The first-ever stock trading link between China and a financial centre in Europe is set to offer access to sophisticated investors only when it begins operating, primarily because of the unique nature of the trading scheme and investment risks involved.

The Shanghai-London Stock Connect programme, which is expected to be up-and-running by the end of the year, will permit eligible London-listed companies to list their shares as China depository receipts (CDRs) in the onshore Chinese market (see box below), while Shanghai-listed companies will be allowed to issue global depository receipts in London.

With Shanghai-Hong Kong Connect (and its Hong Kong-Shenzhen sister scheme) in contrast, Chinese investors can buy Hong Kong-listed stocks directly under daily quotas.

Investors who aim to participate in the Shanghai-London Connect will have to meet minimum requirements in assets and investment knowledge, according to a consultation paper on CDR listing rules released by the Shanghai Stock Exchange (SSE) last Friday (October 12). This is likely restrict participation to mainly institutional investors and high-net-worth individuals.

Mainland investors seeking to participate in the London-Shanghai trading link will need to have at least Rmb3 million in their securities and cash accounts over the past 20 trading days, excluding any funds obtained through margin financing or short selling, according to the consultation paper. In contrast, mainland investors in the Shanghai-Hong Kong Stock Connect need to maintain Rmb500,000 in their trading accounts.

Financial institutions will need to carry out due diligence on investors as well: they are required to conduct a comprehensive evaluation of investors’ asset levels, their knowledge of investments, risk tolerance and creditworthiness. They will also need to ensure that investors understand how CDRs are traded, and fully appreciate the investment risks involved.

“Do investors know what CDRs are? What are the risks involved? How much do investors know about the background of the London issuers? These are the considerations [that regulators took on board] … when they decided on the thresholds [for investment],” Patrick Wong, head of China sales and business development at HSBC Securities Services, told AsianInvestor.

The connect programme should theoretically help Chinese investors turn their portfolios into more global ones with less regulatory and foreign exchange risk.

Although mainland investors will be purchasing CDRs in renminbi and therefore assuming lower foreign exchange rate risk, if the pound slips against the renminbi, they will still be exposed to some currency risk as the CDRs track shares denominated in pounds on the London Stock Exchange.

In addition, CDRs also carry liquidity risks. If the CDRs are held in the hands of just a few investors, while the underlying London-listed shares have a broader investor base, the resulting liquidity premium could lead to a price differential between the CDR and the listed shares in London, a Hong Kong-based financial analyst who declined to be named told AsianInvestor.

The one-week consultation on the listing rules run through October 19.

MORE TRADING LINKS LIKELY

Meanwhile, the China Securities Regulatory Commission (CSRC) also announced trial measures on the Connect scheme on the same day the SSE released the draft listing rules, after a one-month consultation on the scheme ended on September 15. The securities regulator provided more operational guidance on the trading scheme, which came into effect immediately.

When the London-Shanghai Scheme is officially launched, investors are likely to give it a cautious welcome and trading volumes will be low, -- similar to how Hong Kong-Shanghai Stock Connect was initially greeted. However, over time investors will warm to the new trading link, Banny Lam, head of research at CEB International, told AsianInvestor.

In coming years, Shanghai will likely link up with more financial centres around the world, using the London-Shanghai Stock Connect model, he predicted.

“We believe there is scope for the Chinese government to allow other foreign companies to issue CDRs in China, based on a similar regulatory design of the Shanghai-London stock connect,” Goldman Sachs said in a report released on October 15.

The CDR approach could be a key component in China’s attempts to continue liberalising its capital market while maintaining capital controls, the report said.

Highlights of the listing rules:
(based on the consultation paper and information from the Goldman Sachs report)

For CDR issuers:

  • Minimum of Rmb20 billion market cap on average for 120 trading days before CDR listing application day.
  • Three years of London Stock Exchange (LSE) listing history and one year of listing history as its mainboard senior company (possibly referring to a member company of a major LSE stock index, like FTSE 100 index).
  • Minimum CDR issuance volume of 50 million shares worth at least Rmb500 million in market cap.

CDR listing process:

  • CDR issuer files application for pre-approval to SSE and CSRC (result of the application will be typically known in 30 trading days).
  • After receiving pre-approval, CDR market makers can start buying underlying stocks from LSE (using own funds or by accepting orders from qualified investors) and convert them into CDRs.
  • Once the converted CDRs total more than 50 million shares and valued at a minimum of Rmb500 million market cap, the issuer can apply for CDR listing on the SSE (the result of the application will normally be announced within 5 trading days).