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SHENZHEN- STOCK CONNECT MARKET BRIEF

The first cross border connect scheme, the for growth companies. Of great interest to the wider investment community might be the number of Chinese tech stocks that investors –Hong Kong Stock Connect, launched will now be possible to gain exposure to under the Connect. in November 2014 and was dubbed the ‘through Indeed, the ChiNext board, which is ’s NASDAQ equivalent of high-growth stocks, will be available to institutional professional train’. Investors and market participants will investors1 under the new Connect scheme. have to wait no longer for the next ‘train’ as While analysts may be busying themselves to gather information on many of the lesser-known firms that will now enter their investable the launch of the Shenzhen–Hong Kong Stock universe, there are also some big companies (6.9 % of average daily Connect has been confirmed for later this year. turnover of SZSE concentrated in top 10 most actively traded stocks2) The joint announcement on 16th August 2016 from the China and familiar names. The initial attention is likely to be on the “new 3 Security Regulatory Commission (CSRC) and the Securities and economy” sectors, including Information Technology, Industrials , Futures Commission of Hong Kong (SFC) came as no in the Consumer Discretionary and Healthcare. ongoing opening up of China’s capital markets. It did finally set the clock ticking on a four-month period for securities firms to prepare. SMALL STEP OR GIANT LEAP? Much of the technical arrangement is expected to follow the What are the implications of this new Connect and will it have a existing Shanghai framework, making Shenzhen an easier project for big impact beyond Hong Kong and China? BNP Paribas believes that it investors and providers to plan towards. Some changes are worth might in fact be a key factor in China A-shares being included in the noting though, such as the removal of aggregate quota across both MSCI global indices, and then in turn benefit from this move because Connect schemes. While the daily trading volume limits remain, they of the resulting investment flows. are segregated between North and Southbound trading with daily Since the formation of the MSCI-CSRC working group in June 2015, quota of RMB 13 billion and 10.5 billion respectively. The removal of we have seen progressive steps being taken to comply with the MSCI this aggregate quota may clear the way for attracting more foreign requirements. Through a number of initiatives, China has been making participation, and provide a catalyst for the MSCI indices A-shares significant progress on improving access to its capital markets for inclusion. ETFs are slated to be available as early as 2017, creating overseas investors. The Shenzhen-Hong Kong Stock Connect is the more investment options, moving the (RMB) forward beyond latest part of this overall policy. It enhances the existing Shanghai a trade and reserve currency. scheme and the removal of the aggregate quota could have wider International investors should sit up and take note. The Shenzhen implications. Connect offers an alternative to the Qualified Foreign Institutional Although MSCI in their recent review did not include A-shares in Investor (QFII) in terms of participating in the Chinese markets without their global indices, it recognised that China has made significant quotas and opens the door to direct access to new growth areas of the steps toward this happening. The quota system was one of the stated market because of the listed constituents. hurdles and with the global index provider not ruling out a potential off-cycle announcement, there is a possibility of inclusion being re- OPENING NEW SECTORS evaluated. With a market capitalisation of more than USD3 trillion, Shenzhen If MSCI took the decision to include A-shares, this would lead to is the world’s seventh largest bourse. Around 880 stocks that are global benchmark trackers needing to make an allocation to Chinese listed on the Shenzhen (representing about 74% of the stocks. The two Connect schemes would benefit from these subsequent total capitalisation) are eligible for investment under the scheme by flows, as would those stocks with larger market capitalisation. As institutions or individuals who have accounts with registered brokers Asset Managers look to make these investments into A-shares, they in Hong Kong. Investors have the option of using special segregated will benefit from the more cost effective options offered by the Stock sub-accounts (SPSA) through approved brokers and custodians Connect when compared to QFII access. (including BNP Paribas), or BNP Paribas’ integrated solutions as it is one of the few foreign banks to offer this mechanism for Shanghai– ALL THAT GLITTERS Hong Kong Stock Connect. It is important for investors to look for investment advisers with What will attract overseas interest and what makes the constituents well-rounded research capabilities. In addition to a strong team of of the Shenzhen Stock Exchange stand out are the sectors that they research analysts covering A-shares from onshore, BNP Paribas has represent. Shanghai is heavily weighted towards large caps and the partnered with China’s #3 Best Research Institute, Essence Securities4, more traditional industries, with a number of stocks already dual- to extend its research coverage of A-shares. This will provide clients listed in Hong Kong. By comparison, Shenzhen has attracted many with top research on some of the key sectors as they open up for the more small- and medium-sized enterprises and has a reputation first time.

