China expands Shanghai-Hong Kong trading link

Chinese regulators will allow domestic mutual funds to buy and sell shares between Shanghai and Hong Kong, in an effort to boost volumes after lacklustre demand has characterised the recently created cross-border trading link.

The Stock Connect allows global investors to trade Shanghai-listed shares without the need for a licence, but also gives many Chinese investors access to Hong Kong stocks for the first time. However, demand in both directions has so far failed to live up to the pre-launch hype.

The China Securities Regulatory Commission said on Friday that the six month-old trading channel will be expanded to include Chinese mutual funds. Until now, the scheme has only been open to wealthy retail investors, many of whom are thought to have found alternative ways to trade offshore shares.

Since mid-November, global funds have bought $20bn of Shanghai stocks through the Stock Connect, less than half the quota allowed under existing rules. Many had initially expected the quota to be used up in a matter of days.

But demand from Chinese investors - known as the "southbound" link - has been much weaker still, with cumulative buying of less than $5bn of Hong Kong stocks.

Mutual funds, meanwhile, have long been restricted to buying overseas securities through the qualified domestic institutional investor (QDII) programme. Access to the Stock Connect will make it easier for such funds to invest outside China, part of Beijing's broader effort to integrate its markets with the global financial system.

Chinese mutual funds had Rmb4.86tn ($780bn) under management at the end of February. The industry largely stagnated following the bursting of China's stock market bubble in 2007, but has revived in recent months as the local market has rallied.

Hong Kong Exchanges & Clearing is already taking steps to boost the northbound leg of the Stock Connect, with rule changes that should make it easier for large institutional funds to use it.

Many investors have been effectively barred from the Stock Connect due to issues around custody and voting rights of Shanghai-listed shares, as well as technical restrictions on settlement times. As a result, only hedge funds and investment banks have been actively using the channel.

The new rules are due to come into effect next Monday, HKEx said earlier this week. Short selling through the Stock Connect began at the start of March, but has yet to draw a single trade.

Despite the disappointing volumes traded through the link, many market participants have praised its hiccup-free rollout, and expect activity to pick up as more large investors sign up.

Adena Friedman, president of Nasdaq OMX, described the Stock Connect recently as a "huge success", that was building "real momentum".

Ultimately, HKEx hopes the scheme will be expanded to include a range of other investments, such as fixed income, commodities and exchange traded funds.

Preparations are already under way to add a link into the Shenzhen stock exchange, which will give foreign investors access to many of China's in-demand tech and healthcare companies. The Shenzhen tie-up is expected to launch in the second half of this year.

Additional reporting by Gabriel Wildau in Shanghai

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