The Shanghai-Hong Kong Stock Connect (“Shanghai Train”), a pilot program for establishing mutual stock market access between Mainland China1 and Hong Kong, was announced2 in April 2014 by Premier Li Keqiang at the Boao Forum for Asia, and was officially launched3 in November 2014. The new cross-border investment channel enables individual investors from Hong Kong and overseas to invest directly in designated securities listed on the Shanghai Stock Exchange (“SSE”), and domestic investors from Mainland China to invest directly in designated securities listed on the Stock Exchange of Hong Kong (“SEHK”), through their respective local brokers for the first time.

This eUpdate is the second part in a series of eUpdates to analyze topics related to the through-train schemes between Hong Kong and Mainland China. Whereas Part 1 explored the key features of the Shanghai Train as well as the introduction of its short selling rules, Part 2 will discuss the Shenzhen-Hong Kong Stock Connect (“Shenzhen Train”) and its unique features.

The Next Train

“A Stock Connect between Shenzhen and Hong Kong should follow that between Shanghai and Hong Kong”, announced Premier Li Keqiang4. On the Hong Kong side, “we are preparing to link up the stock markets between Hong Kong and Shenzhen. We are also reviewing the procedures to enhance the Hong Kong-Shanghai connect”, echoed Secretary for Financial Services and Treasury Chan Ka-keung.

Although details regarding the Shenzhen Train had yet to be spelt out, it is expected that the Shenzhen Train would have a larger quota than the Shanghai Train5. Anticipation reached such a level that when the China Securities Journal reported on potential earlier-than-expected launch of the Shenzhen Train6, Hong Kong stocks put on the strongest performance seen in a month, although the SEHK was quick to deny that a launch date would be announced soon.

Subsequent to the recent slump, in which the SSE and Shenzhen Stock Exchange (“SZSE”) have lost some 26.9% and 35% of their value respectively7 since reaching historic high on June 12, 2015, the more prudent market-watchers became concerned that the Shenzhen Train could be delayed. However, the reasons behind the recent slump, ranging from aggressive short-selling to the tightening of margin finance and market manipulation by the authorities, are unrelated to the Shanghai Train. On the contrary, foreign investment in the A-share market has seen steady growth, and the average daily northbound turnover has increased from RMB5 billion (equivalent to8 US$810 million) in January and February 2015 to RMB11.36 billion (equivalent to US$1.83 billion) in June 2015. Given the volume of northbound capital, even though it cannot single-handedly stall the steep fall, it would nonetheless do more good than harm to the markets.

Addition, not Continuation

Currently ranked amongst the top 10 largest in the world by market capitalization9, at just over US$2 trillion by April 201510, the SZSE is the fourth largest stock exchange in the world by turnover, averaging over US$495 billion per month, more than twice that of the London Stock Exchange and not far behind third-placed Shanghai, which averaged US$507 billion per month11. Contrary to the large-scale state-owned enterprises in the SSE, many of which are in the banking and energy sectors, the SZSE and its ChiNext are often seen as the Chinese equivalent of Nasdaq. Comprising mainly high-growth small and medium enterprises, the SZSE is more tilted towards mid-caps, with a significant proportion of companies from cutting-edge industries such as software, high-tech and biotechnology. The different composition of the SSE and SZSE is summarized in the table below.

Number of listed Companies   1,041  1,672  1,780
Market Capitalization (USD billion)  $5,610.1  $3,463.0  $3,998.8
Value of Share Trading (monthly
average in USD billion)
 $2,802.8  $2,037.6  $353.0

Shanghai, Shenzhen and Hong Kong exchanges: key statistics as of April 2015
Source: World Federation of Exchanges

The investment threshold for individual investors in Mainland China, currently at RMB500,000 (equivalent to12 US$80,522.43) for the Shanghai Train, could be lowered significantly to suit the Shenzhen Train, facilitating higher volumes of capital inflow from Mainland China to Hong Kong. Moreover, as the daily quota of the Shanghai Train has been used up on more than a few occasions, the Shenzhen Train may be equipped with a larger quota right from the beginning.

