Introduction

Since adopting the Open Door Policy some 35 years ago1, Mainland China2 has largely completed the transition from a centrally planned economy to a market-based economy, while achieving remarkable growth during the process. In the second decade of the twenty-first century, the country is seeking sustainable growth and convergence towards high-income status3. To this end, the Third Plenary Session of the Eighteenth Communist Party of China Congress, which took place in November 2013, put forward an ambitious and comprehensive agenda of reforms to start a new chapter in Mainland China’s economy development4.

Historically, Hong Kong has always played a pivotal role in Mainland China’s economic and financial reforms. The most important entrepôt for Chinese trade for decades, Hong Kong is the largest capital source of Mainland China’s overseas direct investment, the center for cross-border RMB trade settlement and offshore5 RMB business, as well as a major overseas capital market for Mainland Chinese enterprises pursuing listings on the Hong Kong Stock Exchange. As an international financial center and offshore RMB hub, Hong Kong is lending its support to Mainland China’s new reforms to:

  1. develop its domestic financial market;
  2. improve international competitiveness of its enterprises; and
  3. liberalize its capital account.

This eUpdate is Part 1 in a series of eUpdates to examine Hong Kong’s role in Mainland China’s economic and financial reforms. Part 1 explores the concrete steps taken so far and the proposed through train schemes (dealing initially with stocks, and subsequently possibly with commodities and bonds).

Development of Domestic Financial Market

Considering the development of the domestic financial markets as the centerpiece of financial reforms, the Central Government has put into place a system commensurate with the development of the country’s socialist market economy, the unique and prevalent economic model employed by Mainland China. The system mainly consists of a money market dominated by interbank bond transactions and lending, the commercial paper markets, a nationwide foreign exchange trading market and a capital market.

However, observers are aware that these markets – the capital market in particular – are still in their early stages of development. They suffer from the apparent lack of investment instruments, poor corporate governance and the irrationality of Mainland China’s investment culture6. These recurrent problems not only substantially impair the efficiency of resource allocation in the financial markets, but also hinder the implementation of reforms in other fields.

By opening its capital market, Mainland China opens also a window to acquire relevant, useful and readily usable experience from other countries or regions regarding how to enhance the quality of corporate governance amongst listed companies, as well as how to build a regulatory framework that is up to international standards – one which can effectively promote and supervise the healthy development of the country’s capital market.

Mainland China need not venture far to find such experience and reference. Hong Kong has established over the years a financial system on par with international best practice7. Having withstood the test of numerous financial crises such as the 1994 Mexican and Latin America “Tequila” Crisis, the 1997 Asian Financial Crisis, the 1998 Russian Default, the 2000 Dotcom Crash and more recently the 2008 Global Financial Meltdown8, Hong Kong’s regulatory regime has proved robust.

Improvement of International Competitiveness of Enterprises

The Third Plenary Session of the Eighteenth Communist Party of China Congress talked of state-owned enterprises (“SOEs”) playing a decisive role in reforms, on the basis that SOEs are to remain the backbone of Mainland China’s economy9 through the continuation of preferential policies, as the Central Government seeks to retain control over the economy.

The example of CITIC Group Corporation10 (“CITIC Group”) is a particularly telling one. The first to be run on quasi-market principles, CITIC Group was at the forefront of the nation's economic reforms under Deng Xiaoping. One of CITIC Group’s subsidiaries (“Operational Co”) managed most of the operating assets of CITIC Group. Another of CITIC Group’s subsidiaries (“Hong Kong Listco”) is listed on the Hong Kong Stock Exchange. In August 2014, the Hong Kong Listco totally acquired the Operational Co from CITIC Group in a deal valued at approximately RMB219.66 billion11 (equivalent to12 US$35.74 billion).

One of Mainland China’s largest SOEs would now have to meet the more stringent disclosure and corporate governance requirements under the Hong Kong regime. As it faces market scrutiny and includes private shareholders, CITIC Group would also have to rely on professional management commensurate with international best practice, instead of the largesse of the state, by enhancing accountability and transparency13. Allowing market forces to improve corporate practices in Mainland China appears to be the new order of the day.

Liberalization of Capital Account

Despite Mainland China’s status as the world’s largest exporter, the US Dollar remains the dominant currency for settlement at the global stage. As the Mainland Chinese financial system further integrates with the world and as the “go abroad” strategy calls for freer capital outflows, the need to internationalize the RMB and accelerate its convertibility becomes greater than ever. As the Central Government set out in the Twenty-third Five-Year Plan14 policy directions for freer cross-border capital flow and higher degree of convertibility of the RMB, Hong Kong has been given a vital role to play.

