Market Views: London-Shanghai Connect’s prospects

We asked two investment specialists and one custody services expert what the outlook for the upcoming Shanghai-London scheme is, given the uncertainty surrounding Brexit.
Market Views: London-Shanghai Connect’s prospects

A stock trading scheme linking Shanghai and London is widely expected to be launched by the end of this year. The Shanghai-London Stock Connect will allow investors in each country to invest in companies listed in the other, provided these companies have a secondary depository receipt listing in place.

But unlike the more established Shanghai-Hong Kong link, the Shanghai-London Connect will only allow investors in each market to buy stocks indirectly in the form of depository receipts, according to a consultation paper released last week.

Stll, experts told AsianInvestor that the new Connect programme should, in theory, help domestic Chinese investors internationalise their portfolios with less regulatory and foreign exchange risk.

But with Brexit looming, is it a trading link that Chinese investors are likely to get excited about?

Britain is scheduled to exit the European Union on March 29, 2019, but a number of obstacles still remain to be overcome. A full exit deal has yet to be negotiated with Brussels, so there is plenty of uncertainty going around at the moment.

That said, the London Stock Exchange has contingency plans in place to ensure it can continue to offer its services to EU customers and, in any case, has some built-in Brexit defences to help maintain its appeal.

With a market cap of $4.37 trillion at the end of July – only slightly smaller than Shanghai's but bigger than Hong Kong's – London is the sixth-biggest stock market in the world, according to data from the World Federation of Exchanges. In addition, more than 400 of the 2,500 companies listed in London are classified as foreign, while the vast bulk of earnings generated by Britain's bluest blue-chip companies – i.e. those is the FTSE 100 index – come from overseas, so they benefit if the pound weakens.

London's historic financial expertise and time-zone advantages, meanwhile, could in theory also help it become a significant new conduit for equity investment into China and partly compensate for the Brexit adjustment still to come – the UK government will surely hope so.

Given this backdrop, we asked two investment specialists and one custody services expert what the prospects for the Shanghai-London Connect scheme could be.

While none of our respondents offered a response on how Brexit could affect the stock trading link, they seem fairly certain that it will further encourage Chinese equity investors to venture overseas to diversify their portfolios more effectively.

The responses have been edited for clarity.

Rob Secker, investment specialist (based in London)
M&G Investments

The proposed launch of the Connect programme by the end of this year is undoubtedly a positive development. However, we have yet to see whether there will be any meaningful flows resulting from the tie-up.

From an international investor’s perspective, being able to invest in the Chinese domestic market is an advantage as China offers some exciting opportunities, as we’ve seen in relation to mainland shares being included in MSCI indices and the opening up of the Stock Connect to Shanghai and Shenzhen.

In comparison to the inclusion of Chinese domestic shares in the MSCI indices, which are expected to trigger significant [capital] inflows from passive investors over the coming year, this development [London-Shanghai] is likely to have a fairly minimal impact. 

The programme’s launch is an encouraging sign that the Chinese authorities are committed with their reforms to opening up the Chinese economy to foreign investors as well as letting Chinese investors buy international shares. 

International investors will likely be drawn to the opportunity to invest in companies focused on the domestic economy and areas such as healthcare and consumer services, which arguably have excellent growth prospects.

From a Chinese investor’s perspective, they will gain access to a host of companies with different geographic exposures that they were previously unable to.

Gary O’Brien, head of custody product for Asia Pacific (Hong Kong)
BNP Paribas Securities Services

We are seeing a good level of interest from European investors on the proposed scheme and from what we understand it is almost certain to go live by the end of 2018.

From what we understand, the scheme should see a slow launch in terms of available securities (structured as depository receipts), which makes sense given the difference of the scheme from existing access models.

Investors are generally being drawn by the proposed settlement cycle (T+2) and the possibility of settlement in US dollars, euros or the British pound. In addition to this, European investors are familiar with the likely settlement model utilising Euroclear for holding of assets and so this makes them a prime target for the scheme as it grows in coverage.

In addition to European investors, we foresee the scheme being of interest to US investors due to the benefits it brings them from a time-zone perspective, when compared with the T+0 settlement cycle schemes available in China and Hong Kong today.

The proposed operating model seems to make it easy for new investors to enter the market and allows their providers (including their custodians) to feel confident they will be ready for the scheme’s launch, despite a number of items having yet to be formally confirmed.

Luke Richdale, investment specialist for emerging markets and Apac equities (London)
JP Morgan Asset Management

The London-Shanghai Stock Connect will start later this year, allowing companies from China to sell global depository receipts in the UK and enabling London-traded firms to list similar securities in Shanghai.

The securities issued by Chinese companies will appear on what the London Stock Exchange calls the Shanghai Board. This is part of a long-term strategy to open Chinese capital markets. We will need to see the fine print, but anything that facilitates access to onshore Chinese equities for our clients is a positive.

Lack of clarity around the UK’s plans for Brexit make it difficult to anticipate how this might impact the Connect, if at all.

¬ Haymarket Media Limited. All rights reserved.