Date
22 September 2017
Stock connect programs fulfill MSCI’s demand for a highly liquid channel to invest in and exit from A-shares while addressing mainland regulators’ concerns over the impact of massive fund inflow and outflow. Photo: Bloomberg
Stock connect programs fulfill MSCI’s demand for a highly liquid channel to invest in and exit from A-shares while addressing mainland regulators’ concerns over the impact of massive fund inflow and outflow. Photo: Bloomberg

Hong Kong will still play unique role after China’s MSCI success

Hong Kong now accounts for just 3 percent of China’s GDP, compared with 20 percent two decades ago. Does that mean the city is no longer that important for China’s economic growth? Not necessarily.

Fang Xinghai, deputy chairman of the China Securities Regulatory Commission (CSRC), said the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect are key factors behind MSCI’s decision to add China-listed stocks to its emerging market benchmark.

This is proof that Hong Kong still has a unique value proposition in China’s financial liberalization.

China’s attempts to get into the MSCI index failed for three consecutive years since 2013 before finally succeeding this year.

The biggest hindrance was the stalemate in discussions concerning MSCI’s demand for the China stock market to allow foreign investors to get in and out easily and quickly.

Chinese authorities are worried about the potential shocks to the domestic financial system that huge and sudden capital inflows and outflows may bring if the market is fully opened.

In this regard, the cross-border stock link programs happen to be a perfect solution.

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

These schemes enable foreign investors to move capital freely while preventing direct shock to China’s financial system through a unique closed-loop design.

Under these two schemes, fund and securities flows are insulated in the closed loop of the two settlement systems.

Once Hong Kong and international investors sell their A shares or mainland investors sell H shares, the money flows back to their home market bank accounts.

This design ensures that the program is used exclusively for the purpose of investment activities between the two markets and cannot be used for other purposes such as money laundering and speculation.

As an additional security measure, the two stock connect schemes have total and daily quotas in order to prevent dramatic fund flow swings in the short term.

MSCI was also concerned whether fund managers need to secure green light from the CSRC to launch A-share-related derivatives.

The top securities regulator hopes that approval would be applied to key derivative products, and liquidity for these products should be kept at home, Fang said.

Here Hong Kong also has a key role to play. Being one of the most active derivatives markets globally, the city has a lot of experience to offer.

We also have the system and infrastructure to facilitate the trading of A-share-related derivatives. Communication between mainland regulatory bodies and Hong Kong should also be quite easy and straightforward.

Hence, it is expected that most of the approved products will be launched through the Hong Kong market.

Fang is highly optimistic about the outlook, predicting that quotas for stock link schemes would run out in the future as more A-shares would be included in the index.

“The next step is to think about the enlargement of the quota,” Fang said.

Hong Kong Exchanges and Clearing (00388.HK) looks set to gain from such developments.

This article appeared in the Hong Kong Economic Journal on June 26

Translation by Julie Zhu

[Chinese version 中文版]

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RT/CG

Hong Kong Economic Journal columnist

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