To conclude, the Shenzhen Train is not a mere continuation of the Shanghai Train, but it will cover a new dimension of companies, stocks and opportunities. As shown in the table above, while the average capitalization of Shanghai-listed companies stands at US$4 billion, the figure for Shenzhen-listed companies is US$1.3 billion, although Shenzhen is home to 60% more listings than Shanghai13. The fast-growing and performance-oriented nature of Shenzhen-listed companies is further evidenced by the exchange’s price/earnings ratio, in which Shenzhen outpaces Shanghai by 37 to 16.6, and the fact that the number of stocks in Shenzhen has quadrupled since 200614.

Double Advantage

Thanks to the existing Shanghai Train and the upcoming Shenzhen Train, the SEHK will enjoy, in addition to its international exposure to investors worldwide, unprecedented access to mainland investors and capital. In the pre-Stock Connect era, mainland Chinese companies would have to decide either listing in Shanghai or Shenzhen for higher valuation, or listing in Hong Kong for international exposure. This “either or” decision is now confined to the bygone era, as listing in Hong Kong will automatically grant the mainland Chinese company access to China’s investor base.

This unique advantage was recently exemplified by Legend Holdings Corporation (“Legend”), the parent company of the world’s largest manufacturer of personal computers Lenovo Group Limited, which raised nearly US$2 billion in its initial public offering in Hong Kong. When asked why Legend chose to list in Hong Kong rather than elsewhere, Liu Chuanzhi, chairman and co-founder of Legend, replied that a Hong Kong listing is more standardized and mainland investors can still invest in the company's shares through the Shanghai Train if they wish. Liu Chuanzhi added that the firm would have achieved a higher valuation if it listed on the A-share market, because of its popularity in Mainland China; however, it chose to list in Hong Kong, as that could help it to become a global firm.

A New Paradigm

Liberalization via expansion and integration appears to be the vehicle with which China implements its economic and financial reforms. Zhou Xiaochuan, Governor of People's Bank of China, recently said that China's capital account could basically become open by late 201515, as RMB continues its development as a global reserve currency. Meanwhile, Jiang Yang, Vice Chairman of China Securities Regulatory Commission, revealed that a potential Shanghai-Taiwan Stock Connect was being considered16.

1.   “Mainland China” in this article refers to the geopolitical area under the jurisdiction of the PRC, excluding Hong Kong, Macau and Taiwan.
2.   “Full text of Li Keqiang's speech at opening ceremony of Boao Forum”, Ministry of Foreign Affairs of the People's Republic of China, April 11, 2014:
3.   “SEHK celebrates the launch of Shanghai-Hong Kong Stock Connect”, SEHK New Release, Hong Kong Stock Exchange, November 17, 2014.
4.   “China’s Li hints at Shenzhen Stock Connect launch” by Derek Au, Asia Asset, January 7. 2015.
5.   “Changes to Q programmes and stock connects will speed liberalisation” by Lisa O’Connor, South China Morning Post, April 28, 2015.
6.   “Hong Kong stocks surge on speculation over stock connect” by Ray Chan, South China Morning Post, May 16, 2015.
7.   “Market rout may speed up Shenzhen-Hong Kong stock connect link” by Ennoch Yiu, South China Morning Post, July 6, 2015.
8.   Exchange rate as of July 13, 2015.
9.   “April Monthly Report” by World Federation of Exchanges.
10.  See footnote 7.
11.  “Comment: Shenzhen next stop on ‘through train’” by Mark Austen, Financial Times, January 26, 2015.
12.  Exchange rate as of July 13, 2015.
13.  “Comment: Shenzhen next stop on ‘through train’” by Mark Austen, Financial Times, January 26, 2015.
14.  “Comment: Shenzhen next stop on ‘through train’” by Mark Austen, Financial Times, January 26, 2015.
15.  “Changes to Q programmes and stock connects will speed liberalisation” by Lisa O’Connor, South China Morning Post, April 28, 2015.
16.  “Shanghai-Taiwan ‘through train’ could be on the way”, Asia Asset Management, April 24, 2015.