Bridging Hong Kong, Shanghai for the future

The China Securities Regulatory Commission's decision to permit stock market access between the mainland and Hong Kong is likely to have a far-reaching impact on the Shanghai and Hong Kong bourses. Under the proposed plan, investors from the Chinese mainland and Hong Kong can freely invest in stocks listed in the reciprocal cities.

Under the pre-stipulated quota, qualified investors from Hong Kong can invest in stocks listed at the Shanghai Stock Exchange. At the same time, qualified investors from Shanghai can also invest in stocks listed at the Hong Kong Stock Exchange. The quota, which is currently set at 550 billion yuan ($88 billion) per year, is expected to fluctuate and eventually increase in the long run.

Bridging Shanghai and Hong Kong, arguably two of the most important financial centers of China for the moment and in many years to come, will create tremendous opportunities.

Be in the offshore renminbi market, the initial public offerings of Chinese companies, or investors' diversified investment choices, Hong Kong provides important complements to both Chinese domestic investors and companies and overseas institutions.

Allowing existing Hong Kong investors to access the Chinese A-share market offers several advantages to Hong Kong. For Hong Kong stocks and the Hong Kong Stock Exchange, such a move can greatly increase the Asian financial center's global competitiveness. Benefiting from the burgeoning economic growth and cross-listing by many Chinese, especially red-chip, high-quality State-owned enterprises, Hong Kong has become a leading financial center for the entire world. Not too long ago, Hong Kong also used to be the global leader in IPOs, thanks to some blockbuster deals from Chinese companies.

However, things are changing rapidly. The tapering of the quantitative easing engineered by the US Federal Reserve has started sending chills into the emerging markets. With the withdrawal of capital, the Hong Kong market has witnessed some substantial drops in market shares.

Closer integration into the Chinese A-share market provides an opportunity to overcome this problem. With the direct-investment channel, not only will international mutual funds and pension funds be given the opportunities to invest directly in the Chinese mainland A-share market without having to take the detour route of qualified foreign institutional investors, but also to anyone with offshore renminbi to invest.

This way, Hong Kong will become the global securities trading center and a center for offshore renminbi trading and investment.

To be fair, allowing Chinese domestic investors to access the Hong Kong stock market may prove to be even more valuable. Given the controls on capital accounts and cross-country listings, Chinese domestic investors are severely underdiversified in their portfolios.

Such underdiversification costs Chinese investors dearly, especially given the exorbitantly high volatility and recent disappointing performance in the Chinese A-share market.

By investing in the Hong Kong market, Chinese investors can not only buy cheaper stocks offered by the same company (for most companies cross-listed between Shanghai and Hong Kong, the H-shares trade at a discount), but also invest in overseas companies that cater to Asian investors and are listed in Hong Kong.

With the direct investment channel between Hong Kong and Shanghai, Chinese investors can use their existing accounts to invest in overseas companies. Such convenience and familiarity will no doubt boost Chinese investors' confidence in investing overseas, which not only helps their portfolio performance but also propels more Chinese capital into the international financial arena.

Companies listed in Shanghai also have reasons to feel encouraged. Although not a bottleneck on the market, additional inflow of international funds will not hamper companies' stock performance. More important, the increment of international investors investing through their Hong Kong accounts can probably bring a shift in the minds of listed companies' management.

Long-term, value-driven international investors may bring incentives to companies that have a long term commitment to becoming better companies and rewarding their investors, and instill better discipline in companies with poor corporate governance and investor responsibility.

With an increasing amount of international capital being invested in Shanghai through the direct mechanism in the future, it is conceivable that the Chinese stock market will have to conform to the international standard of emphasizing information disclosure and corporate governance.

Otherwise, international investors will not be attracted and will eventually bail out of the market.

At the same time, their presence will motivate Chinese listed companies and the stock market to offer better protection to investors through a safe and more reliable investment environment, thereby pushing forward the long-awaited reform in Chinese capital markets.

Regardless which city benefits more, it is clear that both should feel happy about the development. This may also settle the rivalry between Hong Kong and Shanghai to become the global center of China.