Comments on the Pilot Program for Establishing Mutual Stock Market Access between Mainland China and HK

See the last page for disclaimer page 1 of 39 Research Department 10 April, 2013 Comments on the Pilot Program for Establishing Mutual Stock Market Access between Mainland China and HK 后附中文翻译 See the last page for disclaimer page 2 of 39 Develop a pilot program for establishing mutual stock market access between mainland China and HK. On Apr. 10, China Securities Regulatory Commission (CSRC) and Hong Kong Securities and Futures Commission (HKSFC) jointly announced a pilot scheme on connecting Shanghai (SH) and Hong Kong (HK) stock exchanges. According to the official plan unveiled, at the first stage, CSRC will implement RMB quota control on taking cross-border trading, and total and daily quota will be restricted to RMB 550bn and RMB 23.5bn, respectively. Within the quota, SH stock market will be allocated RMB 300bn and RMB 13bn for total and daily quota and HK RMB 250bn and RMB 10.5bn, respectively. Stocks available for pilot investments include constituent names in the Shanghai Stock Exchange (SSE) SSE 180 index, SSE 380 index, Hang Seng Composite LargeCap index, Hang Seng Composite MidCap index and shares of all SSE-listed companies which have issued both A shares and H shares. This pilot program will be launched after a 6-month preparation period. Qualified domestic investors to invest in HK market only include institutional investors and individual investors with security account aggregate balance of no less than RMB 500,000. Both A share and HK stock markets will benefit from incremental liquidity and higher trading volumes. As of end of Mar., total and free-float market cap on SH market amounted to RMB 14.8 trillion and RMB 13.3 trillion, respectively, and total market cap on HK stock market was HK$23.1 trillion (equivalent to RMB 18.0 trillion, based on the average RMB/HKD FX rate of 1.28 in 2014 YTD). Incremental liquidity by fully using investment quota could therefore account for 2.0% and 1.4% of total market cap for SH and HK, which might not be significant by looking at the numbers themselves. However, during the first three months of 2014, average daily trading turnover (ADT) in SH and HK was RMB 82.7bn and HK$68.3 bn (equivalent to RMB 53.4bn). Therefore, on a daily as well as static basis, relevant investment quota could increase ADT in the A share and HK market by around 15.7% and 19.7%, respectively, which we think should have significant impacts. More policy initiatives could be expected ahead amid deepening mutual market access. According to the current scale of daily trading, both SH and HK quotas might be exhausted in 23-24 trading days, equivalent to a 1-month period. However, we expect the pilot program to be a first step towards the opening-up of capital markets in China and to deliver the policy intent to keep pushing forward related reforms. Actually, qualified individuals / enterprises in Shanghai Free Trade Zone (SHFTZ) have been allowed to invest securities overseas since Dec. 2013 and Qianhai Economic Zone in Shenzhen officially announced in Feb 2014 QDII2 pilot scheme to be introduced before the end of 2014. With deepening RMB internationalization and China continuously proceeding with market deregulation in the big picture of making reforms, more policy moves could be expected in the future, including further opening-up of cross border investments. Premier Li just stated on Boao Forum intent to actively push forward implementation of mutual market access between SH and HK stock trading. Hence, investor enthusiasm could continue to be boosted by such an expectation and exert positive impacts on market trading activities. Valuation premium / discount for dual listed names to be narrowed. Among the tradable stocks under the pilot program, we expect domestic investors to prefer A+H dual listings on the higher familiarity and therefore, these H shares could be among their first batch of potential investments. In particular, H share names with larger discount to their A share names could be considered more attractive. In addition, individual investors could be more inclined to pick mid to small cap stocks given that retail investors in China usually demonstrate this kind of investment style. Please refer to the following table for shares under our coverage that benefit from the policy and enjoy discount to their A share names. Companies whose business closely links to market trading activities will also benefit more from the pilot program. Those companies could mainly include China securities firms listed in HK, such as GTJAI (1788 HK), Haitong International (665 HK), Citics Sec. (6