China Marts Offer Fortune Cookies As Trading Opens to Foreigners blog update to a story we’ve been covering for the past several months is courtesy of extract from 25 Sept NYT coverage from Alexandra Stevenson and Neil Gough.

Image courtesy of Yip/Reuters

Image courtesy of Yip/Reuters

O’Connor, the UBS-owned hedge fund with AUM of $5.6bil is just one of the financial industry firms ratcheting up their presence in Asia as China’s stock market prepares to open its doors to foreigners. Dealers have been hired by it from UBS’s proprietary trading desk and Singapore offices. In August, it hired John Yu, a former analyst at SAC Capital Advisors. But O’Connor is not alone.

Bankers, brokerdealer brokerage firms and hedge funds all have been gently expanding their Asian businesses to benefit from a single event: the largest launching into China.

China intends to join the Shanghai stock exchange to its counterpart in Hong Kong over the following month as part of an initiative announced by Premier Li Keqiang this year to open China’s markets to foreign investors that have been largely shut out.

The move will enable foreign investors to trade the shares of firms listed on the Shanghai stock exchange directly for the very first time, and mainland Chinese investors to buy shares.

An open market between the mainland and Hong Kong’s potential rewards are tremendous for investors. Now, the only method for foreign investors to trade stocks that are Chinese is indirectly via a restricted quota plan that allows a trickle of foreign money to the nation.

“This is the single most significant development in China’s aim to internationalize this market,” one senior Western banker in Asia said of the planned reform, speaking on the condition he not be named because he was not authorized to speak freely in the problem.

The application, called Shanghai-Hong Kong Stock Join, will create the second-biggest equity market in the world in regard to the market value of the listed companies that were combined, said Dawn Fitzpatrick, the chief investment officer of O’Connor. The biggest stays the NY Stock Exchange.

“It is additionally likely to develop a more efficient method for the global marketplace to value many Chinese businesses, which aspect alone makes the market more attractive,” she added.

Officials have now been aiming for sometime, although the formal starting date for the plan hasn’t yet been announced. Employees at brokerage firms have been working additional weekend shifts participating in mock trading sessions to examine their readiness for the brand new plan. On one recent weekend, 97 brokerage firms simulated a failure of their copy data systems for the Shanghai-Hong Kong two way trade.

O’Connor, for the part, is among a little group of hedge funds that have participated in the quota program, named the qualified foreign institutional investors plan. They sell and buy shares denominated in both renminbi and Hong Kong dollars.

The wide open connection allows hedge funds like O’Connor to enlarge their business between both exchanges and trade directly. Still, challenges remain, and some significant questions have not been answered.

This program is portion of a more comprehensive reform package announced by President Xi Jinping a year ago. Critics point to other reform initiatives, such as the construction of planned and new free trade zones, that have already been slow to take off.

Last September, regulators in Shanghai agreed to let a small group and British hedge funds raise from Chinese investors within a pilot program. Any of these businesses has complained that progress continues to be slow and weighed down by bureaucratic hurdles.

Linking the Shanghai and Hong Kong exchanges is not a brand new thought. In 2007, Hong Kong officials declared a strategy that was similar allowing Chinese investors to achieve access Hong Kong’s stock market. That plan never took off.

And while foreign and Chinese investors will have the chance to buy hundreds of companies that have been formerly off limits, they will be limited by quotas. The combined two way trading volume will soon be limited at 23.5 billion renminbi ($3.8 billion), about 20 percent of the combined average daily trading volume on both markets. Individual mainland Chinese investors will need at least 500,000 renminbi in their brokerage account to purchase Hong Kong shares, a brink that excludes retail investors.

Foreign buyers will be unable to buy shares and sell them on exactly the same day. It remains uncertain whether they’ll be permitted to take part in short-selling or to purchase shares using margin funding. And, in renminbi, all trades will likely be settled in another hurdle, introducing added risk for foreign investors.

Additionally, there are unresolved dilemmas over taxes. Foreign investors are liable for paying capital gains taxes, but

China has not taxed such investments under the existing quota scheme.
Given these and other uncertainties, businesses which compiles indexes which are monitored by funds with trillions of dollars invested in stocks have so far declined to add mainland Chinese shares in their own indexes.
That could change just as next year, when MSCI is scheduled to review shares that are Chinese.
“Were China’s domestic A-shares to be contained in the MSCI benchmarks, it will be a game-changer, bringing billions of dollars of capital,” analysts at HSBC in Hong Kong wrote this month in a research report.Regardless, some investors are pushing.

Charles Li, the chief executive of Hong Kong Exchanges and Clearing, the stock market operator, has been forthright concerning the limitations of the trading program.”It’s not perfect,” Mr. Li wrote in a post on his official blog last month. “While we’ve managed to find a solution to all the challenges of aligning two very different markets, a few of the differences were so critical that our alternatives will necessarily constrain the market.”