“A win-win for China and Britain. More jobs. More investment. Higher living standards as a result in both our countries.” That was the pledge made when George Osborne, the UK’s Chancellor of the Exchequer, announced a feasibility study to examine closer links between the London and Shanghai stock exchanges. The Chancellor went on: “The mutual benefits of connecting our markets are clear – increased access to international capital for Chinese firms, unparalleled investment opportunities for Chinese and international investors, enhanced stability for both markets and efficient allocation of resources – acting as the basis for sustainable economic growth.”
Behind the grand claims, however, the details of the proposed link are minimal. Neither the stock exchanges nor the Treasury wished to comment on how such a link would work in practice, the terms or duration of the feasibility study or the date by which investors can expect the link to be active.
Indeed, some observers point out that there have been links between the two for some time. The first Memorandum of Understanding (MoU) between the City of London and Shanghai was signed back in 1994, and a further two were signed in 1998 and 2004. In October, Alderman Alan Yarrow, Chartered FCSI(Hon), CISI Chairman and Lord Mayor, signed the most recent MoU
with the Shanghai Municipal Government. In fact, the feasibility study was first mooted two years ago.
Both the British and Chinese have a vested interest in pursuing a link, however. The UK Government is overtly wooing the Chinese Government, as was clear from the ceremonious state visit to the UK by President Xi Jinping in October. The bosses of China Development Bank, China Construction Bank and Agricultural Bank of China rang the London Stock Exchange’s (LSE's) opening bell on three days in one week as they issued renminbi bonds in London. Indeed, more than 50 Chinese companies are already listed in London, and nine of its international banks are members of the exchange.
The Lord Mayor believes the link has the potential to further unfurl China’s economy to the rest of the world. “With a feasibility study only just having been agreed, it is too early to comment substantially on the specifics of such a connect, but the City of London has full confidence in both stock exchanges' ability to work together to explore this subject, and we will welcome the findings of the study as and when appropriate,” he told the Review
. “This announcement is certainly further proof of the potential for financial innovation linked to China’s dedication to the gradual opening up of its capital market – and of the important role that leading global institutions, such as the LSE, can play in supporting new developments.”
The LSE’s Chief Executive, Xavier Rolet, was clear about the opportunity in an interview during the state visit. Rolet pointed to the huge size of China’s stock market, which is ten times bigger than all European exchanges combined, and to its rapid economic growth. The International Monetary Fund (IMF) estimates that the Chinese economy could be worth £16.7tn within the next five years.
“The scheme would bolster London’s status as a global financial centre”
China is aiming to liberalise its financial markets, albeit slowly. The recent turbulence in the Shanghai Composite Index is likely to have increased the enthusiasm among Chinese authorities for a wider, and perhaps more stable, investment base than the armies of day traders and small investors that currently account for some 80% of activity in the market. And that is something a direct link with London could facilitate.
“This is another step in attempts by China’s government to open up its financial markets while creating an infrastructure that allows them to retain a high degree of control,” says Chang Liu, China Economist at Capital Economics. “For the UK, the scheme would bolster London’s status as a global financial centre. As things stand, only Hong Kong gives foreign investors equivalent access to the Shanghai market.”
Lessons from Hong Kong
China also has a blueprint for international co-operation in Shanghai-Hong Kong Stock Connect, launched in November last year. The scheme allows anyone with a brokerage account in Hong Kong to buy shares in China, subject to a maximum aggregate quota of ¥300bn (£30bn), as well as giving investors in China access to selected Hong Kong-traded shares. While it is too early to say whether a similar arrangement with London would follow the same pattern, the success of the Hong Kong scheme – albeit on a relatively small scale – means it is likely that the bankers and regulators involved in the feasibility study will be looking at the way it operates.
The Chinese authorities have restricted access to trading in its companies. Currently, international investors can only buy B shares, denominated in foreign currencies, which have low trading volumes and over which there are concerns about reporting standards. Trading in A shares had been limited to domestic investors and a small number of Qualified Foreign Institutional Investors, but it is now more widely available due to the Hong Kong scheme. Demand has not been particularly high, however, with the daily limit on investment into China hit only once, on the day of the scheme’s launch, according to Liu.
The IMF's estimate of the Chinese economy's worth in 2019
Experts have already been predicting the extension of the Connect scheme to other areas. Neil Katkov and Hua Zhang of financial consultants Celent said in an analysis of the scheme issued in the summer: “The next phase of China’s capital markets opening could involve stock connect programs to other international markets, such as between Shanghai/Shenzhen and Taiwan, Singapore, Tokyo, New York and London.”
A matter of time
There are, however, significantly more obstacles in London’s way. The first, and most challenging, is the time difference. While Hong Kong and Shanghai share a time zone, Shanghai is seven hours ahead of London, so there is limited overlap of trading hours. Other difficulties could include the limited support for short selling in the Hong Kong scheme; uncertainty over asset fungibility – that is, the ability to deliver shares traded on the different markets to settle trades; the need to have a single-day timeframe for settling trades; and agreement on which currency will be used to settle the trades, according to Celent.
There will also be concerns about safeguards for investors, given the differences in governance and reporting standards between the two markets. Indeed, some say China’s markets are more like a casino
than an exchange, with some spectacular corporate collapses in recent years. The nation’s government also has a huge influence over finance and the economy, to the extent that journalists and traders reporting on this year’s stock market falls have been arrested.
Meanwhile, the level of transparency of Chinese companies traded only on their local markets is generally lower than that required in markets like London.
But China seems committed to expanding its international financial links. In the past year alone, it has signed MoUs with the Irish Stock Exchange and SIX, the Swiss stock market. China has also agreed an arrangement with Euronext, which will promote its cash, derivatives, commodities and index data in the People’s Republic of China. Like the LSE, details of how these arrangements work in practice are limited, underlining the political sensitivity surrounding ties with China.
The LSE is already one of the most international stock markets. It is the leading non-domestic marketplace for Russian equity and index derivatives, thanks to its International Order Book. This enables people to invest in foreign listed shares through an electronic trading platform that covers 44 countries. Depositary receipts stand in for shares. London also has a shared order book with Norway’s stock exchange, the Oslo Børs, for example. These are relatively loose links, however; an arrangement similar to the Shanghai-Hong Kong Stock Connect would have a wider reach. London also has the largest number of foreign company listings, at 532 in 2014, compared with 527 for New York, according to independent adviser TheCityUK. Adding a direct trading link with China, which is still one of the fastest-growing economies in the world and home to some of the most innovative companies, would be a significant feather in its cap.
But Liu warns investors not to raise their hopes of rapid action. He points out that the Hong Kong agreement took more than two years and adds: “Given that there are obstacles unique to a Shanghai-London Stock Connect type arrangement, such as the two markets being in different time zones, it is likely that we won’t see the scheme launched for some time yet.”