26 March 2019
Companies with substantial overseas businesses, such as HSBC Holdings, might become popular targets for Chinese investors under the stock link program. Photo:  Reuters
Companies with substantial overseas businesses, such as HSBC Holdings, might become popular targets for Chinese investors under the stock link program. Photo: Reuters

Why China’s clampdown on fund outflows is good for stock link

China’s foreign exchange regulator has tightened its control over foreign exchange purchases in a bid to curb capital outflows.

The State Administration of Foreign Exchange (SAFE) is stepping up scrutiny of foreign currency purchases while pledging to punish those involved in illegal capital transfers.

Moreover, Chinese citizens are now required to submit more detailed information when applying to renew their US$50,000 annual foreign exchange purchase quota.

The new application form requires foreign currency buyers to indicate how they plan to use the money and when they plan to spend it.

The funds are restricted to non-investment purposes such as tourism, education, business travel and medical care.

Buying foreign exchange to acquire overseas property, securities, life insurance or other investment-style insurance products will be banned.

Those who violate the new rules may face a fine of 30 percent of the principal, plus an additional penalty of up to 50,000 yuan (US$7,183).

They will also lose their foreign exchange quota for the following two years, the watchdog said.

Individuals may lie about how they will use the funds when applying for foreign exchange quota, and the authorities may lack resources to track each transaction.

However, random checks are expected to deter people from violating foreign exchange rules.

The SAFE has been tightening capital outflows since last year. For example, if five or more individuals are found to have remitted foreign currency into the same overseas bank account, they will be blacklisted and deprived of their foreign exchange quotas, or they could even face charges of money laundering.

With such measures, mainlanders find it more difficult to buy as well as remit foreign exchange abroad.

Chinese authorities will thus be able to sharply reduce capital outflows while keeping the annual foreign exchange quota unchanged.

As such, the Stock Connect program has become the only legal channel for making overseas investments.

So what makes the stock market link different?

Hong Kong Exchanges and Clearing chairman Charles Li cites the program’s “closed capital loop” mechanism.

This means that mainlanders who buy stocks listed in Hong Kong through the stock connect program can only get their money back in renminbi when they sell them.

Under the current system, mainlanders can buy Hong Kong stocks through the Shanghai and Shenzhen stock link programs.

The capital is automatically converted into Hong Kong dollars for settlement of their stock purchase transactions.

That would not take up their annual foreign exchange quota, and they don’t need to apply for use of foreign exchange. Beside, there is no limit to the amount they can invest through the program.

However, they can’t convert Hong Kong equities into foreign exchange.

When they sell the stocks, their funds are converted back into yuan and remitted to their onshore account.

Capital outflow pressure in China largely comes from mainlanders’ desire to protect their wealth amid the renminbi’s depreciation.

To fulfill this function, the stock link program is ideal.

Of course, not all Hong Kong shares are suitable for that purpose. The majority of state-owned enterprises and mainland private firms listed in Hong Kong won’t do because their revenues and profits are mainly derived in yuan.

But companies with broad geographical diversification and overseas businesses, such as HSBC Holdings (00005.HK), Cheung Kong Infrastructure Holdings Ltd. (01038.HK), Samsonite International SA (01910.HK), AIA Group (01299.HK) and PRADA SpA (01913.HK) might suit their needs.

Southbound trading has started to gain traction in the last quarter of 2016.

The Stock Connect program may continue to gather momentum this year as Beijing steps up efforts to stem capital outflows.

This article appeared in the Hong Kong Economic Journal on Jan. 3.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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