchange in September that ETFs listed on both Shanghai and Shenzhen exchanges could be included in the Connect Scheme next year. “Then IPOs through IPO Connect, followed by listed bonds and the interbank bond market,” she continued.

Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman in Dublin, said in a blog: “The inclusion of ETFs in the Shenzhen-Hong Kong Stock Connect opens up another route to mainland China investors, which is sort of an El Dorado for asset managers.”

Tuffy cited regulators who have said ETFs will be included in the Shenzhen-Hong Kong Stock Connect after it “has been in operation for a period of time and upon the satisfaction of relevant conditions”. He added that details will be required on which type of ETFs will be allowed, whether there will be any quota restrictions and if there will be any domicile requirements on the ETFs or managers. It is likely that only Hong Kong-domiciled ETFs will be allowed to be sold to mainland investors.

“If the program does move forward, it could be a great way for asset managers to access investors in mainland China and should expand the range of investment opportunities for mainland investors beyond the 200 ETFs that are currently available in Hong Kong,” added Tuffy. “The Shenzhen-Hong Kong Stock Connect is definitely something for managers to keep an eye on as it could be a critical piece of Hong Kong’s plan to establish itself as a global fund center.”

In addition to launching the link with Shenzhen, Hong Kong and Swiss regulators have signed an agreement for the mutual recognition of funds and asset managers. This will allow eligible Swiss and Hong Kong public funds to be distributed in each other’s market through a streamlined vetting process.

Tuffy said in an email to Markets Media: “The  Hong Kong/Switzerland deal is important because it is the clearest signal yet of Hong Kong’s intent to become a major cross-border fund domicile. It is also noteworthy because  is the first  time that an Asian and European  jurisdiction have entered into a mutual recognition agreement.”

Carlson Tong, chairman of the Hong Kong Securities and Futures Commission, said in a statement: “This pioneering initiative, whereby home-grown Hong Kong funds – for the first time – gain direct access to the investing public in a European market, is a testament to Hong Kong’s commitment to develop the city into an international asset management centre.”

China Post Global became the first Hong Kong-based asset manager to acquire a European Ucits exchange-traded fund umbrella when it bought the Market Access ETF range from the UK’s Royal Bank of Scotland in March this year. China Post Global is a joint venture established last year as the international asset management arm of China Post Fund, one of China’s largest state-owned enterprises.

China Post Global will list two smart beta Chinese ETFs based on Stoxx indices in Europe in the first quarter of next year. The minimum variance ETF will give international investors access to China while minimising volatility, and the quality ETF will focus on companies with consistent earnings and strong fundamentals.

“These will be the first smart beta Chinese ETFs in the  European market and an important strategic development” said Dolan.

He believes it is highly likely that China A-shares, traded on the Shanghai and Shenzhen stock exchanges in renminbi, will be included in the flagship MSCI emerging market index in 2017 after being rejected this year.

“Regulators are working hard to iron out remaining obstacles and have been responsive to investor concerns,” added Dolan. “There is a firm direction of travel and the destination towards an open economy is very clear. It is a question of when, not if.”

Dolan added that the recent launch of Ceinex, the China Europe International Exchange, in Frankfurt was also a significant milestone for accessing China. Ceinex was launched last November as a joint venture between the Shanghai Stock Exchange, Germany’s Deutsche Börse and China Financial Futures Exchange.

“Renminbi-denominated ETFs on Ceinex could also be made available to onshore Chinese investors,” said Dolan.

BNP Paribas believes that the Shenzhen link might be a key factor in China A-shares being included in the MSCI indices as part of a number of initiatives China has made to improving access to its capital markets for overseas investors.

“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,” said the French bank. “If MSCI took the decision to include A-shares, this would lead to global benchmark trackers needing to make an allocation to Chinese stocks.”

Chinese regulators also opened up the $7.3 trillion onshore CIBM market to international investors this year, which Dolan said has attracted interest, but it is a very young market.

“There are interesting investment opportunities and fixed income ETFs will eventually be launched,” added Dolan. “The market is too important and significant for there not to be.”

BNP Paribas said foreign bond buying has accelerated since the CIBM announcement, with overseas holdings up 15% between February and June this year, according to the People’s Bank of China. Chinese bond yields are more attractive than those in many developed markets which have negative interest rates.

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