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How the Shenzhen-Hong Kong Connect Will Benefit ETF Investors

Shenzhen-Hong Kong Stock Connect, a programme for establishing mutual stock market access between the Shenzhen and Hong Kong exchanges has been approved

Jackie Choy, CFA 19 August, 2016 | 11:01AM

On 16 August 2016, the Hong Kong Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) approved, in principle, the launch of the long awaited Shenzhen-Hong Kong Stock Connect, a programme for establishing mutual stock market access between the Shenzhen and Hong Kong exchanges. This will build upon the foundation that was laid when the Shanghai-Hong Kong Stock Connect programme came into operation on 17 November 2014.

Having a more diverse opportunity set for accessing A-shares may ultimately reduce fees

In addition to the announcement of the Shenzhen-Hong Kong Stock Connect programme, the regulators shared that ETFs will ultimately be considered as eligible securities under both Stock Connect programmes. The effective date for the inclusion of ETFs will be announced after the Shenzhen-Hong Kong Stock Connect has been in operation for a “period of time”. Other operational details have yet to be announced.

The Shenzhen-Hong Kong Stock Connect is expected to be formally launched in approximately four months.

Unanswered Questions Regarding “ETF Connect”

While it is encouraging that ETFs will be included in the Stock Connect programmes, there are some lingering questions regarding their eventual inclusion.

A launch date will be announced separately after Shenzhen-Hong Kong Stock Connect has been in operation for a period of time and upon the satisfaction of relevant conditions.”, cited from the SFC/CRSC announcement; and what are the “relevant conditions”?

For existing ETFs in Hong Kong/China, which type of ETFs will be allowed? For example, will it be any specific domiciliation requirement on the ETF or the ETF manager? Any specific exposure? What are the application procedures for an ETF to be eligible for inclusion?

Implications for the ETF Industry

We view the establishment of the Shenzhen-Hong Kong Stock Connect as another step by China towards further opening up its capital markets. We see a number of implications for the ETF industry.

ETFs that are ultimately deemed eligible for inclusion in the Stock Connect programmes will be available to a wider group of investors in Hong Kong and China. The additional demand that will likely result would translate into growth in assets under management and product availability in both markets.

For A-Share ETFs, or ETFs with A-Share exposure, the Shenzhen-Hong Kong Stock Connect will provide a wider channel to access the A-Share market, expanding to stocks listed on the Shenzhen Stock Exchange. As a result, ETFs could potentially reduce their reliance on their existing QFII/RQFII quotas. However, their ability to do so would remain constrained by the daily quota in place.

Having a more diverse opportunity set for accessing A-shares could intensify competition and may ultimately serve to reduce trading costs as well as management fees for A-Share ETFs. In addition, offering ETFs on across borders could foster competition and potentially put pressure on fees on products with similar exposures.

With the investment channel covering the Shenzhen Stock Exchange, all shares with both A-Share and H-Share listings, currently 90 stocks, will be available to investors in both Hong Kong and China. Intuitively, this should help narrow the pricing differences between the two markets for these stocks. That said, there still exist pricing gaps on Shanghai-listed stocks with both A-Share and H-Share listings.

Overall, we welcome the introduction of the Shenzhen-Hong Kong Stock Connect and the inclusion of ETFs as eligible securities under the Stock Connect programmes, especially since it could ultimately benefit ETF investors.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Jackie Choy, CFA  is an ETF strategist at Morningstar, based in Hong Kong.