Abstract: At present, China's financial opening has entered a new stage of high-quality development, which will have a profound impact on China's economic and financial development and reform. China's financial market opening process started with the launch of the Shanghai-Hong Kong Stock Connect on November 17th, 2014, and has made a series of important achievements through steady progress.
Over the past five years, the Shanghai-Hong Kong Stock Connect has been operating smoothly, with the scale of transactions increasing steadily. The practice of the Shanghai-Hong Kong Stock Connect has six important implications for China to comprehensively promote financial opening: first, China should conform to the trend of the time and market demand; second, it is important for us to have entrepreneurship; third, we should be bold to explore and innovate; fourth, we should try the best to overcome difficulties and pay attention to details; fifth, we should make advances in a gradual approach; sixth, we should enhance investor protection and prudential supervision. Financial openness will encounter new situations and challenges in the future. Chinese regulatory authorities can draw on the successful experiences of the Shanghai-Hong Kong Stock Connect in expanding financial opening and making China a strong financial power.
It has been nearly five years since the Shanghai-Hong Kong Stock Connect was officially launched on November 17, 2014. At present, China's financial opening has entered a "fast lane" with relevant government agencies having announced a series of measures to promote the process. As China's financial opening effort has entered a new stage of high-quality development, it will have a profound impact on China's economic and financial development and reform. The development of the Shanghai-Hong Kong Stock Connect has important implications for financial opening.
I. China's financial industry gradually accelerated the pace of opening
The strategic significance of financial openness lies in the fact that it will help China build a high-level and open economy. In recent years, China's economy has entered a "high-quality" development model, which will form a joint force with financial openness and fully highlight China's comparative advantages. At the same time, financial openness will also inject new momentum into the development of the financial industry. Through financial opening, China can promote the comprehensive reform of its financial industry, better deal with financial risks, and strengthen the construction of financial supervision capability. As an important institutional reform five years ago, the Shanghai-Hong Kong Stock Connect has played an important leading role in promoting the process of opening the financial industry.
On November 12th, 2013, the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) adopted the decision of the CPC Central Committee on "Several Major Issues Concerning the Comprehensive Deepening of Reform". In the decision, it was first proposed that China should "promote the two-way opening of the capital market", both "going out" and "bringing in", as well as "improving the convertibility of cross-border capital and financial transactions in an orderly manner", which is also an important institutional background for the launch of the Shanghai-Hong Kong Stock Connect.
After reviewing the important events related to opening China's capital market in recent years, it can be found that the launch of the Shanghai-Hong Kong Stock Connect marked a starting point of China's financial opening process, which officially began in 2014. Since then, China officially liberalized the restrictions on foreign institutions investing in the inter-bank bond market in 2016, and in December of the same year, the Shenzhen-Hong Kong Stock Connect was officially opened. In 2017, the "bond connect" between Chinese mainland and Hong Kong was launched. It is not exaggerated to say that it is the opening of China's stock market and bond market from 2014 to 2016 that has led to MSCI's active promotion of the inclusion of A shares in the emerging market index in June 2017.
With the further opening of the bond market in 2018, China's government bonds and policy financial bonds were successfully included in the Bloomberg Barclays Indices. In the same year, the settlement system and tax system of bond connect were further improved. In September 2018, A shares were officially included in the FTSE index. In June 2019, FTSE Russell formally added A shares to its global stock index system. In September 2019, the State Administration of Foreign Exchange decided to remove limits on investment quotas for Qualified Foreign Institutional Investors (QFII) and Renminbi Qualified Foreign Institutional Investors (RQFII).
Considering the above milestones of capital market opening, since 2014 when "Shanghai-Hong Kong Stock Connect" took the lead, China's capital market opening has made steady progress and achieved significant results in the past five years.
At present, the Shanghai-Hong Kong Stock Connect is running smoothly. Data show that its trading volume reached 1 trillion yuan on the 1st anniversary；3.5 trillion yuan on the 2nd anniversary; 6 trillion yuan on the 3rd anniversary and 10 trillion yuan on the 4th anniversary. By August 2019, the trading volume of the Shanghai-Hong Kong Stock Connect had exceeded 15 trillion yuan. It's successful experience has enlightened China in how to further promote the financial opening-up. Currently, China has set up the corresponding institutional frameworks, the key lies in how to implement them. Each system, rule and approach of opening-up should consider different application environment. Therefore, there is still a lot of detailed work to be done. I would like to share a few inspirations from the successful launch of Shanghai-Hong Kong Stock Connect.
II. The opening up of financial sector need to comply with the trend with executive agencies more devoted to details
First of all, financial opening-up should conform to the market demand. The launch of the Shanghai-Hong Kong Stock Connect is actually the combination of "the right time, the right place and the right people". "The right time" lies in the fact that "Shanghai-Hong Kong Stock Connect" meets the needs of national policies and strategies. "Right place" means that the domestic and foreign investors have strong urges to actively participate in the market transactions. In general, the Shanghai-Hong Kong Stock Connect is in line with the development needs of China's deepening of economic reform, the investment needs of investors, the internationalization needs of RMB, and the strategic needs of "building Shanghai as an international financial center while solidifying Hong Kong's role as a global financial center".
