Market Views: Will the Shanghai-London Connect succeed?
The Shanghai-London Stock Connect finally went live last week as part of China’s wider efforts to open up its onshore market, but the intricate trading mechanism of the scheme could dampen the enthusiasm to access opportunities in both London and China, however attractive they might look.
Although the scheme still serves as a channel for cross-border share trading, it doesn’t work like other trading links, such as the Shanghai-Hong Kong Stock Connect, where Chinese or Hong Kong investors can buy shares listed on each other’s exchange directly.
The new structure only allows trading conducted through global depositary receipts (GDRs) for Chinese companies listing in London, and Chinese depositary receipts (CDRs) for London firms listing in the onshore Chinese market. What it means is, unless these companies make themselves available on another exchange, no one is trading anything under the scheme.
One should not forget the requirements listed companies have to meet before they can issue CRDs or GDRs, and the resources needed of them to facilitate the process.
The question then remains: what other measures can encourage more take-up of the programme? What is the biggest challenge for institutional investors to invest through the Shanghai-London Stock Exchange?
AsianInvestor asked six industry specialists to give their takes.
The following extracts have been edited for brevity and clarity.
William Chuang, Asia equity portfolio manager
Axa Investment Managers
We believe the new connect will have very minimal impact in the near term. We have seen Chinese companies issuing shares in Europe during the past year, where the liquidity has proven to be quite poor.
The success of the programme must be judged on not just the number of Chinese companies issuing GDRs (global depositary receipts) in London, but also the number of UK companies issuing CDRs (Chinese depositary receipts) in Shanghai. Now that Huatai Securities has kicked off the process, we need to see a speedy CDR issuance to ensure that the link is indeed two-way.
For companies thinking about listing their shares on the other side, it is important that they not only prepare themselves to do the investor education, but also that they have realistic expectations about the end-market. For Chinese companies thinking about issuing GDRs, one factor to consider would be the close-to-5% dividend yield currently available for FTSE 100 companies.
As mentioned in earlier example, liquidity will be the biggest issue for institutional investors when accessing the London-Shanghai Stock Connect. While we don’t know how much investor demand there is in mainland China for UK companies, most foreign investors who want to access onshore China can already do so through Hong Kong Northbound Connect.
Michael Howell, managing director
Market depth is vital. Simply listing securities is not enough but there needs to be a good trading environment. The presence of a broader market for trading and issuing Chinese government bonds and trading the renminbi will help. The LSE needs to think about integrating its offering with these other markets, and to make London the one-stop in Europe for China instruments
Liquidity and transparency are the biggest issues. Long-term viability of linkage crucially requires liquidity. This must be sustained over the long-term and not just be a short-term feature. [To achieve liquidity], it needs free flow of information, backed by solid research as well as the ability of market markets to access capital. Both of these latter factors may be compromised by a combination of Mifid 2 and Basel 2 regulations. The issuance of transparency is helped by trading recognised securities like GDRs with common standards.
The solution requires broader sharing and understanding of information about Chinese companies and markets. This will need to be encouraged. In addition, we need to think beyond stocks to Chinese government bonds and the offshore renminbi. The wider and deeper London’s markets the better.
Will it succeed? We’re hopeful, but above all the LSE will need to be more encouraging to research firms and market makers.
Barry Tong, joint Asia-Pacific head of transaction advisory services
In order to ensure the stability of both bourses, a total trading cap of Rmb550 billion on cross-border stock trades is employed on the Connect. Although the trading cap is considered as fairly high, the mismatch in trading limits between the SSE and LSE as well as the stocks traded on the SSE are subject to a daily price limit of ±10%, while there is no such regulation on the LSE.
These trading limits restrict the market to effectively reflect the correct price of the equities on both markets instantaneously and increase arbitrage opportunities from overnight trading. Therefore, these restrictions could gradually be relaxed to facilitate the programme in the near future.
The unprecedented investment link between the two countries’ stock exchanges: the London-Shanghai Stock Connect launched on June 17 amid Brexit anxiety and slowdown in global growth engine. One major challenge for institutional investors to invest through the Connect is the largely illiquidity in the beginning phase of a new programme due to limited choices to invest with Huatai Securities still only the company under the scheme.
Tuan Huynh, chief investment officer for emerging markets
Deutsche Bank Wealth Management
It’s now only the starting point for the London-Shanghai Stock Connect.
Going forward, we think the regulators could consider easing the rules to facilitate more take-up of the programme, including by:
- lowering the capital requirement for investors, which is currently at the daily average of Rmb3 million, in order to encourage more investor participation;
- allowing more smaller companies to issue GDRs or CDRs on the other exchange by lowering the requirements on company financials and market sizes – this could diversify the investment choices for investors; and
- eventually giving the investors the capability to directly trade on the other exchanges instead of through GDRs/CDRs, like the setup in Shanghai-Hong Kong Stock Connect.
We think the main challenges is the limited number of companies that have issued the GDRs/CDRs on the other exchange. UK companies can only issue CDRs backed by existing shares, which means that they cannot raise fresh funds. This regulation lowers the attractiveness of being listed in China for the UK companies.
Having said that, we think this programme could enable more long-term investments to flow into China, especially in the current volatile stock market environment.
Paul Lau, head of capital markets for China
We expect the London-Shanghai Stock Connect to be implemented gradually. In the long run, we believe allowing LSE-listed companies to raise funds through eastbound transactions could be one of the steps to facilitate further take-up of the programme. This will also allow better liquidity of the issuer’s shares and possibly a better appetite for the stocks in the overseas market.
Another long-term measure is to consider relaxing the eligibility requirements for both eastbound and westbound listings so that more participants can benefit from the increased connectivity between the two markets.
As in any cross-border transaction, there could be challenges of building up investor literacy of differences in investment cultures and business practices. These are important elements to grow the investor’s appetite for both the eastbound and westbound listings, while it is usually much easier to deal with the technical aspects of challenges in the programme (different time zones, trading practices, etcetera).
On the other hand, information asymmetry could exist due to geographic distance and regulatory differences.
These issues could go away as the programme continues to develop and the connectivity of the markets continues to increase.
Gary O’Brien, head of custody product for Asia Pacific
BNP Paribas Securities Services
For investors looking to gain wide exposure to Chinese securities based on short-term market conditions, the China-Hong Kong Stock Connect scheme or the onshore schemes are still the go-to solutions due to the much wider breadth of coverage. So the key to ensuring success of the Shanghai-London scheme will be the number of listings we see in the coming months.
What we can see is that there is a lot of interest from investors to understand how the scheme will work in order to determine if it makes sense to incorporate it into their investment strategy. We have clients who are already actively participating and so this can only grow once the depositary receipt listings increase. The scheme has implemented a smart operating model which will make it easy for new investors to gain exposure quickly.
Our clients can simply utilise their existing account structure to settle transactions without having to set up something bespoke for a limited number of investments. This means that, unlike in other schemes, the post-trade flow should not be seen as a challenge (due to the standardised settlement cycle and choice of settlement currency).
As such, it is plausible in the short-term that investors will add Shanghai-London Stock Connect to their China access suite, instead of using it to replace the existing schemes they use.