Shanghai-Hong Kong Connect Scheme Generating Significant Securities Lending Demand

Less than a year after its inception, the Shanghai – Hong Kong Connect Scheme has become an integral component of Asia’s capital markets.  In this article, we discuss the early-successes of the Connect Scheme and highlight which areas of the securities lending market are benefitting most. 

Hong Kong equities rallied following the April holiday break on strong trading activity from mainland Chinese investors via the Shanghai-Hong Kong Stock Connect scheme (“the Connect scheme”). The scheme provides Chinese investors with unprecedented access to the Hong Kong market and also offers foreign investors increased access to the Chinese capital markets. It is expected that the Connect scheme will spur greater trading volumes and strengthen the connection between the two markets, which is also translating to securities lending demand.

After a tepid first few months, the Connect scheme has witnessed increased volumes, driven by mainland investors taking advantage of attractive discounts for Hong Kong shares relative to domestically traded ‘A’ shares. Mainland investors are also benefitting from relaxed guidelines that have enabled Chinese mutual funds to participate in the scheme.

The increase in volume has been significant and is an early indicator of success for the Connect scheme. The daily trading quota for Chinese investors into Hong Kong, known as the Southbound quota, reached its limit of 10.5 billion yuan (US$1.7 billion) for an unprecedented two consecutive trading days in April while trading volumes on both the Hang Seng Index (HSI) and Hang Seng China Enterprises Index (HSCEI) have soared.

From a securities lending perspective, we have witnessed strong borrowing demand in several stocks that saw significant price rallies as a result of increased trading volumes. Borrower demand has been robust for shares of Alibaba Pictures, Evergrande Real Estate Group, Kingsoft Corp and Shanghai Electric Group. Other stocks that have also seen an increase in demand are Gome Electrical and Haitong Securities but, given ample liquidity, lending fees have been relatively softer for these securities.

Lending demand in Hong Kong has been robust in the first half of 2015, driven by lingering concerns over the state of the Chinese economy. Sectors in focus have been brokerage, energy, luxury goods/retail and property. We expect that demand will continue to remain strong in the near term, given the uncertain growth outlook for the Chinese economy.

Top 5 Things to Know About the Connect Scheme

  • The Connect scheme was launched in November 2014, just 7 months after the initial concept was conceived by regulators in Shanghai and Hong Kong.
  • The two markets combined form the 2nd largest equity market by market capitalization ($10.3 trillion).
  • Despite the initial euphoria, trading volumes in the first few months were lacklustre as various operational and legal challenges prevented participation by investors.
  • Short selling and securities lending are currently permitted; however, a number of restrictions apply for investors who wish to lend or borrow securities**.
  • In April, China’s regulator relaxed rules to permit the $780 billion AUM domestic mutual funds industry from participating in the Connect scheme, providing a major boost to trading volumes.

* As of May 31, 2015 (Source: Bloomberg)

** For more information, please contact your BBH Relationship Manager

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