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16.11.2015 01:49 Age: 2 days

China's Stock Connect hasn't tapped into foreign money

The lackluster takeup has left Beijing looking for other ways to counteract capital outflows, reports the Wall Street Journal.

The launch of a stock-trading link between Hong Kong and Shanghai a year ago was meant to be a landmark in the opening up of China's financial markets, at a stroke allowing more foreign investors than ever to own shares in Chinese companies.

But the anticipated flood of foreign money into Chinese stocks hasn't materialized, while the 12 months since Stock Connect was initiated have been a period of tumult in China's stock markets.

What's more, a series of other changes Beijing had hoped for have been put on the back burner. Market participants had expected Stock Connect to be extended to trading in Shenzhen stocks over the summer. Seven out of eight major international banks polled by The Wall Street Journal now don't expect that to happen until the first half of next year, at the earliest.

Plans to list the CSI 300 futures contract in Hong Kong, which would have allowed global investors access to the biggest index of mainland stocks, have been delayed as a result of the turmoil. In a major setback during the summer, index provider MSCI decided not to include domestically listed Chinese shares, known as A-shares, in its popular Emerging Markets Index-a move that could have sent billions of dollars flowing into the Shanghai market from funds that track the index.

The lackluster takeup of Stock Connect has left China looking for other ways to counteract capital outflows.

As an exercise in attracting foreign money, Stock Connect has "failed miserably," said Kevin Lai, chief economist for Asia excluding Japan at Daiwa Capital Markets. "The excitement only lasted six months." He said the sums brought in by Stock Connect have been dwarfed by money leaving China as its economic growth slows and its currency, the yuan, weakens.

Just 120.8 billion yuan (US$19 billion) has been drawn into Shanghai stocks through Stock Connect since last November, only 40.3 per cent of the total permitted under the program, which allows overseas investors to buy shares on the Shanghai market, and Chinese investors to trade in Hong Kong.

The total flows into China via Stock Connect over the past year represent just 10.7 per cent of a single day's average trading turnover on the Shanghai market last week. Hong Kong has meanwhile attracted just 91.8 billion yuan of investment from Chinese buyers, equivalent to 36.7 per cent of the total allowed.

Such outcomes are far below expectations at the time Stock Connect was inaugurated last November, just as Beijing was hosting a major regional summit. China's stock markets had been closed to foreigners since their establishment in 1990, except for a handpicked group of institutional investors who have had access to Chinese financial markets since 2003.

Authorities in Beijing hoped the trading link would attract more professional fund managers from Hong Kong and elsewhere to invest in the Shanghai stock market, to provide some counterweight to the legions of amateur investors and speculators that have long dominated trading there.

Stock Connect's shaky start didn't help. Key rules were finished at the last minute, such as the tax status of foreign funds. Months passed before Luxembourg and Ireland, the top two fund-management jurisdictions in Europe, approved the use of Stock Connect by funds domiciled there.

The trading link's start also coincided with policy moves by Beijing that fueled a renewed fever for stocks among ordinary Chinese investors-those whose influence the trading link was supposed to help dampen.

After the country's central bank cut interest rates last November, Chinese state media editorials encouraged retail investors to buy even more stocks, sparking a 151% run-up in the Shanghai market for the 12 months to June 12.

Those foreign investors not worried by the market bubble have been spooked by Beijing's reaction since it burst in the summer. As authorities fought to contain the selling, fund managers were arrested, state-owned investment funds stepped in to support the market and hundreds of companies voluntarily suspended their shares.

July was the first month of net outflows from Shanghai via Stock Connect as investors took flight. Inflows recovered the next month, but have idled ever since.

The question now is whether interest in Stock Connect will recover from a mixed first year. Inclusion in MSCI's Emerging Market Index could yet spark the program back to life.

"For the vast majority of the investment world, until MSCI adds the onshore market, there's not a real necessity to utilize it [Stock Connect]," said Brendan Ahern, chief investment officer at KraneShares, a manager of China-focused exchange-traded funds that couldn't use the trading link for the first two months because of technical and legal hurdles.

Some remain optimistic. Stock Connect's teething pains have been "difficult and traumatic," said Pat Lardner, chief executive of Irish Funds, an investment-management industry association. But they have led to more-frequent consultations between the financial industry and Chinese market regulators, he said. "It may well give a better long-term foundation."

One test of confidence in Stock Connect is how soon the program will be extended to include shares traded in Shenzhen, China's second-biggest onshore stock market.

"It's feasible it [the expansion of Stock Connect] could be in 2015," adds KraneShare's Mr. Ahern. "But with each passing day it becomes a lower probability."


China's Stock Connect hasn't tapped into foreign money