Yuan Pricing for Mainland China Buyers Could Lift Hong Kong Stocks

Key Takeaways:

• Hong Kong and mainland stock regulators will create a mechanism allowing mainland Chinese to buy Hong Kong stocks using China’s yuan through an existing connect program
• The new arrangement could boost overall trading in Hong Kong by allowing mainlanders to more easily buy Hong Kong stocks, which are now priced in Hong Kong dollars

By Lau Ming

An 8-year-old program allowing mainland Chinese to buy stocks in Hong Kong could soon get some new grease, as regulators on both sides of the border discuss a plan that would let mainlanders pay for trades using their local currency, the yuan. If implemented, such a plan could provide a major liquidity jolt for Hong Kong’s stock market, where all trades are currently limited to the local currency, the Hong Kong dollar.

Hong Kong’s finance secretary Christopher Hui said last Monday that the highly autonomous region of China was about to enter consultations with its mainland counterparts on such yuan-based pricing for the Shanghai-Hong Kong and Shenzhen-Hong Kong stock connect programs. Such a move would advance the broader aim of further integrating China’s domestic A-share markets, which are largely closed to foreigners, and Hong Kong, which is a favorite trading ground for China stocks by international investors.

The two existing connect programs allow investors in the mainland’s two main stock exchanges in Shanghai and Shenzhen to invest in the Hong Kong stock market. Since the Shanghai connect program was launched in 2014, more than 500 Hong Kong stocks have been made available for trading through the two channels. Those include large-, mid- and small-cap components of the Hang Seng Composite Indexes, as well as Hong Kong shares of stocks that are listed on both the mainland and in Hong Kong.

Stanley Chik, head of research of Bright Smart Securities, believes that yuan pricing will appeal to investors who might be interested in shares of dual-listed companies whose Hong Kong stocks trade at a big discount to their mainland counterparts, providing a sort of arbitrage opportunity.

The Hang Seng China AH Premium Index that tracks such stocks stayed above 130 points and reached 152 points at one time last year, implying that mainland-listed A-shares were valued more than 30% higher than Hong Kong-listed shares of the same companies, and sometimes even 50% higher or more. But mainland-traded A-shares and Hong Kong-traded shares for the same company aren’t convertible, and Chik doubted regulators would create any space for major arbitrage activity in the stock connect schemes.

Big discounts of H-shares

Many popular ETFs pegged to popular gages like the Hang Seng and CSI 300 indexes are currently available in both Hong Kong and on the mainland, and thus the Hong Kong product wouldn’t hold much appeal to mainland investors, said the head of an asset management company that issues yuan-based ETFs. Accordingly, only stocks that are not listed on mainland exchanges, such as like Tencent (0700.HK) and Alibaba BABA, would be likely to appeal to mainland-based investors, including those seeking to trade Hong Kong stocks in yuan.

The dual-currency arrangement could reduce stock spreads between the two markets by giving mainland investors better access to the Hong Kong shares of dual listed companies.

A case in point is the Hong Kong-listed shares of blue-chip stock China Life Insurance (2628.HK; 601628.SH), which are more than 60% undervalued compared with their mainland A-share equivalents. That big spread may owe partly to lack of interest in the company’s Hong Kong stock through the connect programs, with such mainland investors holding only 3% of China Life’s Hong Kong-listed stock. By contrast, the gap is only 30% for China Pacific Insurance (2601.HK; 601601.SH), perhaps partly because mainland investors hold a much larger 20% of its Hong Kong-listed shares.

Hong Kong-listed shares of two other dual-listed stocks, Great Wall Motor (2333.HK; 601633.SH) and Ganfeng Lithium (1772.HK; 002460.SZ), traded at discounts of 60% and 30%, respectively, to their A-shares counterparts last year, attracting investors seeking to profit from the difference. But mainland investors sold off Hong Kong-listed shares of both companies this year, dropping from 47% to 37% for Great Wall’s Hong Kong stock and 23% to 15% for Ganfeng. That shows valuation discounts only have so much attraction, and investors also look at factors like market conditions and individual company performance as well.

Lower forex costs

One of the biggest attractions of yuan pricing will be lower foreign exchange costs for mainlanders who buy Hong Kong stocks. Under the current regime, mainland investors need to convert yuan into Hong Kong dollars to buy Hong Kong stocks. Brokerages also often take 3% of the trading value as deposits to hedge against lack of money for settlement at the end of the day due to forex volatility. So, when the yuan is particularly volatile, risks related to foreign exchange costs can run high. But allowing Hong Kong-listed shares to be traded directly using yuan will eliminate the forex risk and costs, which could help boost trading volume.

One of the most direct beneficiaries of increased trading volume would be the Hong Kong Stock Exchange(0388.HK). Last year, the exchange recorded a total of HK$9.3 trillion ($1.2 trillion) worth of transactions through the connect schemes, an increase of 70% compared with the previous year, and a daily transaction value of HK$41.7 billion, an increase of 71%. Its revenue from the schemes and other revenues combined jumped by a sizable 41% to HK$2.72 billion, a record high for the fifth consecutive year.

Currently only a handful of the nearly 300 Chinese stocks listed in the U.S. have concurrent listings in Hong Kong. Many more may be eager to list in the city as they face greater delisting risks in the U.S. That, in turn, could attract more investment from mainland China for companies that can enroll in the connect programs.

But Bright Smart’s Chik emphasized that mainland retail investors have to meet certain criteria before they can invest through the connect schemes. And with many retail investors locked out of the market for failing to meet such criteria, the potential for more transactions will also be limited, even with yuan-pricing. Meantime, many mainland institutional investors tend to look for long-term value by focusing on fundamentals and individual stock valuations. Such investors are likely to look more closely at any yuan-pricing arrangements to determine whether it really brings any new benefits to justify more cross-border trade.