Markets prepare for launch of landmark stock scheme

The past weekend was extremely busy for securities brokerages, as they made final checks before the Shanghai-Hong Kong Stock Connect program starts trading on Monday.

Hong Kong Exchanges and Clearing Limited (HKEx) and the Shanghai Stock Exchange (SSE) both had pre-launch system readiness tests on Saturday, the latest round of a series of tests that began in August in preparation for the program.

In a statement on Saturday, HKEx said 97 participants that account for about 80 percent of HKEx's securities market turnover had participated in the test, and that it was completed smoothly.

The SSE test involved 89 eligible securities firms, and the daily quota of 10.5 billion yuan ($1.7 billion) for southbound trading - in which mainland investors can buy Hong Kong-listed stocks under the program - was used up in two hours, Shanghai-based Oriental Morning Post reported Sunday, citing an unnamed source who was involved in the test.

Tax policy settled

Following efforts to address the capital gains tax issue, all preparations for the stock connect scheme have been completed, HKEx Chief Executive Charles Li wrote in a blog post on the HKEx's website Saturday.

Previous media reports had said that international investors were concerned about whether the authorities would levy capital gains tax on investments in Shanghai-listed stocks via the program.

But China's fiscal, tax and securities authorities jointly announced Friday that there would be a temporary exemption from capital gains, starting from Monday.

Mainland individuals that buy shares in Hong Kong through the scheme will be exempt from capital gains tax for three years starting from Monday, but will still be subject to dividend tax, according to a statement on the Ministry of Finance's website.

Hong Kong-based individuals and institutional investors buying shares in Shanghai will also be temporarily exempted from capital gains tax starting from Monday, but for an unspecified period, according to the statement.

This should give investors some confidence, Li said.

Southbound trading

Li said he did not have any expectations for trading volume on the first day. "This is a long-term scheme and its success will be measured in years, not days or weeks," he said.

The stock connect scheme will create the world's second-largest stock exchange by market value, second only to the New York Stock Exchange, Goldman Sachs said in a research note released in September.

Analysts believe southbound trading could reach 100-200 billion yuan within three months under an aggregate trading quota of 250 billion yuan.

Southbound trading sets no limits for institutional investors, but mainland retail investors must hold more than 500,000 yuan in securities and cash accounts to buy stocks listed in Hong Kong.

"We've received an increasing number of clients showing interest [in the stock connect scheme], and so far around 60 individuals have opened an account at our branch," Gao Feng, an account manager at a branch of Haitong Securities in Beijing, told the Global Times Thursday.

"Most individual investors are still holding a wait-and-see attitude as they are not familiar with the Hong Kong stock market," he said.

But Liu Li'nan, a strategist with Deutsche Bank, said southbound trading is increasingly attractive to mainland investors compared with six months ago, as the strong rally in the A-share market in the past few months has narrowed the valuation gap between A and H shares, and H shares have begun to look cheap.

"We estimate the southbound trading could reach anywhere between 100 and 200 billion yuan in the next two to three months," Liu said in a research note sent to the Global Times Friday.

Northbound trading

In a report published last week, China International Capital Corporation estimated that the daily quota of 13 billion yuan for northbound trading will be used up quickly in the first few days, due to the variety of investors that are likely to be interested, such as hedge funds, institutional investors and individuals who are interested in the A-share market.

Hong Kong-based securities firms have been active in attracting investors to the new scheme. Bright Smart Securities, for instance, has offered promotions including a three-year exemption from brokerage fees for buying A shares, a 10,000 yuan transportation subsidy for mainland investors to open an account in Hong Kong, and a lucky draw for an iPhone 6 Plus.

In terms of post-launch efforts, HKEx's Li told a press conference on November 10 that there would be system enhancements to allow short selling of A shares in Hong Kong in early 2015.

Yuan's globalization

Under northbound trading, Hong Kong and overseas investors need to acquire offshore yuan before they can invest in the A-share market. Hong Kong-based banks have been competing to attract yuan deposits due to growing demand for the currency.

Both Hang Seng Bank and Bank of China (Hong Kong) are offering preferential interest rates for yuan deposits.

The launch of the stock connect program, together with other moves such as setting up offshore clearing banks and signing new yuan cross-border swap lines, has underlined China's efforts to promote use of the yuan in the global market, analysts said.

"With the expansion of the Renminbi Qualified Foreign Institutional Investor program and the interbank bond market access program, as well as the launch of the Shanghai-Hong Kong Stock Connect, we believe offshore yuan deposits will continue to grow at a robust pace and we maintain our estimate that offshore yuan deposits will reach 2.5 trillion yuan by the end of 2014," said Liu from Deutsche Bank.