Being the first15 offshore market to use RMB as the settlement, investment and funding currency, Hong Kong has steadily expanded the range of RMB products and services, including investment funds, commodity-linked products, exchange-traded funds, REITs, equities, insurance policies and notably the “dim sum” bond. As the international hub for RMB trade settlement, Hong Kong is estimated to handle approximately 80%16 of RMB payments globally. In the first four months of 2014, total RMB trade settlement conducted through banks in Hong Kong reached RMB1.95 trillion17 (equivalent to US$317.27 billion), an increase of 76% over the previous year. Whereas bond issuance has reached RMB338.8 billion (equivalent to US$55.12 billion) in the first three months of 2014, 890 bonds have been issued by 107 issuers from January to May 201418.

In addition to growing demand in Hong Kong, the RMB trade and its expansion have led to changes in capital flow such as the relaxation of regulations regarding foreign direct investment and equity investment. As an offshore RMB hub, Hong Kong functions as the testing ground for Mainland China’s liberalization of its capital account in complying with international regulatory frameworks.

Proposed Stock Through Train Scheme

By opening the securities market to foreign investors, the Central Government is pursuing a strategy of “fragmenting the market with separate investors”19. What this means in practice is that foreign investors would be permitted to buy foreign currency-denominated shares and debt instruments in either domestic or overseas markets. This includes B Shares20, H Shares21 and Red Chips22, as well as overseas foreign currency-denominated bonds. However, RMB-denominated A Shares23, bonds and other money market instruments were not included until the Qualified Foreign Institutional Investor program24 was launched in 2002. Foreign retail investors are still prohibited from buying and selling RMB-denominated A Shares, bonds and other money market instruments.

Mainland Chinese residents have so far been largely prohibited from buying, selling and issuing capital or money market instruments in the overseas market25, but change is on the horizon, as Premier Li Keqiang announced the proposed stock through train scheme (“Stock Train”) at the Boao Forum for Asia in April this year. In his keynote speech, he announced that the Central Government is to launch a range of measures and policies to actively support Hong Kong to develop into an offshore RMB business hub as well as an international asset management center. He added that Mainland China will actively create favorable conditions to establish a Shanghai-Hong Kong Stock Exchanges connectivity mechanism which, by opening up a two-way flow, will promote healthy development of the capital markets of both Mainland China and Hong Kong.

Under the Stock Train, retail investors from Mainland China and Hong Kong will, for the very first time, be permitted to cross-trade stocks listed in Hong Kong and Shanghai, up to a total one-off quota of RMB550 billion (equivalent to US$89.49 billion). Specifically, Mainland Chinese investors may trade up to RMB250 billion (US$40.68 billion) worth of Hong Kong-listed H Shares, subject to a daily maximum of RMB10.5 billion (US$1.71 billion), whereas Hong Kong investors may trade up to RMB300 billion (US$48.81 billion) worth of Shanghai-listed A Shares, subject to a daily maximum of RMB13 billion (US$2.12 billion)26.

Hong Kong and overseas investors participating in the Stock Train through the Hong Kong Stock Exchange will remain protected by Hong Kong legislation27 through its common law system and robust regulatory regime. As Hong Kong Financial Services and the Treasury Secretary Chan Ka-keung pointed out:

“[T]he through train scheme will give a new role for Hong Kong to play in the economic reform and opening up of China. It allows international investors access to the mainland markets through Hong Kong28. We are filling a niche that is something very new. Instead of selling Chinese shares, instead of just selling Chinese investment projects overseas, we are filling a demand in China which is about achieving market reform in a risk-controlled manner29. From a regulatory standpoint that is quite smooth and the cost for China is relatively low. You don’t have to open up your own market, change your regulations, deal with offshore [participants]. You just let Hong Kong do the work.”

The Stock Train:

  1. demonstrates that Mainland China is committed to accelerating the pace of its capital account liberalization;
  2. marks yet another policy milestone in the move to internationalize the RMB, as it offers additional investment channels in the offshore circulation mechanism, which is conducive to the development of a multi-tier capital market in Mainland China;
  3. reinforces Hong Kong's role in the two-way opening-up of Mainland China's capital market; and
  4. functions as a testing ground for the opening up of Mainland China’s markets and stock capital accounts in an orderly way30; in other words, a reform with risk management.

Proposed Other Through Train Schemes

In its history of implementing reforms, Mainland China tends to move one step at a time, starting new programs and, when the time is right, expanding them in a controlled manner. In the foreseeable future, both the Hong Kong and Shanghai Stock Exchanges will focus on working out the details in establishing the link between them. Going forward, the Stock Train could lead to similar connections with other exchanges. Premier Li suggested a link could be established between the Hong Kong and Shenzhen Stock Exchanges. This model may also be extended to other areas, for instance, commodities through the London Metal Exchange owned by the Hong Kong Stock Exchange or the bond market31.


