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Shanghai-HK stock connect: What you should know

Hong Kong Stock Exchange
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Hong Kong Stock Exchange

Come October, overseas investors eyeing China stocks will have greater access to its equity market, when a new trading link between Shanghai and Hong Kong is launched connecting the two bourses worth $5.5 trillion in combined market capitalization.

Here are five things you need to know:

1) What is it: The scheme, known as the Shanghai-Hong Kong stock connect, was announced by Chinese premier Li Keqiang in April. It will allow global investors, institutional and retail, to trade Shanghai 'A' shares via the Hong Kong stock exchange while Chinese mainland investors will be able to trade Hong Kong 'H' shares via the Shanghai Stock Exchange for the first time. At present, only institutional investors abroad with secured quota from the government can invest directly in China's domestic markets.

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2) Who is involved: Brokerages have given a strong response to the new trading scheme but the full list of eligible brokers will only be announced after the market readiness tests, starting this week, are concluded.

3) Market reaction: The plans have helped fuel huge rallies in stock exchanges of both cities in recent months. The Shanghai Composite Index has risen more than 8 percent since the start of July and is up more than 12 percent since the lows hit in March this year. Hong Kong's benchmark Hang Seng hit three-year highs in July and is up 5.6 percent year to date.

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4) Broker concerns: While a link between the two major markets is a landmark development, there are still concerns in terms of actual execution as both exchanges ultimately operate in different regulatory environments. For example, mainland investors are subject to tax on capital gains, which is not applicable in Hong Kong. Also, Chinese investors must have the stocks in their accounts on the day they plan to sell, while Hong Kong investors need only transfer stocks to brokers two days after the trade. Different trading hours in the two exchanges might hamper the scheme's efficiency, too.

5) Biggest challenge: Quota restrictions could potentially be the biggest challenge to the success of the scheme. Beijing has placed a 13 billion yuan daily cap on the amount Hong Kong investors can trade in A-shares, with a 300 billion yuan total in cap; while mainland investors can invest up to 10.5 billion yuan a day or 250 billion yuan total in Hong Kong stocks. The Hong Kong Exchanges and Clearing Chief Charles Li, recently tempered optimism over turnover increasing dramatically on either bourse: "We should not have high expectations unless Beijing increases the quota."

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