Beijing has floated the idea of allowing share swaps in firms listed in mainland China (A-shares) and in Hong Kong (H-shares), powering the Hang Seng Index to a record high, while the Shanghai market skidded.
The Shanghai Composite Index had fallen almost 3 percent in the afternoon session, while the index of Chinese firms listed in Hong Kong rose 1.3 percent, helping push up the benchmark Hang Seng to a record 30,025.07 points.
"The A-H swap reports helped spark a correction this morning as investors expect implementation of such a plan would depress the (mainland) stock prices of companies dual-listed in Shanghai and Hong Kong," said Orient Securities stock analyst Zhou Fengwu.
The Shanghai market is under heavy corrective pressure after the index repeatedly notched up record highs, finally breaching 6,000 points on Tuesday. The index has almost doubled this year, fueled by cash thrown off by China's galloping economy and outpacing an 88 percent gain in H-shares.
A-shares are more expensive mainly because Chinese savers have few investment options beyond stocks, real estate and bank deposits. Capital controls mean they can't invest abroad, while, at home, financial markets are still underdeveloped and interest rate caps make other investment products unattractive.
With no derivative instruments enabling investors to short sell, mainland share prices have risen unimpeded by people betting against the herd.
For nearly a year, senior Hong Kong officials have been proposing a plan that would allow arbitrage to narrow the high premium, currently 48 percent, commanded by the mainland's A-shares over Hong Kong-listed H-shares.
The value of the A-H premium index, launched in July, fell nearly 4 percent on Thursday.
Tu Guangshao, vice chairman of the China Securities Regulatory Commission, said on Wednesday that officials in the mainland and Hong Kong were looking into the share swap plan.
He did not elaborate but said there was a great deal of room for cooperation between the two stock markets.
One leading China fund manager said there was still too little information to know exactly what the plan might mean.
"This could be very substantial, so I need to do some due diligence," said the fund manager, who preferred not to be named.
Any plan would have to overcome China's capital controls and restrictions on ownership: foreign investors are strictly limited in how much they can invest in China, while Chinese citizens may currently invest in Hong Kong only through the limited Qualified Domestic Institutional Investor program.
"It is still at the study stage and there's still quite a long way to go before it is operational," Jiang Chaoliang, chairman of Bank of Communications, told reporters during the Communist Party Congress on Thursday. "The regulators have asked us for our opinions."
Allowing swaps between shares on the two bourses would imply harmonization of prices in the two centers, meaning a huge shift for firms such as Jiangxi Copper, whose A shares cost more than double its H shares.
Its Shanghai stock was down 4.5 percent at 67 yuan ($8.91), while its Hong Kong shares rose 4 percent to HK$30.75 ($3.96).
It could also be bad news for firms such as oil giant PetroChina, which is preparing to list its shares in Shanghai next month. The float could raise more than $7 billion.
Earlier this month, China's top coal company, Shenhua Energy revealed the imbalance in the two markets when it sold shares in Shanghai for the first time.
Although long available to investors in Hong Kong, the shares attracted $360 billion in subscriptions in the Shanghai offering. The A shares fell 4 percent on Thursday, but still had a 68 percent premium over the Hong Kong price.