This really could be a big deal for China stocks

Dhara Ranasinghe | Special to
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Plans to allow greater foreign investment in Shanghai's A-share market could prove to be a game changer for investment in Chinese shares, analysts say.

A scheme called the Shanghai-Hong Kong stock connect, announced earlier this year and due to be formally launched in October, will allow foreign investors to place buy or sell orders on Shanghai's A-share market through brokers in Hong Kong. Chinese investors meanwhile will be able to use mainland brokers invest in Hong Kong's H-share market.

"So far it is relatively difficult for international investors to get access to Chinese A-shares and with this connect scheme, we will have an additional 550 billion renminbi ($88.6 billion) on top of existing [investment] allocations, so there is more money going into this space," said Francois Perrin, head of greater China equities at BNP Paribas Investment Partners.

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Under current regulations, foreigners have only limited access to China's A-share market – basically the shares of mainland Chinese firms listed in Shanghai or Shenzen.

The big investors in this market are domestic investors with foreign investors granted limited access through programs or pilot schemes such as the QFII (Qualified Foreign Institutional Investor) designed to open up Chinese markets.

According Citibank, foreign investors make up about 1 percent of the turnover in the Chinese A-share market while domestic retail investors account for about 80 percent.

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In a June report Citibank said one long-term implication of the Shanghai-Hong Kong stock connect scheme would be to "improve A-share market fundamentals and efficiency with a more balanced investor base; A-shares may be added to global indexes (for example the MSCI Emerging Market stock index) which would result in substantial liquidity flow into the A-share market."

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Chinese stocks have performed poorly compared with other major emerging markets and developed markets in recent years, against expectations for a stellar performance due to cheap valuations and relatively robust economic growth.

The benchmark Shanghai Composite is up just 0.4 percent year-to-date, compared with a gain of almost 8 percent in the S&P 500 and 3.8 percent in Hong Kong's Hang Seng stock index.

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Still, analysts say the connect scheme should provide a significant boost to Chinese shares in the second half of this year.

"So far we've heard a lot of discussions about structural reforms and the potential impact on growth. There is some concern from investors about the real-estate market," said BNP Paribas' Perrin, speaking on CNBC about reasons for weakness in Chinese stocks.

"But going through 2104, we have strong momentum on Chinese equities linked with the Shanghai-Hong Kong stock connect," he added. "It will put China back on the agenda for a number of international and domestic investors and is something that could be a game changer for Chinese equities."

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Stephen Sheung, head of investment strategy at SHK Private, said that while establishing the connect scheme was significant, the impact on Chinese shares was likely to be felt over a longer time period.

"This [the Shanghai-Hong Kong connect] is a big deal here," said the Hong-Kong based analyst.

"The official timing for its launch is October, but it could take longer. This is a game changer but it is most likely that the impact will be felt later rather than right now," Sheung added.