1   “Open Door Policy” means the economic policy initiated by Deng Xiaoping in 1978 to open up China for foreign investment.
2   “Mainland China” in this article refers to the geopolitical area under the jurisdiction of the People’s Republic of China, excluding Hong Kong, Macau and Taiwan.
3   Press Release No. 14/260, International Monetary Fund, June 5, 2014.
4   Press Release No. 14/260, International Monetary Fund, June 5, 2014.
5   “Offshore” in this article refers to the other jurisdiction areas of Mainland China, in particular, Hong Kong.
6   “Shedding Light on China’s Massive Shadow Banking Market - Landmark Corporate Bond Default” by John Chrisman, Christopher W. McFadzean and David Richardson:
http://www.dorsey.com/eu-chinas-shadow-banking-market-landmark-corporate-bond-default-pt1/.
7   “Hong Kong: China’s Global Financial Centre”, Financial Services and the Treasury Bureau of Hong Kong, November 2013.
8   “Hong Kong: China’s Global Financial Centre”, Financial Services and the Treasury Bureau of Hong Kong, November 2013.
9   “China shuffles the deckchairs of state ownership”, China Economic Review, June 18, 2014.
10  Established in 1979 with the support of Deng Xiaoping, CITIC Group is an SOE covering a wide range of business operations such as commercial banking, investment banking, trust, insurance, fund management, asset management, real estate, engineering, energy and resources, infrastructure, machinery manufacturing and information technology. On July 7, 2014, Fortune Magazine released its Global 500 list for 2014 based on the revenue of companies in 2013. CITIC Group ranked in the 160th place with a revenue of RMB 375.10 billion (equivalent to US$ 61.03 billion).
11  Announcement issued by CITIC Pacific on August 25, 2014: http://www.hkexnews.hk/listedco/listconews/SEHK/2014/0825/LTN20140825644.pdf.
12  Exchange rates as of August 29, 2014.
13  “CITIC Group Corporation's plan opens door to greater economic reforms”, South China Morning Post, April 6, 2014.
14  “Financial Development and Reform Plan for the 12th Five-Year Plan Period (2011-2015)” published in September 2012.
15  RMB activities in Hong Kong are supported by the RMB liquidity pool in Hong Kong, which is the largest outside Mainland China. At the end of 2013, RMB customer deposits and certificates of deposit issued by banks in Hong Kong together amounted to over RMB1 trillion (Hong Kong: The Premier Offshore RMB Business Centre).
16  “Strengthening Hong Kong as a Leading Global International Financial Centre”, Financial Services Development Council, November 2013.
17  As per statistics of the Financial Services and the Treasury Bureau:
http://www.gov.hk/en/about/abouthk/factsheets/docs/financial_services.pdf.
18  “Internationalization of the Renminbi”, Asian Development Bank, July 30, 2014.
19  “Capital account management and its outlook in China”, BIS Papers No 15.
20  “B Shares” in this article refers to shares issued by companies incorporated in Mainland China. They are listed on the Shanghai and Shenzhen Stock Exchanges and quoted in foreign currencies. They are not listed on the Hong Kong Stock Exchange. In the past, only foreigners or foreign institutions were allowed to trade B Shares. Since February 2001, Mainland Chinese investors have also been permitted to trade B Shares, but they must trade through legal foreign currency accounts.
21  “H Shares” in this article refers to shares issued by companies incorporated in Mainland China and listed on the Hong Kong Stock Exchange.
22  “Red Chips” in this article refers to companies listed on the Hong Kong Stock Exchange and controlled by Mainland China entities, by way of direct or indirect shareholding and/or representation on the board of directors. Red-chip companies are incorporated outside Mainland China.
23  “A Shares” in this article refers to shares issued by companies incorporated in Mainland China. They are listed on the Shanghai and Shenzhen Stock Exchanges and quoted in RMB. They are not listed on the Hong Kong Stock Exchange.
24  “Qualified Foreign Institutional Investor program” is a program that permits certain licensed international investors to trade A Shares listed on the Shanghai and Shenzhen Stock Markets.
25  Qualified Domestic Institutional Investor program launched in 2006 allows Mainland China investors to invest in foreign securities markets via certain fund management institutions, insurance companies, securities companies and other assets management institutions which have been approved by China Securities Regulatory Commission.
26  “Joint Announcement of CSRC and Securities and Futures Commission” published on April 10, 2014.
27  “Shanghai-Hong Kong Stock Connect FAQ for Investors”, Hong Kong Exchanges and Clearing Limited, April 30, 2014.
28  “Through Train Stock Scheme ‘Will Take Off’”, South China Morning Post, May 20, 2014.
29  “Reform crucial to Hong Kong economy, says treasury chief”, South China Morning Post, May 20, 2014.
30  “HKEx looks beyond through train stock scheme”, South China Morning Post, May 23, 2014.
31  “All aboard the through train: Shanghai-Hong Kong stock connect”, UK Foreign and Commonwealth Office, April 2014.