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Connect and reflect

18 November 2014 By Peter Thal Larsen

Investors are getting carried away with Hong Kong Exchanges and Clearing’s options in mainland China. Though the owner of the Hong Kong bourse should benefit from a stock-trading link with Shanghai, shareholders will have to wait for big gains.

Banks and stockbrokers have spent months breathlessly talking up the connection between the two exchanges, which went live on Nov. 17. HKEx, which has a near-monopoly over equity trading in the former British colony, offers a focused bet on increased stock market activity. That helps explain why its shares have risen 33 percent so far this year, even though the benchmark Hang Seng Index is up just 2 percent.

The Hong Kong-Shanghai scheme is a joint venture, so both exchanges share cross-border trading fees regardless of which way the money flows. Yet even if the link is a runaway success, the financial benefits won’t be huge at first. Assume that investors on both sides of the border buy shares up to the maximum 550 billion yuan ($90 billion) currently permitted, and that all those shares change hands three times per year. In that scenario, HKEx’s half of the combined trading volumes would be about HK$4 billion ($520 million) a day, according to Morgan Stanley. That’s about 6 percent of the exchange’s average daily turnover this year.

If the link-up is that successful, the betting is that regulators will raise or remove the quotas. Then hyperactive mainland punters could pile into Hong Kong stocks without restraint. Shares in Shanghai-listed companies change hands twice a year, on average – four times the level of turnover in Hong Kong.

In the longer run, the scheme could expand to include China’s second stock exchange in the southern city of Shenzhen, and other asset classes. It also improves the chances that Chinese stocks will be included in benchmark emerging market indices, further boosting global demand.

However, these improvements are some way off. On the day the scheme went live, mainland investors used just 17 percent of the permitted daily quota of 10.5 billion yuan to buy Hong Kong stocks. HKEx shares have dropped 8 percent since then. Though the exchange is well-placed to benefit from the link with China, shareholders have got ahead of themselves.


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