Amid feverish recent speculation, the Shenzhen-Hong Kong Stock Connect got the green light yesterday evening and is slated to go live in December. It will have two key differences from its Shanghai counterpart: no aggregate limit on trading volume, and exchange-traded funds (ETFs) will be included next year.

The four-month delay before launch is designed to give securities firms four months to prepare, said China Securities Regulatory Commission (CSRC) and Hong Kong's Securities and Futures Commission (SFC) in a joint announcement last night. The Shenzhen link will therefore arrive some two years after its Shanghai counterpart kicked off

The inclusion date for ETFs will be announced after the link Connect has been live for a period and has satisfied certain conditions. The Hong Kong, Shanghai and Shenzhen exchanges will need more time to refine the system for registration and settlement of those products, said a CSRC spokesperson. 

Meanwhile, Chinese mutual funds will be allowed to trade Hong Kong stocks through the Shenzhen link immediately after launch. That was only permitted with the Shanghai link four months after it went live.

The daily volume caps will be the same as for the Shanghai Connect – Rmb13 billion ($1.97 billion) for the northbound leg and Rmb10.5 billion for the southbound.

Mixed demand

Soaring Shenzhen equity prices are tipped initially to dampen foreign demand for using the link. The Heng Seng Index and the Shanghai Composite Index were trading at price-earnings multiples of 12x and 17x respectively yesterday, while the Shenzhen Composite was showing P/E multiples of 46x.

However, growing Chinese appetite for overseas assets is expected to drive mainland flows into Hong Kong. Southbound volumes Shenzhen to Hong Kong should therefore stay strong, following the trading pattern of Shanghai Connect south leg, said Kinger Lau, Hong Kong-based chief China equity strategist at Goldman Sachs.

Mainland investors have ramped up their use of the Shanghai Connect to access Hong Kong stocks in the past few months, leaving only 18% of the aggregate quota available. Rising demand for foreign assets and higher-yielding equities, in light of a weakening renminbi, have been key drivers, as reported.

The timing of the approval before the G20 meeting in Hangzhou on September 4 and 5 allows the government to demonstrate a continuous commitment to financial reforms and also leaves enough time for the launch before seasonally quiet December, noted Aidan Yao, senior emerging Asia economist at Axa Investment Managers. 

Douglas Morton, London-based head of research for Asia at Northern Trust Capital Markets, said Shenzhen Connect would move China closer to the inclusion of A-shares in index provider MSCI’s global emerging-market benchmarks. 

Different opportunity set

Sally Wong, chief executive of the Hong Kong Investment Funds Association, said the Shanghai and Shenzhen trading links offered different opportunity sets for overseas investors. The Shanghai market has more ‘old economy’ companies from traditional industries and more large-caps, whereas Shenzhen has more ‘new economy’ names and more small- and mid-cap growth stocks, said Wong.

Under the northbound scheme, all stocks in the Shenzhen Component and Shenzhen small/mid-cap innovation indices with market capitalisation of Rmb6 billion or more, and all those dual-listed in Shenzhen and Hong Kong, will be eligible for trading.

The ChiNext board, China’s Nasdaq-styled board of high-growth stocks, will be also included in the northbound scheme, but the regulator will only allow foreign institutional professional investors to buy such stocks initially. 

Under the southbound scheme, stocks in the Hang Seng Composite SmallCap index with a market cap of HK$5 billion or more will be included, in addition to shares eligible under the Shanghai Connect's southbound leg.

Other Connects?

Questions remain over when or whether other trading links might be established, such as Bond Connect, and several others, linking China to the Singapore, Taiwan and the UK.

The CSRC has said it would assess the impact of Britain's vote to leave the EU on a potential Shanghai-London link. And Charles Li, chief executive of the Hong Kong exchange, reiterated yesterday that the the Connect scheme could expand to link to other equity markets and to include other asset classes such as bonds or commodities.