1 Subject to announcement to be made by Hong Kong regulators. 4 Essence is a top-15 broker in China and was voted #3 Best Research Institute in China in the 2015 New 2 Source: SZSE, from 18th July – 15th August 2016. Fortune Magazine. 3 Industrial stocks in Shenzhen should also qualify as “new economy” – most of them don’t operate in 5 Sources: BNP Paribas; Hong Kong Stock Exchange; Bloomberg; BNP Paribas Research “SZ-HK Stock the traditional areas. Connect: Small is beautiful” as of August 2016 6 Sources: BNP Paribas, Wind; CEIC The bank for a changing world

SHENZHEN-HONG KONG STOCK CONNECT MARKET BRIEF

In light of this exciting direct access to new stocks, it is necessary they look at China. BNP Paribas is well-equipped to support clients to temper this with some words of caution. Some analysts have raised with CNH investment products, hedging and risk management tools concerns as to the valuations of the stocks listed in Shenzhen. By way and keep them informed of the latest developments in the Connect of example, the Shanghai Composite Index (SHCOMP Index) currently scheme and other significant initiatives. trades at approximately 14.5 x 2016E PE5, a little higher than other Once the Shenzhen-Hong Kong Stock Connect is implemented, emerging markets. But the Shenzhen Composite (SZCOMP Index) together with Shanghai-Hong Kong Stock Connect and the opening up has eye-watering multiples of 24.9x 2016E PE5. Nonetheless, there of the China Interbank Bond Market (CIBM), which altogether takes are still attractive opportunities that exist in the Northbound link, up to around 85%5 of China’s capital markets (including both fixed including technology, automobile, capital goods and airports sectors. income and equities), will be accessible without the need to apply Another consideration is the precedent of the take up of the for a quota. BNP Paribas, combining its regional presence and global Shanghai scheme. After a slow start, Southbound investment has network, is in a strong position to facilitate cross-border investments seen a recent pick up, as investors are keen to grasp Hong Kong’s into China. attractive valuations and to avoid RMB depreciation, with around 80% of the quota utilised as of 16th August 20166.However, there has not For more information, please contact: been as much take up by investors into China with less than half of the quota used. EXECUTION & SYNTHETIC ACCESS These factors may weigh on investors’ minds as they take balanced BNP Paribas Global Markets, 63rd Floor, Two International decisions around exposure to China’s information technology sector. Center, 8 Finance , Central, Hong Kong The levels of risk may lead initially to a reserved take-up or more SYNTHETIC SOLUTIONS appetite for synthetic solutions, such as those offered by BNP Paribas. James Scully, Head of Prime Brokerage Sales & Trading, APAC, SEIZE THE INVESTMENT OPPORTUNITIES Global Markets, Direct line: +852 2108 5468, james.scully@.bnpparibas.com While December 2016 remains the target, the exact date that the Shenzhen Connect will start trading is not known yet. But those with EQUITY CASH existing SPSAs or BNP Paribas integrated solutions for settlements Carrie Cheung, Head of Execution, Equity Cash, APAC, in the Shanghai-Hong Kong Connect will be able to start trading on Global Markets, Direct line: +852 2909 8709, day 1 with proven management of clearing, settlement and custody [email protected] solutions. New investors, such as fund managers trading an index, will be able to utilise BNP Paribas’ open architecture opting for an integrated or a SPSA model, whichever suits their constraints best. CUSTODY Direct access to the China technology market will interest investors BNP Paribas Securities Services, PCCW Tower, from and the US who will no longer need to rely on proxies. Taikoo Place, 979 King’s Road, Quarry bay, Hong Kong, Participating will require choices of investment model and a global Website: http://securities.bnpparibas.com bank with a worldwide network to provide 24-hour services in Stéphanie Marelle, Executive Officer, Hong Kong Branch, CNH. As one of seven CNH Primary Liquidity Providers, BNP Paribas Regional Head of Clearing and Custody, is designated by the Hong Kong Monetary Authority and has the Direct line: +852 3197 3855, flexibility and credentials to serve these needs. [email protected] The Shenzhen Connect represents another important step in the CLIENT RELATIONS mobilisation of China’s capital markets and the internationalisation of the RMB, which will also be included in the International Monetary Angely Yip, Head of Sales and Relationship Management Fund (IMF)’s Special Drawing Rights (SDR) basket from 1st October North Asia, Asset Owners & Asset Managers, 2016. More options for quota-free investment provide international Direct line: +852 3197 3548, [email protected] firms with strategic alternatives, alongside QFII allocations when

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