The Scheme is a’market’ which is designed to allow Hong Kong investors both institutional and high net worth individuals who have at least RMB500,000 ($80,000) to trade shares in Mainland Chinese companies and for Chinese investors to access overseas company shares through the Hong Kong market. It will have its own exchange and clearing house in the local market. Chinese Investors will have to meet certain criteria to be able to invest in the constituents of the Hang Seng LargeCap Index and the Hang Seng Composite MidCap Index and all H shares in the indices which have a corresponding A share listed in Shanghai.
The Scheme also allows Hong Kong and international investors to trade eligible shares in Shanghai. These will be constituents of the SSE 180 Index and SSE 380 Index plus any shares not in these indices but which have corresponding shares listed and traded in Hong Kong.
The Scheme is designed to achieve the full benefits of a free and open trading market while maintaining adequate risk management controls and enjoying full government support. All trades will be done in Renminbi and the government hopes that the expected flow of the currency will provide a healthy and significant offshore system and should be a step towards the internationalisation of the Chinese currency.
The Chinese have accepted that their companies will have to meet the listing requirements and standards of reporting in Hong Kong before being traded there and will regulate them to that end. Both exchanges will share the revenue generated and will have the same rights and obligations so that both sides have a huge incentive to cooperate thus ensuring that the home investors are adequately protected against market misconduct in the originating market. Total trades will be subject to a maximum daily quota so that trades will be dealt on a first come first served basis. When the scheme has settled in, these restrictions are expected to be phased out.
The introduction of this scheme in the autumn of this year will ensure that Hong Kong is the centre by which China enters the international financial arena. It will enable Mainland investors to gain a wider diversification in their portfolios and will enable international investors to gain direct access to Mainland companies.
The scheme has been received with enthusiasm in China and Hong Kong. Currently, 90 brokers or 91% of those that are eligible in Mainland China have applied to join the pilot programme. There are also 215 or 43% of eligible Hong Kong brokers that have applied for the programme.
Chinese investors in stocks on the Hong Kong exchange will have to pay stamp duty on the transactions but should not be subjected to other Hong Kong taxes. Currently, they are exempt from paying Individual Income Tax on the disposal gains of shares listed in Shanghai and Shenzhen and through the Qualified Domestic Institutional Investor Scheme when investing in Hong Kong. It is not yet clear that the same will apply on the disposal gains and dividend receipts of overseas stocks.
For overseas investors in Chinese A shares it is not clear whether or not the taxation rules which have applied to institutional investors that have had limited access to the A shares through the Qualified Foreign Institutional Investor Programme currently will apply under the Scheme. Under these rules dividend income and disposal gains are subject to Chinese income tax as it applies to corporates and investment income tax as it applies to individuals. It is also not clear if withholding tax will apply as the shares will be held in a nominee name within the Hong Kong clearing company. All these issues are yet to be resolved ahead of the expected launch in October this year.
The main reason for the introduction of this scheme is to widen the internationalisation of the Renminbi. As the second largest economy in the world and likely to be the largest in a few year’s time the currency should be easily used for trade outside of China. The currency is managed by the Chinese authorities to be maintained within a narrow range against the Dollar and this is unlikely to be changed in the short term as it allows for the currency to be managed to the benefit of China. This action gives the currency gradual exposure to the impact of the market without taking away this control. For individuals within China it gives them the ability to gain exposure to assets outside China.
For overseas investors this action will enable those who manage a Chinese portfolio to gain wider coverage, a more directly diverse portfolio with the knowledge that they can be confident in the standards of reporting and corporate governance that they understand is there. High net worth individuals will also be able to gain direct exposure to individual companies in China.
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