With China seeking to establish itself as the next global hegemon and Trump’s ‘America First’ Policy continuing to rewind previous efforts for globalisation, perhaps it’s an opportune time to better understand what exactly is going on in the Oriental East. With China continually promoting its Belt and Road Initiative, the internationalisation of the Renminbi (RMB) is a key step in achieving its goals. And a key player in the internationalisation of the Renminbi is China’s offshore RMB market: Hong Kong.
Unlike other stock exchanges, Hong Kong’s stock market has a unique characteristic to it, in the form of access to China’s rather closed off, enigmatic stock markets. This is achieved through the Bond Connect Scheme, the Stock Connect Scheme and the issuance of H-shares. H-Shares are shares of a company incorporated in Mainland China that list themselves on the HKSE. Whilst these shares are regulated by Chinese law, they are denominated in Hong Kong Dollars (HKD) and open to purchase from foreign investors. This contrasts with companies that list themselves in China, where they issue out A-Shares and B-Shares.
A-Shares are shares of a company that are listed in either the Shanghai Stock Exchange (SSE), or the Shen Zhen Stock Exchange (SZSE). These shares are typically only available to Mainland Citizens and select foreign institutions that purchase them through a ‘Qualified Foreign Institutional Investor System’. A-Shares were formerly only available to mainland citizens but have since been slowly deregulated as China takes steps to gradually open its financial markets. That being said, there is still a monthly 20% limit on the repatriation of funds to foreign countries for foreigners investing in A-shares.
B-Shares were initially China’s response to opening their markets to foreign investors. They are shares of a company that are quoted in foreign currencies: USD in the SSE and HKD in the SZSE. Although open to both domestic and foreign investors, access to Chinese investors is tricky due to the difficulty in converting the RMB to foreign currencies (China has strict controls on its currency in order to maintain its pegged value to the USD and take care of its Current Account). A Chinese firm can issue both A- and B-Shares on stock markets. However, A-shares demand a premium as they are more easily traded than B-shares, given their ease of access for domestic investors in A-shares and foreign investors in B-shares.
With the distinction in shares established, we now turn to the two aforementioned schemes that China has established with its offshore RMB market. Firstly, the Stock Connect is a scheme that allows investors trading in the HKSE to access stocks that are listed in the SZSE and SSE, i.e. they now have access to A-Shares. Although the exchange rate is strictly controlled by the Chinese authorities, this step opens foreign investors up to what has previously been a highly closed off market, promising prospects of new opportunities for profit as growth in US and EU markets stagnates.
The Bond Connect scheme was introduced in 2017, several years after the Stock Connect Scheme. The Bond Connect essentially allows foreign investors to tap into China’s USD9.0tn debt market without having to set up an onshore account. This will be particularly exciting for foreign investors as with interest rates set to rise in the coming year, the value of Western bonds will fall.
Of course, while foreign investors gain access to mainland markets, mainland investors will also gain access to foreign stocks, which offer far higher yields compared to the low-yielding investment opportunities that consumers are limited to in onshore markets (due to strict regulatory controls by Chinese authorities). This manifests as increased liquidity flowing into the HKSE as onshore consumers begin seeking higher returns, drawing firms to list in Hong Kong – in 2017, 90% of all IPOs on HKSE were oversubscribed.
China’s growth shows little sign of slowing down, and as it continues to grow its international presence and open its financial markets, there is little doubt that their offshore RMB market will continue flourishing and provide new opportunities and higher profits for investors.