[HONG KONG] As China tightens its grip on capital controls, one state-sanctioned haven from a weakening yuan is drawing attention.

Mainland investors will turn to buying Hong Kong stocks through cross-border exchange links as other ways of purchasing overseas assets become more difficult, said Kenny Tang, vice chairman at Jun Yang Financial Holdings Ltd. An increase in flows would provide a boost to a stock market that has trailed global peers over the last four years, he said.

Policy makers stepped up measures to stem outflows as the yuan suffered its worst annual loss against the US dollar in more than two decades, including requiring extra documentation from individuals converting yuan and blocking the use of Chinese bankcards to buy insurance products in Hong Kong. As a high-profile part of President Xi Jinping's pledge to integrate China's financial markets with the world, the Shenzhen and Shanghai bourse links aren't facing the same threat, even with money flowing into Hong Kong so far in 2017 outpacing cash being sent the other way.

"If you look at the channels which are open right now, they are closing, and the stock connect still remains a channel which is open," said Sam Le Cornu, co-head of Asian-listed equities at Macquarie Investment Management Ltd.

"It's a closed-loop system but arguably you can get exposure to Hong Kong-denominated assets, which are pegged" to the US dollar.

While mainland investors using the link have to be repaid in yuan when they sell their Hong Kong shares, they are shielded from any depreciation in the Chinese currency while their money is on the other side of the border.

The fortunes of Hong Kong's stock market are becoming more closely linked to the ebb and flows of those funds. Record monthly spending on the city's shares in September via the Shanghai link helped the Hang Seng Index cap its biggest quarterly advance in seven years. Those funds dried up in early October, and the gauge suffered a 5.6 per cent loss in the final quarter of 2016. Inflows picked up again toward the end of December as the yuan fell to a fresh 8 1/2 year low, before slowing again this month.

Hong Kong's bourse links are the best way for mainland investors to buy assets whose value is pegged to America's currency, BNP Paribas SA said in a report on Jan 9. Southbound flows may accelerate this year, supporting Hong Kong-traded Chinese shares, it said.

The connection with Shanghai started in November 2014, giving mainland individuals direct access to shares listed in the former British colony for the first time, and the Shenzhen program began last month. Because the links have closed-loop designs - Chinese investors get the proceeds in yuan when they sell - purchases don't count toward an individual's US$50,000 annual quota for foreign currency conversion.

Hong Kong's equity market could use an influx of buyers. The Hang Seng Index eked out a gain of just 0.4 per cent last year, compared with 9.5 per cent for the S&P 500 Index, and has underperformed an index of global equities since 2013.

The measure trades at valuations 28 per cent below that of the MSCI All-Country World Index, according to data compiled by Bloomberg.

"In the long run, the stock connects will be a more popular or convenient way for mainland investors to invest overseas because capital controls in mainland China are being tightened," said Jun Yang Financial's Mr Tang.

BLOOMBERG