Once a project is identified, all the staff of executive departments, from top to bottom, should have a sense of responsibility and the spirit of entrepreneurship. The Shanghai-Hongkong Stock Connect started from a spark of thought, then turned to a blueprint, a specific plan, and eventually to the official launch, the whole process is very difficult. Such a huge project, involving many parties, with tight schedule and challenging tasks, cannot be done without a strong enforcement agency or a strong sense of responsibility. Back in those days, it were many people who worked day and night that facilitated the well-off launch of the Shanghai-Hongkong Stock Connect.
During the project execution, we also need to make efforts in overcoming difficulties and paying attention to details. Although the Shanghai and Hongkong Stock Exchanges are in the same time zone, their systems are very different. Therefore the stock connect requires attention to details. For example, their trading hours may be inconsistent, and the holiday arrangements may also be different. The Shanghai Stock Exchange set a 10% limit on the rise and fall of individual stocks per day, while the Hongkong Stock Exchange has no such rules. In terms of the day trade system, the Shanghai Stock Exchange adopts "T+1" approach, while the Hongkong Stock Exchange uses "T+0" model. For the stock settlement system, the Shanghai Stock Exchange settles the trading on "T+1" basis, while the Hongkong Stock Exchange settles on "T+2" basis. In addition, the staff had complex and extensive discussions on the specific arrangements of boarding lot, quotation price limit and other technical details, striving to achieve scientific and satisfying results.
III. We must be innovative to press ahead with financial opening
The Shanghai-Hong Kong Stock Connect program was launched when China's capital account was not fully convertible, creating a new model of cross-border securities investment that features easy operation and controllable risks. Of particular note, the program does not entail changes in market rules or investor behaviors in the two cities, and this requires institutional innovation. The major innovation of the program is the adoption of a dual SPV architecture (or order routing mode). Shanghai Stock Exchange and Hong Kong Stock Exchange are directly connected, each providing order routing services in a service provider set up by the other and taking orders from local investors to buy or sell stocks of the other. Meanwhile, the program features net cross-border settlements. There would only be a very small proportion of real cross-border flow of funds in the total transactions of over a dozen trillion yuan. Such program would never have come into shape without innovative thinking.
Certainly, the Shanghai-Hong Kong Stock Connect program is different from QFII. People usually wonder why the program is necessary as the A-share market in China is already open to foreign investors with the QFII mechanism in place. I think the two are different mainly in terms of their business carriers, investment portfolios and transaction currencies. QFII is a dollar-based system while the transactions under the Shanghai-Hong Kong Stock Connect program are in RMB terms. This means that under the two systems, the cross-border funds are managed differently, and investors enjoy different levels of convenience. If QFII is like a "cruise ship", the Shanghai-Hong Kong Stock Connect is more like a "bridge" – they are two different channels linking the pair of cities. Moreover, the investment portfolio strategies under the two systems are not the same. Compared to QFII that focuses on long-term investments and value investments, the investment portfolio under the Shanghai-Hong Kong Stock Connect is more diversified.
IV. Financial opening should progress step-in-step with emphasis on investor protection and prudential regulation
When the Shanghai-Hong Kong Stock Connect program started, quota management was a priority. Initially there were both a cap on total quota set at RMB 300 billion yuan and a cap on daily quota. But in 2016, the cap on total quota was removed, and in May, 2018, the daily quota cap was elevated by as much as 4 times. It's the same with the objects of transaction – most of the transactions targeted large-cap shares at the initial stage of the program, but later the scale of the transaction objects was enlarged. This tells us that a new institution for openness must be promoted in a step-by-step manner. That makes it easier to succeed.
Meanwhile, investors across the Chinese market were well communicated on related regulations since the program was initiated. In addition, securities authorities in the two cities - the CSRC and the SFC signed the Memorandum of Understanding on Strengthening of Regulatory and Enforcement Cooperation under Shanghai-Hong Kong Stock Connect, which provided for ways to deal with differences in the standards for identifying misbehaving transactions including insider trading and market manipulations. The Memorandum filled the blank of regulations on cross-border transactions with its detailed stipulations on regulatory information sharing, report of illegal trading, assistance in investigation and other related issues of concern.
Put simply, high-level financial opening is of great significance. It can be seen from the last five years since the Shanghai-Hong Kong Stock Connect program commenced that pressing ahead with financial opening is no easy task. The institutional climates, concrete programs and working methods in the current financial opening drive are highly diversified, and new problems may emerge in the future. I believe there is a lot to learn from the experience of the Shanghai-Hong Kong Stock Connect to facilitate further opening of the financial sector in China, which will be pivotal to the financial and economic advancement of the country.
