Rich values, poor rules dog Hong Kong-Shanghai stock volumes

[HONG KONG] Profit-taking and queasiness about the rules blighted trading via the Shanghai-Hong Kong stock connect this week after a brisk first day when mostly hedge funds and private banks snapped up all the available mainland shares within hours.

The scheme, which lets foreign investors directly invest in Shanghai-listed shares for the first time and mainland investors buy Hong Kong stocks, reached the 13 billion yuan (S$2.75 billion) daily "northbound" quota on Monday, but achieved only 37 per cent on Tuesday, 20 per cent on Wednesday and 18 per cent on Thursday.

That was partly down to a well-telegraphed ambush by mainland investors, who ran up the price of their stocks in the months before the launch, and promptly sold them into the initial rush from Hong Kong.

But big institutions gave the scheme a wide berth, concerned about taxation matters and technical rules that make trades more risky and uncertain.

The Shanghai market has picked itself up from a multi-year trough to rise 27 per cent this year, the third best performer in Asia after India and Pakistan. "There was a lot of anticipation on the stock connect scheme before the launch," said Arnout Van Rijn, Asia-Pacific equities fund manager at Robeco in Hong Kong, part of a team that manages US$250 billion in assets globally.

That was particularly true of stocks that Hong Kong brokerages had been pushing hard.

For example, Kweichou Moutai Co Ltd,, China's top seller of fiery liquor baijiu, which has been among the top 10 stocks traded on the northbound leg in the first three days of trading, had raced up more than 50 per cent so far this year. It fell 10 per cent this week as mainland investors pocketed their profits.

Another brokerage favourite, Daqin Railway, operator of railroad coal transport in northern China, has risen more than 50 per cent since March and hit a 4-1/2 year high on Monday, but has since declined nearly 10 per cent. "Further intakes of A-shares will be much slower as the excitement has been exhausted on the launch day, and potential investors turn cautious," said Du Changchun, analyst at Northeast Securities in Shanghai.

Southbound trade was always expected to be lighter, as mainland investors have shown little enthusiasm for previous schemes to invest abroad, preferring the lure of real estate.

Even so, the take-up was dismal, falling from 17 per cent on the first day to 2 per cent on Thursday.

While the fast money may still dip in and out of the market, the rules governing the scheme are deterring traditional long-only funds, which serve retail investors and have more risk-averse mandates.

Rahul Chadha, co-chief investment officer at Mirae Asset Global Investments in Hong Kong, said they hadn't invested but would do so "in due course" and had instead invested in Chinese companies with listings in Hong Kong.

One complication in trading a Shanghai listing through the connect is the "pre-selling" requirement to deliver stock to a broker the day before sale, which leaves the seller exposed to movements in the stock for longer.

Institutions are also unnerved by the lack of a concept of beneficial ownership in China, which elsewhere in the world makes a clear distinction between those conducting the mechanics of a trade and the owner on whose behalf they trade.

And while China said last week it would temporarily exempt taxes on profits made from the stock connect scheme, fund managers are wary of a retrospective tax charge. "The taxation issue hasn't really been solved, and large institutional investors dislike any uncertainty," said Jesse Lazarus, an analyst at Shanghai-based Z-Ben Advisors Ltd.

Such concerns have dogged previous attempts to give foreigners access to Chinese stocks, such as the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) schemes.

The government has yet to clarify the tax treatment for those schemes, and Z-Ben's Lazarus estimates between US$400 million and US$1.2 billion in tax could be owed by fund managers under the QFII quota, if the government were to call it in.

"Think about the documentation and how many days the (tax) lawyers need to look at that - and pre-selling of stock is still an issue for many institutional investors," said Vincent Chan, head of China research at Credit Suisse.

The Shanghai Stock Exchange declined to comment for this story, while the Hong Kong exchange did not immediately respond to requests for comment.

REUTERS