Hong Kong-Shanghai Valuation Gap Narrows After Bourse Link Test

Sep 01, 2014 6:15 am ET

Sept. 1 (Bloomberg) -- The valuation difference between Chinese shares traded in Hong Kong and Shanghai narrowed for a fourth day after brokerages said the first full trial of the cities’ exchange link went smoothly.

The Hang Seng China AH Premium Index of dual-listed companies rose 0.4 percent to 93.45 at the local close, signaling a narrower discount on mainland shares. First Shanghai Financial Holding Ltd. successfully completed more than 200 mock trades, said Eliot Li, a director at the Hong Kong-based brokerage. Haitong Securities Co. will be ready if the link starts as planned in October, said Zhuang Wei, a vice general manager at the Shanghai brokerage.

“The market rehearsal went quite smoothly,” Li, the director of corporate development, sales and marketing at First Shanghai, said by phone. “I am quite optimistic about the program in October. I think we will be ready.”

Forecasters from Morgan Stanley to Robeco have predicted the exchange link will help reduce gaps between dual-listed shares by making it easier for arbitragers to move money between the two markets. The connect, which allows a net 23.5 billion yuan ($3.8 billion) of daily purchases between Asia’s biggest stock markets after Japan, offers a new route for international buyers to access Chinese stocks and for mainland investors to put money into Hong Kong equities.

Mock Trades

The Hang Seng China AH Premium index, which today completed its longest stretch of gains in four weeks, has slipped 0.3 percent since the link was announced in April.

Bourse officials are seeking to hammer out any technical issues after hundreds of brokerages expressed interest in taking part in the connect. A similar plan allowing Chinese investors to buy Hong Kong stocks in 2007, later abandoned, helped drive the Hang Seng Index to a record.

Zheshang Securities Co. faced no major issues after participating in the weekend test, said Zhang Chun Chun, who works in the firm’s technical department. Kelvin Shek, head of the information technology department at Guotai Junan International Holdings Ltd., said the rehearsal went smoothly.

First Shanghai placed mock trades in 10 stocks, using different lot sizes to test computer systems, clearing and settlement, according to Li, who spoke from an Italian restaurant in Hong Kong where he was eating lunch with colleagues after working through the weekend on the test.

Failure Test

The Hong Kong bourse will simulate a system failure on Sept. 13, according to its website. Mainland brokers will also conduct tests in mid-September, the China Securities Regulatory Commission said on its microblog Aug. 29.

“The test went smoothly and we didn’t encounter any major problem or technical issue,” said Zhuang, vice general manager of retail sales and Internet finance at Haitong. “If it starts in October as is speculated by the market and the media, Haitong Securities will definitely be ready for it.”

A total of 97 brokers, which handle about 80 percent of Hong Kong’s trading volume, participated in the two-day trial, the city’s exchange said in a statement yesterday. All planned scenarios in the rehearsal were covered and the exchange will conduct a “detailed analysis” of the test, Hong Kong Exchanges & Clearing Ltd. said.

Connecting markets with different trading rules, regulators, currencies, taxes and holidays has occupied brokers since the link was unveiled by Chinese Premier Li Keqiang on April 10.

Capital Flows

Technical aspects of trading through the connect should run smoothly, though there are still some unresolved issues for investors, including how their transactions will be taxed, said First Shanghai’s Li.

While China’s laws suggest foreign equity investors are subject to a capital gains levy, the government has never collected it, according to PricewaterhouseCoopers. MSCI Inc., which kept mainland shares out of its global indexes in June, said the lack of clarity on tax policy was one of investors’ biggest concerns.

China restricts the movement of capital across its borders, with local investors limited to buying overseas securities via the Qualified Domestic Institutional Investor program. International money managers seeking yuan-denominated A shares need to go through the Qualified Foreign Institutional Investor program.

When the exchange link starts, Chinese institutions and investors with at least 500,000 yuan in their securities account will be able to buy Hong Kong shares using yuan through mainland brokerages, which will place their orders through Hong Kong’s bourse. Overseas institutions and investors can trade shares on the SSE 180 Index and SSE 380 Index, as well as dual-listed stocks, using Hong Kong brokerages.

Broker Rally

For the weekend test, “I would give it 9 out of 10 based on our company’s own system,” Zhang said. “Still, this is a dry run. When we officially do the link, investors may not be familiar with the new regulations that come with this. That may be one thing we have to look out for.”

The connect may bolster the earnings prospects of brokerages, 200 of which in Hong Kong expressed interest in participating to the exchange as of June. Average daily turnover in the city slid 7.9 percent in the first half from a year earlier, while nine brokerages have stopped trading in 2014, according to data from the stock exchange.

Citic Securities Co., the biggest listed Chinese brokerage, gained 15 percent in Shanghai trading through last week since the link was announced in April. First Shanghai Investments Ltd. more than doubled in Hong Kong. HKEx shares rallied 35 percent, versus an 8.3 percent advance in Hong Kong’s Hang Seng Index and a 5.3 percent gain in the Shanghai Composite Index.

“We finished the whole testing with expected results,” said Shek at Guotai Junan International. “Everything is ready, we’re just waiting for the launch.”

--With assistance from Darren Boey in Hong Kong.