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Stock Connect ETFs inclusion to enhance Chinese investors’ offshore exposure

The cross-border ETF link between Hong Kong and mainland China is set to boost the country’s global market integration and further strengthen Hong Kong's ETF flow.
Stock Connect ETFs inclusion to enhance Chinese investors’ offshore exposure

The inclusion of exchange-traded funds (ETFs) in the Hong Kong-mainland Stock Connect scheme could further enhance onshore Chinese investors' offshore exposure, but experts said product expansion, for instance allowing the inclusion of non-Chinese stocks, would increase investor participation.

The Hong Kong Exchanges and Clearing (HKEX) and Shenzhen and Shanghai stock exchanges announced their agreement to include eligible ETFs in the Stock Connect scheme on December 24. The exchanges will work closely on the details of inclusion, including business and technical preparations such as amendments to relevant rules in the coming months, the announcement said. 

“With these regulatory changes, promoting cross border activity, the growth opportunities are immense for the China ETF Market. The rapid growth in products in the China ETF space coupled with the increasing investor interest, demonstrate a positive outlook for the ETF landscape in China.” Rahul Sen Sharma, managing partner at Indxx, told AsianInvestor.

Frederick Chu,
Haitong International

Frederick Chu, head of ETF business at Haitong International, told AsianInvestor that the move is encouraging and that he expects a growing trend in product development and capital flow.

“It’s encouraging to see traction on the long-awaited ‘connect-based’ cross-border ETF-Connect scheme,” Chu said, “mainland China has been picking up pace aggressively, driven by a growing variety of thematic ETFs as well as investors inclusion of ETFs into their portfolio. The China ETF market size has been enjoying double-digit percentage of growth since 2018.”

The strong growth is supported by Chinese onshore investors’ appetite towards offshore assets for diversification.

“Mainland investors have a strong appetite for overseas investment in order to diversify their portfolio. Under limited and restrictive channels, ETF-Connect can provide them an efficient way to do so, under an already established in-and-out mechanism under the Stock Connect model,” he added.

“One most important aspect will be the scope of eligible ETFs – whether non-China/HK geo focus will be allowed. This may greatly determine the level of interest from onshore investors to participate in the scheme. Assuming no such restrictions, I believe ETFs with underlying US stocks would be most attractive,” he continued.

PRODUCTS LINE UP

China’s ETF market grew 70% in the nine months to the end of May to $120 billion in 2021, making it the second-largest market in the region. The Shenzhen Stock Exchange currently lists 212 ETFs with a combined market capitalisation of $39 billion, according to Indxx. 

Another Brown Brothers Harriman June report noted that 2020 was a banner year for ETFs in Greater China as it grew into a $270 billion industry and is showing no signs of slowing.

HKEX CEO Nicolas Aguzin, in a commentary piece, said that the agreement underscores close partnership with mainland stock exchange and clearing partners, and will give global investors direct, efficient access to Hong Kong and Mainland China’s rapidly developing ETF markets, which in turn will bring greater choice, liquidity and opportunity to Hong Kong’s markets.

In the third quarter of 2021, Hong Kong ETFs average daily trading volume reached HK$7.7 billion, an 83.3% increase compared with 2019’s HK$4.2 billion (see data below).

"As for Hong Kong, it has historically benefited from providing China onshore access through Hong Kong-listed ETFs. In recent years, Hong Kong has seen more innovative ETF product types such as leveraged inverse (including China A shares underlying), HS Tech, Reits, and thematic ETFs gathering decent tractions," Chu told AsianInvestor.

However, he believes, in order to develop into an ETF hub for the APAC region, there is more to be done to strengthen the ETF ecosystem. "The Hong Kong ETF market’s lack of liquidity is sometimes a reflection of inadequate level of investor participation. With more product types offered, ETF-Connect is likely to pour in fresh southbound capital flows into Hong Kong ETFs and give an enhanced injection to the market."

Although the details are still being worked out by the exchanges and regulators, the market has tracked strong trading volume and product development.

In December, HKEX launched the listings of ETFs that track the MSCI China A50 Connect Index. A total of three new ETFs products that track the MSCI China A50 Connect Index are available in HKD, USD and RMB counters.

The MSCI China A50 Connect Index is designed to have a comprehensive representation of the Chinese economy by including 50 of the largest stocks in the China A-share large-cap universe and targeting at least two stocks from each sector. The new products are aimed at providing more options for foreign players who have been eager to participate in Chinese assets.

PUSHING FORWARD

China has been pushing link schemes between the mainland and other territories for years. Last month, it proposed to expand the existing Shanghai-London stock connect programme to eligible listed companies in Shenzhen, Switzerland and Germany.

Separately, the Shenzhen Stock Exchange and the Singapore Exchange on December 30 signed a memorandum of understanding (MOU) to establish an ETF product link for eligible fund managers to offer ETFs to investors in each other’s markets.

The Stock Connect scheme between Hong Kong and Shanghai was launched in 2014, followed by the Hong Kong-Shenzhen scheme two years later.

Since the launch of the connect scheme, northbound transactions with a trading volume of Rmb64 trillion have been recorded, along with HK$23.1 trillion for southbound. The scheme has contributed a net inflow of Rmb1.5 trillion and HK$2.1 trillion into mainland A-shares and H-shares, respectively, according to Hong Kong Stock Exchange (HKEX) data.

ALSO READ: Foreign holdings in China A-shares soar 30 times under Stock Connect

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