Abacus | Shenzhen-Hong Kong Stock Connect party open, but is anybody coming?

It’s been a long time coming, but last week China’s State Council finally signed off on the Shenzhen-Hong Kong Connect initiative that will let non-mainland investors buy and sell shares listed on the Shenzhen Stock Exchange. What’s more, mainland regulators scrapped the upper limit on shares offshore investors can hold through the two-year old Shanghai-Hong Kong Connect, and said Shenzhen would have no such ceiling. A daily throttle will still limit the pace of purchases, but in effect Beijing has just thrown its jealously-guarded domestic A-share market fully open to foreign investors.

Whether foreigners will be interested is another matter, and the precedent is hardly encouraging. Under the Shanghai-Hong Kong Connect deal, they have been allowed up to 300 billion yuan of Shanghai-listed A-shares. As of the middle of last week, they owned just 143 billion yuan – less than half their allotted quota.

Foreign investors’ coolness towards Shanghai stocks is unsurprising. The Shanghai market is dominated by state-owned enterprises. The biggest single sector consists of heavy industrial companies – coal miners, metal-bashers, and the like – which together make up 32 per cent of the Shanghai A-share index. These are the companies that have been hit hardest by China’s economic slowdown. Suffering grievous over-capacity and facing a long, painful downsizing, they have little to attract foreign investors.

The second biggest segment of the market, at 29 per cent by capitalisation, is made up of financial companies, principally China’s big state-owned banks. After years of reckless lending to support state industries, these have been left on a mountain of largely unrecognised non-performing assets and are in dire need of recapitalisation; again, hardly an enticing prospect.

In any case, if foreign investors wanted exposure to Chinese energy companies or banks, they would find many of them listed in Hong Kong, and cheaper than in Shanghai. Where Chinese companies have both mainland A-share and Hong Kong H-share listings, as of last week the A-shares were on average 26 per cent more expensive. That’s considerably less than the 40 per cent premium A-shares sported at the end of last year, but even so, it’s not exactly appetising.