A pioneering journey

Ten years on, success of Stock Connect between Hong Kong and China paves the way for new opportunities

Stock Connect, an innovative initiative launched a decade ago, has revolutionised market access for cross-border investments. Since its rollout in November 2014, the scheme has evolved into a vital gateway for investment flows between China and Hong Kong, enabling investors to seamlessly trade eligible stocks via local exchanges and clearing houses.

China’s capital accounts are only partially open, with restrictions on both inbound and outbound investments. But international investors can access stocks listed on the Shanghai bourse via Hong Kong through the Shanghai-Hong Kong Stock Connect without needing a licence?or an individual quota. Additionally,?trades can be funded using offshore renminbi instead of the onshore currency.

Conversely, qualified Mainland investors can access Hong Kong-listed stocks through their local exchange, funding?transactions with onshore renminbi?rather than Hong Kong dollars.

At its inception, the scheme imposed daily and aggregated quotas for both northbound and southbound trades. And only select index constituent stocks on the two exchanges were eligible for investment.

Despite these limitations, Stock?Connect quickly became a favoured?channel for foreign investors seeking to invest in Chinese stocks. Although the Qualified Foreign Institutional Investors programme launched in 2002 to open?up China’s markets offered broader?access, Stock Connect streamlined the?process, allowing foreign investors to?avoid the complexities of a cumbersome approval process and extensive paperwork. This ease of access proved to be a game-changer.

In 2016, the Stock Connect scheme was expanded to include Shenzhen, leading to a steady increase in trading volumes and injecting new vitality into the securities markets of both jurisdictions.

According to a Hong Kong Exchanges and Clearing (HKEX) report marking a decade of Stock Connect, foreign investors bought a net of 1.8 trillion RMB?(US$249.2 billion) worth of Chinese?stocks over the past ten years via Stock Connect, while Mainland buying of Hong Kong shares has reached HK$3.4 trillion ($437.2 billion). Total foreign holdings of Chinese stocks has surged more than 20-fold.

The success of Stock Connect paved the way for Bond Connect in 2017, ETF Connect in 2022, and Swap Connect in 2023.

There is also the Shanghai-London Stock Connect. Rolled out in 2019, this programme enables Chinese and UK brokers and their clients to access each other’s markets through two-way depository receipt arrangements. However, in spite of several high-profile transactions initially, the scheme has struggled to gain traction, largely due to geopolitical tensions.

Stock Connect also inspired the creation of Wealth Connect in 2021, which?allows individual investors in the?Guangdong-Hong Kong-Macau-Greater Bay Area to purchase eligible cross-border wealth management products offered by banks in the area.

Enhancements

The range of securities eligible for Stock Connect has expanded since inception and daily quotas have increased, ensuring that the offerings remain relevant and competitive.

As of September 2024, there were more than 3,300 eligible stocks covering approximately 90% of total market capitalisation and more than 80% of trading volume across the Shanghai, Shenzhen and Hong Kong bourses.

The launch of ETF Connect in July 2022 has significantly enhanced investor choice and boosted trading volumes of Chinese stocks. The number of eligible northbound ETFs has grown from the initial 83 to 225 as of September 2024, accounting for more than 30% of total ETF trading volumes in the Shanghai and Shenzhen markets.

Meanwhile, the number of eligible?southbound ETFs has quadrupled to 16, representing 97% of total ETF trading volume in the Hong Kong market.

In March 2023, the southbound channel was expanded to include international companies with a primary listing in Hong Kong. Other enhancements on the horizon include block trading, RMB counter inclusion, and REIT Connect.

There have also been several significant improvements to enhance trading and settlement services for Stock Connect, including the introduction of special segregated account services in 2015, removal of aggregate quotas in 2016, a quadrupling of daily quotas in 2018, and the launch in 2023 of a settlement acceleration platform, Synapse, for northbound trading utilising DAML smart contract technology.

Success factors

Foreign investors initially dominated?Stock Connect activities through their northbound investments. But over time,?an increasing number of Mainland?investors began utilising the southbound channel for cross-border investments.

A turning point occurred in 2015 when Mainland mutual funds, insurance companies, annuity funds, and other institutions were allowed to participate in the scheme. By 2023, the aggregate value of southbound investments had surpassed northbound investments.

As of September 2024, market capitalisation of securities held in Hong Kong by investors from the Mainland via Stock Connect was over HK$3.3 trillion, more than 200 times the figure in 2014. Northbound holdings of A-shares totalled 2.4 trillion RMB, accounting for 77% of the total value of A-shares held by international investors.

Including fixed income held through Bond Connect, international investors held nearly 7.6 trillion RMB worth of Mainland securities through the Connect schemes.

Several reasons have contributed to the success of Stock Connect, including the fact that funds within the scheme can only be used to buy and sell eligible securities, and the proceeds have to be returned through the local settlement system. This design creates a closed loop for fund and securities flows, ensuring prudent risk management and preventing disorderly cross-border capital flows.

To further minimise cross-border?flows, same-day stock and fund settlements are first netted locally and then reconciled on a net basis with the other side. As a result, Stock Connect has facilitated more than 177 trillion RMB of cross-border transactions over the last ten years, with only about 1.2 trillion RMB in net cross-border capital flows.

Regulatory alignment and cooperation between Hong Kong and China have also been crucial for the scheme’s success, minimising friction, encouraging investor participation, and bolstering market confidence.

Luring the Middle East

The Connect schemes have established themselves as essential tools for global investors, offering unparalleled access, enhancing liquidity, and fostering international collaboration.

While the potential for growth remains substantial, there are risks. Fluctuations in China’s economic growth and global financial instability could deter foreign investment, impacting market liquidity and stability. Policy shifts could also create uncertainty and reduce the appeal of the schemes.

Most notably, escalating geopolitical tensions between the US and China pose serious challenges to Hong Kong’s status as an international financial centre. If this worsens, it could lead to intensified trade wars, additional sanctions, and stricter regulations, ultimately diminishing investor confidence and hampering cross-border trading activities.

These risks have prompted the Hong Kong government to develop a so-called Hong Kong-Middle East Corridor, an initiative which aims to leverage the city’s position as a global financial centre to facilitate business and investment opportunities between Asia and the Middle East.

According to a recent HSBC report, the two regions combined account for 30%, or $86.3 trillion, of total global financial assets.

Hong Kong and Saudi Arabia signed a memorandum of understanding in 2023 to promote dual listings. And Hong Kong and Dubai are discussing collaboration for the issuance and listing of green bonds.

In November 2023, CSOP Asset?Management listed a Saudi Arabia exchange-traded fund on the Hong?Kong bourse, the first in Asia. This led to the listing in July 2024 of two Chinese funds on the Shenzhen and Shanghai exchanges that invest indirectly in the Middle East through the CSOP ETF, which is now the world’s largest ETF investing in Saudi Arabian stocks.

Meanwhile, Saudi Arabia launched the Albilad CSOP MSCI Hong Kong China Equity ETF in September, the first on the Saudi stock exchange tracking Hong Kong and Chinese companies listed in?Hong Kong. Two other similar ETFs?were listed on the Saudi bourse a month later.

These developments can potentially lead to Hong Kong becoming a key gateway connecting two vast, uncorrelated pools of capital. But this will require innovative and entrepreneurial initiatives from both the government and the industry, dovetailing with China’s Belt and Road national policies to unlock opportunities.

*This article was published in Asia Asset Management's December 2024 magazine under the same title.