Investors have welcomed a landmark pilot scheme set to link the stock exchanges of Shanghai and Hong Kong to enable institutions and wealthy individuals to trade cross-border via local brokerages.

The move is seen as a key step in the opening up of China’s capital market, helping to promote RMB internationalisation as well as the development of both Shanghai as an global financial centre and Hong Kong as an offshore RMB hub and destination for mainland investors.

Formal launch of the Shanghai-Hong Kong Stock Connect initiative – commonly known as QDII 2, although there is a QFII application – is expected in six months.

The news was unveiled by Chinese premier Li Keqiang yesterday, with the project’s scope outlined by Hong Kong’s Securities and Futures Commission (SFC) in a joint statement with the China Securities Regulatory Commission (CSRC).

The initiative is designed to improve the investor profile of the Shanghai Stock Exchange (SSE), expand investment channels for offshore RMB funds and facilitate orderly flow of RMB funds between the two markets, notes the SFC.

It will operate between the SSE, Hong Kong stock exchange, China Securities Depository & Clearing and Hong Kong Securities Clearing, with a direct link for cross-border clearing.

It will presage unprecedented coordination between the sides, strengthening information exchange, investigatory standards, training and cross-boundary enforcement.

The launch will take place only when trading and clearing rules and systems have been finalised, regulatory approvals granted and market participants had the opportunity to adapt their systems, stresses the SFC.

October is being mooted as the likely start date, which Shanghai-based consultancy Z-Ben Advisers notes could coincide with the launch of the HK-China mutual recognition scheme for funds.

“The landmark agreement gives global investors greater access to China’s extraordinary growth story, and allows Chinese savers to diversify their holdings,” says Peter Wong, deputy chairman and chief executive of HSBC.

“This is further confirmation of China’s commitment to financial reform, and reaffirms Hong Kong’s role as the fulcrum of China’s broader economic integration with the global economy.”

According to the announcement, trading will be allowed in component companies of the SSE180 or SSE380 indices, A/H dual-listed stocks and large/mid-cap Hang Seng stocks. This may be enlarged in future to include exchange-traded debt and smaller-cap stocks.

Initial quota for the programme has been set at a total of Rmb550 billion ($88.5 billion), split into an Rmb300 billion pool for investment into SSE companies and Rmb250 billion for HKEx stocks.

Daily trading quotas have been set Rmb13 billion for SSE stocks and Rmb10.5 billion for HKEx stocks. It appears these will be calculated separately rather than as a daily net, notes Z-Ben, with the prospect that quota limits will be adjusted in future.

On the mainland side, institutions and individuals with more than Rmb500,000 in their securities and cash accounts will be eligible to participate.

“It has been a long time coming, but the through-train’s great grandson finally pulled into the station,” says Z-Ben in a report.

The consultancy points to an acceleration of China’s reweighting in global equity indices as one long-term implication. “While MSCI and FTSE may hate quotas, every other structural argument against upweighting China is being demolished by the RMB internationalisation plan,” it states.

No matter how much pushback institutional investors mount against upweighting, Z-Ben suspects they will be investing a greater share of their capital in A-shares by this time next year.

Bill Maldonado, CIO for Asia Pacific and global CIO for equities at HSBC Global Asset Management, described the scheme as a positive development that reinforces the reform agenda being rolled out in China.

“Together with the recent announcements on widening of the currency band and increase in quotas, it underlines the positive momentum which is building in China.

“The move further reinforces our confidence in investing in Asia and our positive stance on China, where we see long-term opportunities arising from the reform.”

Z-Ben sees the Hong Kong subsidiaries of mainland brokerages as the big winners of this scheme, with UBS and Goldman Sachs (via Gao Hua Securities) the only players able to route cross-border orders from customer to dealing floor in-house.

Everyone else will have to use the Shanghai and Hong Kong exchanges’ support programme, which will act as an order-matching system in order to conduct such trades.

“That means a potential pricing advantage may fall into Chinese brokerages’ laps,” says Z-Ben. “We suspect that, even if a perfectly equitable pricing system is developed, Chinese brokerages will still ultimately make more money from the new programme than their foreign competitors.

“In our view, more money is likely to flow into China, through any available investment channel, than will flow out.”

Jack Wang, head of the institutional client group at Hong Kong-based CSOP Asset Management, says the new initiative will stimulate demand for A-share products.

“Previously there was a discount in some A-shares to H-shares, especially the blue chips,” he tells AsianInvestor. “When the two market connect, the discount will likely be eliminated.”

CSOP’s A50 ETF and actively managed equity funds saw strong inflow after the announcement. Wang confirms that CSOP will likely apply for fresh quota for its A50 ETF.

However, he notes that RQFII ETFs which track performance of large cap stocks will face downside risk for management fees as investors will be able to access China via the new initiative instead.

Wang suggests that CSOP will design more diversified products to include underlyings that the initiative will allow investors to access.