HONG Kong and Shanghai’s stock markets will bet a new link soon as China moves to allow cross-trading of equities between the cities’ exchanges.

A pilot program is expected to be launched in six months to offer investors from China’s mainland direct access to invest in selected companies listed on the Hong Kong exchange. It will also enable Hong Kong investors to trade shares of designated Shanghai-listed companies, securities regulators said last month.

The plan is the latest in China’s campaign to liberalize its capital market and boost trading on the lackluster A-share market.

“It is an important step in the opening-up of the mainland capital market and will boost the attractiveness of both markets to international investors,” the China Securities Regulatory Commission and Hong Kong’s Securities and Futures Commission said in a joint statement on April 10.

The benchmark Shanghai Composite Index rose 1.4 percent on the news, and the Hang Seng Index added 1.5 percent.

The new trial program, which will allow two-way cross-boarder investment by individuals, is an updated version of an earlier project dubbed the “Hong Kong Stock Through-Train.”

In 2007, the State Administration of Foreign Exchange of China said it would run an experimental program in Tianjin, a coastal city near Beijing, to allow Chinese mainland individuals to buy Hong Kong stocks directly.

However, the experimental program never materialized, and in 2010, the forex regulator said it had been scuttled. No reason was given.

Currently, individual investors on the mainland are allowed to invest in offshore capital markets only through funds offered by approved commercial banks, fund managers or securities firms under the Qualified Domestic Institutional Investors (QDII) program.

Overseas investors can invest in the mainland stock market only via funds under the Qualified Foreign Institutional Investors and Renminbi Qualified Foreign Institutional Investors programs.

The proposed new program will be open to mainland institutional investors and individual investors with minimum assets of 500,000 yuan (US$80,645). There is no threshold for investors in Hong Kong.

A DBS Group Research report said the program would have a long-term impact on the asset allocation of mainland investors, who have been profoundly under-investing in equities by international standards.

Chinese households, according to DBS, allocate 12 percent of their financial assets in securities, and park 64 percent in cash and deposits. By contrast, US households park 44 percent of their financial assets in securities, with only 16 percent in deposits.

Market irregularities

“The underinvestment in equities by Chinese households could largely be attributed to irregularities in the mainland markets,” said the Singapore-based bank. “Issues such as insider trading and opaque reporting practices erode retail confidence.”

DBS added, “The pilot scheme allows mainland investors to diversify their investments in the Hong Kong market, which is characterized by a much higher degree of liquidity and operations under effective and transparent regulations.”

However, UBS Securities said mainland investment in Hong Kong shares is likely to be limited because retail investors will be subject to the rule requiring assets of 500,000 yuan or more.

“Currently, only 2.8 percent of mainland retail investors have such a large book size, and the remaining majority will not be eligible to participate,” UBS strategists Lu Wenjie and Chen Li wrote in a note issued last month.

Meanwhile, the utilization of quotas under the QFII, RQFII and QDII programs also indicates that investor interest in cross-board investment leans more toward the A-share market.

According to UBS, nearly all the approved QFII and RQFII quotas are fully utilized. By contrast, Chinese mutual funds utilize only 40 percent of the QDII quota.

Analysts said the A-share market, which has been underperformed for years, will benefit from increased capital flows.

Under the new program, however, cross-border investment will still be subject to quotas.

Hong Kong investment in the mainland market will be limited to an aggregate quota of 300 billion yuan and a daily cap of 13 billion yuan. Mainland investment in Hong Kong stocks will be limited to an aggregate quota of 250 billion yuan and a daily cap of 10.5 billion yuan.

The trial will be limited to companies dual-listed on Shanghai and Hong Kong exchanges, as well as blue-chip companies tracked by the SSE 180 Index, SSE 380 Index, the Hang Seng Composite LargeCap Index and Hang Seng Composite MidCap Index.

That means 266 Hong Kong-listed shares will be eligible for the program, along with about 560 stocks listed in Shanghai.

Zhang Yidong, an analyst with Industrial Securities, said the 300-billion yuan quota, if fully utilized, would trigger a 6.6 percent gain among underlying stocks on the Shanghai exchange.

Class A shares that are traded at deep price discounts to their H shares in Hong Kong are expected to be the most immediate beneficiaries of the program.

“Financial, energy, material and industrial companies with dual-listed shares will experience a new level of arbitrage,” said Tim Craighead, director of Asian Research for Bloomberg Industries.

Shanghai-listed A shares now are traded at an average 4 percent discount to H shares, and that discount may narrow if mainland stocks are more accessible to Hong Kong investors, Craighead said.

Ping An Insurance’s A shares, which were trading at a 26 percent discount to its H shares, rose 7.12 percent when the new program was announced. The A shares of Anhui Conch Cement Co, trading at a discount of 36 percent to its H shares, also surged by the daily limit of 10 percent that day.

However, analysts of Guoyuan Securities warned against too much optimism. The tie-up of the two markets may boost liquidity but won’t change fundamentals, they said.

Moreover, there is also the possibility that the new trial may end up offsetting the role of QFII and RQFII programs in channeling overseas capital.

Encouraging move

Still, market watchers say they are encouraged by the latest move.

The A-share market is driven by retail investors, who contribute around 80 percent of trading volume. The dominant role of retail investors, who tend to seek quick profits from fluctuations in share prices, has led to a culture of speculation and market volatility.

By comparison, more than 60 percent of turnover on the Hong Kong exchange comes from institutional investors.

UBS’s Lu said the new program should attract value-oriented Hong Kong investors to the Shanghai market.

The new link may also provide a catalyst for the mainland securities regulator to accelerate market reforms.

Shanghai and Hong Kong’s stock exchanges are quite diverse. For example, the mainland stock market has a daily price movement limit of 10 percent, while there is no such limit in Hong Kong. Investors in mainland markets have to wait at least a day before selling shares they buy. No such restriction exists in Hong Kong.

Mainland securities regulators have talked about allowing day trading of blue-chip shares on a trial basis, but no tangible progress has been made yet on that front.

“As a major international financial center, Hong Kong has a much more mature stock market system and trading mechanism than does the mainland,” said Fang Lei at Ping An Securities.

“The opening of mainland exchanges to Hong Kong investors may prod regulators to expedite reforms that have been long anticipated, such as allowing day trading, adjusting stamp duty (for stock trading) and regulating dividend payments,” Fang said. “That would benefit the market in the long run.”