Why the London-Shanghai Connect may never take off
The London-Shanghai Stock Connect is touted as one of China’s biggest economic reforms to open its domestic stock market to international investors. For London, the scheme presents a golden opportunity to bring local companies closer to what is set to be the world’s largest economy within the next few years.
But while both the Chinese and the UK authorities have high hopes that the link will stimulate cross-border share trading, it could struggle to find success, faced as it is with multiple challenges.
It has been more than a year in the making, but the London-Shanghai Stock Connect is yet to be launched officially. Unlike previous stock trading schemes between Shanghai, Shenzhen and Hong Kong, both China and the UK have kept the scheme extremely low profile and no launch date has ever been annouced, which makes it questionable as to whether the programme is proceeding as planned.
Some industry experts point out that this is due to the new scheme’s structure, which is different compared to other trading links.
The London-Shanghai stock connect will only allow investors in each market to buy stocks indirectly in the form of depository receipts – Global Depositary Receipts (GDR) for Chinese companies listing in London, and Chinese Depositary Receipts (CDR) for UK firms listing in China’s onshore market.
This is not like the Shanghai/Shenzhen-Hong Kong links where Chinese investors can buy Hong Kong-listed stocks directly according to daily quotas.
Under this structure, both exchanges are not in an active position to decide on the launch because it is effectively determined by the first company to list under the new scheme. In other words, trading under the scheme will only start when the first company makes its debut on another exchange.
But there are now signs that the new stock connect will soon go live. Chinese brokerage Huatai Securities has said that it plans to start conditional trading for its GDRs on the London Stock Exchange on June 17. The deal will be subject to the closing of its $1.54 billion to GDR sale jointly arranged by JP Morgan, Huatai Financial and Morgan Stanley.
It is clear that Beijing hopes to replicate the success of the stock connect schemes between Shanghai, Shenzhen and Hong Kong, which have spurred billions of dollars in stock trading each day across the three exchanges.
There is little doubt, however, that in terms of trading volume, the London-Shanghai Stock Connect will never match the links between Hong Kong and Shanghai/Shenzhen, through which public investors can trade more than 1,800 stocks.
Industry experts that FinanceAsia spoke to reckon that the scheme was designed for mainland-listed companies to access an untapped pool of capital in the UK and Europe, rather than bringing London-listed firms to China.
After all, while Chinese institutional and retail investors can freely trade London-listed stocks, the mainland stock markets remain largely shut to international investors, with the exception of access through securities accounts in Hong Kong or the Qualified Foreign Institutional Investor (QFII) scheme.
Theoretically, it was ideal for Chinese companies to introduce UK and European funds, many of which are struggling to find good investment opportunities as long as the European Central Bank keeps interest rates negative and earnings growth among European companies remains low.
The harsh reality, however, is that there is a severe lack of familiarity among European investors towards mainland-listed companies since many of them do not have business on the continent. Huatai Securities, for instance, currently operates its offshore business only in Hong Kong and the US.
That could largely explain why Chinese companies have not shown any interest in listing in London so far.
Separately, the eastbound link – London-listed firms listing in the form of CDRs – could never evolve as an effective channel for UK companies to tap Chinese interest because it does not allow them to raise new funds.
Without selling new shares before trading begins, UK companies could struggle to create a meaningful free float and generate stock liquidity.
No British company has so far expressed interest in issuing CDRs. HSBC and Burberry are tipped to consider the plan, but neither company has confirmed its interest.
Above all, Brexit remains the biggest risk weighing on the new trading link. Any change in Brexit, could impact the scheme in the form of taxes, dividends, settlement and information disclosure, to name just a few.
This adds on to other technical issues including the time difference, cross-border capital flow and foreign exchange settlement.
As one of the industry sources has pointed out, the London-Shanghai trading link is a symbolic rather than a practical initiative to internationlise China’s stock market. This is unlikely to change in the near future.