Brent Lewin | Bloomberg | Getty Images
A trading link between Shenzhen and Hong Kong may look
good on paper, but it's likely to suffer the same fate as the
Shanghai-Hong Kong Stock Connect unless Beijing changes the rules,
analysts say.
This week, Chinese premier Li Keqiang hinted at a widely-anticipated cross-border trading program between Shenzhen and Hong Kong, but investors aren't overly excited. The program would likely be based on the existing Shanghai-Hong Kong Stock Connect, which met lukewarm success following its debut late last year.
For the first twenty trading days, average northbound quota usage on the Shanghai-Hong Kong Stock Connect – investors buying Shanghai-listed A-shares – was 25.3 percent of the daily quota, lower-than-expected. Meanwhile, southbound quota usage was just 4.5 percent of the daily quota.
Read MoreChina's stock market is not in a bubble
"Investors have too many issues regarding the technicality of the existing Stock Connect, in particular custodial platforms," said Dariusz Kowalczyk, senior economist and
strategist at Credit Agricole, referring to a practice where stocks are kept in brokers' names rather than clients' names.
Europe's principal fund regulator, Luxembourg's Commission de Surveillance du Secteur Financier (CSSF), prevented large funds from participating due to concerns that the system doesn't protect investors in the event the custodian bank goes bust.
Another major factor keeping foreign investors away is the requirement for investors selling A-shares in Hong Kong to deliver shares to brokers the day before the trade, a settlement cycle called 'T plus zero.'
"Unless there's a change in technical procedures for foreign investors, the Shenzhen-Hong Kong stock connect won't be any more successful than the first," Kowalczyk said.
This week, Chinese premier Li Keqiang hinted at a widely-anticipated cross-border trading program between Shenzhen and Hong Kong, but investors aren't overly excited. The program would likely be based on the existing Shanghai-Hong Kong Stock Connect, which met lukewarm success following its debut late last year.
For the first twenty trading days, average northbound quota usage on the Shanghai-Hong Kong Stock Connect – investors buying Shanghai-listed A-shares – was 25.3 percent of the daily quota, lower-than-expected. Meanwhile, southbound quota usage was just 4.5 percent of the daily quota.
Read MoreChina's stock market is not in a bubble
"Investors have too many issues regarding the technicality of the existing Stock Connect, in particular custodial platforms," said Dariusz Kowalczyk, senior economist and
strategist at Credit Agricole, referring to a practice where stocks are kept in brokers' names rather than clients' names.
Europe's principal fund regulator, Luxembourg's Commission de Surveillance du Secteur Financier (CSSF), prevented large funds from participating due to concerns that the system doesn't protect investors in the event the custodian bank goes bust.
Another major factor keeping foreign investors away is the requirement for investors selling A-shares in Hong Kong to deliver shares to brokers the day before the trade, a settlement cycle called 'T plus zero.'
"Unless there's a change in technical procedures for foreign investors, the Shenzhen-Hong Kong stock connect won't be any more successful than the first," Kowalczyk said.
A second cross-border trading scheme could create
uncertainty due to a layer of new rules, according to Fraser Howie,
director at Newedge Financial: "The existing stock connect is an
amalgam of Hong Kong and Shanghai rules, so creating an entirely new set
of rules for the Shenzhen program will confuse things."
Trading volumes in a Shenzhen-Hong Kong scheme could also take a hit on the back of the Shanghai Composite's recent outperformance. It was the world's second-best-performing index in 2014, with gains of 53 percent; "Why leave a bullish onshore market to go offshore?" asked Kowalczyk.
Trading volumes in a Shenzhen-Hong Kong scheme could also take a hit on the back of the Shanghai Composite's recent outperformance. It was the world's second-best-performing index in 2014, with gains of 53 percent; "Why leave a bullish onshore market to go offshore?" asked Kowalczyk.
Bright spot
Shenzhen could draw more foreign investors than Shanghai
given the former's focus on small-cap firms within the technology and
consumer sectors, according to a recent white paper by Thomson Reuters
and regional trade association ASIFMA.
"For some investors, the companies listed on Shenzhen's market are a good representation of China's growth trajectory over the long term," the report said, adding that the market mostly features companies in their early stages. In contrast, Shanghai's index features mostly larger state-owned-enterprises (SOEs).
Shenzhen's ChiNext index, a NASDAQ-style exchange of small-cap firms that has appreciated over 15 percent this past year, could also boost demand.
Read MoreChina stocks roar back in 2014
"It will be interesting to see which of Shenzhen's 1,500 stocks are allowed into the new stock connect seeing as most of the interesting ones are in the ChiNext. I think the government should just allow all the stocks and let investors choose," said Howie of Newedge.
He noted that Shenzhen's small firms are far from cheap, trading at a P/E ratio of 100x earnings: "You have to assume that small-caps will be chased, but it could very well end up as a buy the rumor, sell the fact type of thing."
"For some investors, the companies listed on Shenzhen's market are a good representation of China's growth trajectory over the long term," the report said, adding that the market mostly features companies in their early stages. In contrast, Shanghai's index features mostly larger state-owned-enterprises (SOEs).
Shenzhen's ChiNext index, a NASDAQ-style exchange of small-cap firms that has appreciated over 15 percent this past year, could also boost demand.
Read MoreChina stocks roar back in 2014
"It will be interesting to see which of Shenzhen's 1,500 stocks are allowed into the new stock connect seeing as most of the interesting ones are in the ChiNext. I think the government should just allow all the stocks and let investors choose," said Howie of Newedge.
He noted that Shenzhen's small firms are far from cheap, trading at a P/E ratio of 100x earnings: "You have to assume that small-caps will be chased, but it could very well end up as a buy the rumor, sell the fact type of thing."
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