What the Shenzhen link means for institutional investors

HSBC’s Florence Lee discusses the critical issues the Chinese market faces and how it is becoming more liberal.

Last week the Chinese government formally approved the Shenzhen-Hong Kong Stock Connect trading link in a bid to create a better regulated trading environment.

Florence Lee HSBC’s head of China sales and business development, EMEA, securities services, spoke with Global Custodian about how this development is the latest sign of China liberalising its financial markets.

Paul Walsh: What are the critical issues for the Chinese markets at the moment particularly with difficulties faced in 2016?

Florence Lee: A lot of our clients and those handling our business in China are focusing on capital outside of China.

We are currently helping institutional investors outside of China to invest into the onshore market in China, so the focus is on inbound investment.

I agree with what economists and journalists are saying that going forward China will no longer have double-digit GDP growth every year, this is not sustainable.

This doesn’t mean that there are no opportunities in China, it is still the second largest economy.

At the moment it is a very low interest rate environment, where fund managers have to look around for opportunities and in some ways this is attractive, particularly for the fixed income market.

Early this year, the Chinese government opened up the China interbank bond market and our clients in the EMEA region gave us a very positive response to this.

In the longer term there is a driver for diversification for example some fund managers consider China as one of the key emerging markets and the second driver is the global index inclusion.

These are the drivers that will see the capital inflow into China’s stock market in the mid- to long-term.

PW: What does the Shenzhen development mean for institutional investors?

FL: For institutional investors this new development represents a continuation of something old as well as something new.

Basically the whole concept in terms of infrastructure and design is a continuation of the Shanghai Hong Kong connect, which was launched in November 2014. The significance was that for the first time ever you could invest money in China directly without going through any regulatory approval.  

The “New” is adding the Shenzhen listed stocks and extending the scope to cover ETFs in order to enhance and enrich the existing Stock Connect programme.  This will make it more attractive for both the foreign and domestic Chinese investors to use Stock Connect in the future.

In the past, no matter who you were, you would have to go through a very lengthy approval process in China with a lot of documents needing to be submitted to Chinese authorities.

When the Stock Connect was launched, all an overseas investor has to do is go to Hong Kong, find a broker, set up a brokerage account in Hong Kong and start trading through the Stock Connect programme.  The new development now finally includes the other stock exchange in China, the Shenzhen, and in terms of stock selection this will give a manager much wider scope.

In the past, looking at the characteristics of these two stock exchanges in China, Shanghai is covering the traditional stocks, such as financial services, energy and material, with more State Owned Enterprise (SOE) found in there.

These are the drivers for Chinese economy since the 1980s.

Now looking into Shenzhen, the drivers are more on the high technology, innovative industries and the pharmaceutical sector, which is driving the new Chinese economy and is what the Chinese government focuses on more for long term sustainability.

PW: What kind of demand can be expected from the Shenzhen and Shanghai trading links once they are fully operational?

FL: If you’re looking at quota utilisation, since the Shanghai launch almost two years ago, at the moment the northbound channel is using nearly 50% of the total quota. However, this total quota has been abolished now, with the announcement of Shenzhen Connect.

The demand at the moment is for the southbound route, which is where Chinese investor’s access Hong Kong shares. Chinese investors have used 80% of the total quota for this channel.

That is why Shanghai Stock Connect has become more popular from a southbound point of view.

PW: What does China need to do to continue opening up its markets and become more appealing to institutional investors?

FL: The last eight months have seen a rapid change in terms of scale and there have been a lot of goodwill gestures made by China to international investors.

At the start of the year, there were many changes, such as with the QFII, where they removed those very stringent regulations such as the lock-up period and injection period on the QFII quota

Now the Chinese regulators have removed most of these to allow more access through the QFII programme.

It’s likely that we will also see the removal of the quota systems with QFII and RQFII, either these will be played down or abolished, as we have seen in Stock Connect.

Provided there is foreign investor appetite, the Chinese market will let you buy without too much restriction or limitation as compared to the past.

The pace of these changes will only get faster and the doors for foreign capital will keep opening.