China A-share/H-share spread trade volumes are set to rise when the Hong Kong-Shanghai Stock Connect goes live, meaning price disparity will narrow and profits from such transactions may be squeezed, say observers.
The spread trade had been impeded because brokers have been running out of qualified foreign institutional investor (QFII) quota, but the proposed Connect scheme has stoked interest, as it will link the HK and Shanghai bourses’ clearing houses and allow people to invest cross-border without a licence or quota.
The trade relies on a stock dual-listed across both markets being cheaper in Shanghai than in Hong Kong. Investors benefit by shorting a company’s H-shares and going long its A-shares in anticipation of the discount narrowing.
Stock Connect will reduce the commissions that brokers charge for trading A-shares, said Richard Johnston, Asia head at Albourne Partners based in Hong Kong. “The cost of executing these trades will come down. People can trade more aggressively once the link is live.”
That may be some compensation for the fact that as more offshore participants are able to trade A-shares, the price differences are likely to be traded away.
“The feeling among market participants is that between now and October, the A-share discount compared to H-shares will narrow,” said Tim Franks, head of hedge fund sales and Asia-Pacific equities for HSBC in Hong Kong. “Those that still have these trades on will run these positions and wait for the right time to unwind and take profit.”
Brokers noted that transaction costs, including broker commissions, stock-borrowing fees, slippage and stamp duty in Hong Kong, eat into profits. Managers following this strategy therefore focus on the most liquid stock with the widest price disparity. They look for stocks whose discount may fall from high double-digits to low single-digits in terms of percentages, said industry players.
One recent spread trade to have profited a number of hedge funds involved Anhui Conch Cement. The stock’s A-share/H-share spread came in from 40% at the start of April to 24% on April 10, when Chinese premier Li Keqiang said Stock Connect would be implemented within six months, said one prime broker. On Monday, Anhui’s A-shares were trading at a discount of 22.5% to its H-shares.
Other dual-listed stocks, including Huaneng Power and non-bank financials such as Ping An Insurance, China Life Insurance and Citic Securities, are being eyed as suitable candidates, say brokers.
Stock Connect will allow investors in Hong Kong to trade all SSE 180 and SSE 380 stocks directly through the Hong Kong exchange without the need for a QFII quota. And Chinese investors will be able to trade all 266 stocks of the Hong Kong Composite Large Cap and Hang Seng Composite MidCap Index Series directly through the Shanghai Stock Exchange.