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Hong Kong gets a shot in the arm as China's offshore financial hub with new products and deeper yuan pool in expanded Connect scheme

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Hong Kong widened its cross-border investment channel with Shanghai and Shenzhen with two new classes of financial products on Monday, elevating the city's status as mainland China's offshore capital hub.

The ETF Connect formally kicked off, allowing global investors to tap 83 exchange-traded funds (ETFs) in China - 53 in Shanghai, 30 in Shenzhen - via accounts held in Hong Kong, an opening that may attract up to 200 billion yuan (US$29.8 billion) of investments within one to two years, according to a forecast by China Asset Management.

Separately, the monetary authorities of China and Hong Kong said they would establish a Swap Connect for global investors to hedge the risks of 3.7 trillion yuan of offshore bonds held by them. The swap will debut at the end of 2022 at the earliest, with interest rate swaps for users to exchang one stream of future interest payments for another, according to a joint statement by the financial and monetary regulators of China and Hong Kong.

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The expansion of the Connect scheme, hot on the heels of the 25th anniversary of Hong Kong's return to Chinese sovereignty three days earlier, is one of the clearest signs of the city's indispensable role as China's offshore financial hub. Hong Kong is the crucial stepping stone for Chinese companies and investors to tap overseas funds, and provides a gateway for global capital to get into China, the world's second-largest economy and capital market.

John Lee Ka-chiu spoke during his swearing-in ceremony as Hong Kong's Chief Executive on July 1, 2022. Photo: Bloomberg alt=John Lee Ka-chiu spoke during his swearing-in ceremony as Hong Kong's Chief Executive on July 1, 2022. Photo: Bloomberg>

"The world is going through seismic changes unseen in a century, but times is on our side, and this is the foundation for our perseverance, determination and confidence," Hong Kong's Chief Executive John Lee Ka-chiu said during an online seminar to mark the fifth anniversary of the Bond Connect programme. "In the progress of [Hong Kong's development] into an international financial centre, we [witnessed] the fact that China's steady development is the most solid support [for] Hong Kong."

The Connect programme began in 2014 as the brain child of Hong Kong's former stock exchange chief Charles Li Xiaojia, giving global funds access to mainland China's yuan-denominated stock market. It also allowed Chinese institutions and professional investors the ability to invest in stocks listed in the Hong Kong stock market.

Julia Leung Fung-yee, deputy chief executive officer of Hong Kong's Securities and Futures Commission (SFC) at the SFC's office in Quarry Bay on 21 September 2021. Photo: Jonathan Wong alt=Julia Leung Fung-yee, deputy chief executive officer of Hong Kong's Securities and Futures Commission (SFC) at the SFC's office in Quarry Bay on 21 September 2021. Photo: Jonathan Wong>

Over the years, the Connect programme grew in size, geography and variety, expanding into the Bond Connect in 2017, the Shanghai-London Stock Connect in 2019, wealth management products last year, and now ETFs and swaps.

"Hong Kong is a place of convenience, [where] investors can invest knowing they are meeting the regulations of China," without being physically on the mainland, said Julia Leung Fung-yee, the deputy chief executive officer of the Securities and Futures Commission (SFC), during an online forum to mark the anniversary of the Bond Connect programme.

The stock markets were mixed after the various Connect programmes were announced. Hong Kong's benchmark Hang Seng index closed the day 0.1 per cent down, after crawling its way out of a 1.8 per cent decline. Shanghai's key gauge rose 0.5 per cent while Shenzhen's major index rose 1.2 per cent.

An ETF is a basket of underlying securities, including stocks, commodities and other asset classes, that investors can buy and sell on an exchange like an ordinary stock.

The ETF Connect will attract long-term funds to China's financial markets, creating the kind of depth and counterweight to short-term capital flows and volatile sentiments, said Xu Meng, executive director of quantitative investing at China Asset Management, which has 10 ETFs included in the first 83 funds eligible for overseas investment.

"It will benefit international asset managers as they usually use ETFs as a tool to optimise liquidity in funds," said Xu, adding that offshore investors tend to include ETFs in their portfolios, as they have better liquidity and more diversified risks compared with investing in a single stock.

A total of 694 ETFs valued at 1.5 trillion yuan trade in Shanghai and Shenzhen, with the offerings having grown 30 per cent last year, according to data from Shenwan Hongyuan Group and Huachuang Securities. That compares with the total market capitalisation of 84 trillion yuan for China's onshore market.

Hong Kong's ETF market is much smaller, hosting only 150 such funds with HK$405.9 billion (US$51.7 billion) in assets under management, according to data provided by Huaxin Securities.

The Swap Connect is a vital enhancement to help investors hedge against risks in the bond market. Global investors have increased their holdings of China's yuan-denominated onshore bonds by 40 per cent every year since 2017 to 3.7 trillion yuan, said Pan Gongsheng, deputy governor of the People's Bank of China (PBOC), during the Bond Connect seminar.

"In today's volatile market and tense geopolitical situation, people are looking to China's very stable economic policy that aims to create a very stable environment," said Jimmy Jim, head of global markets at ICBC (Asia) Limited. "This is very important to the investor - they can better predict what is happening and lower market risk"

It will kick off through the so-called northbound trade, allowing global investors access to China's financial derivatives market through a connection between the clearing houses in both China and Hong Kong.

The timetable for the southbound leg, which will enable mainland investors to access the Hong Kong financial derivatives market, was not immediately clear.

Hong Kong also received a shot in the arm in its role as the world's largest offshore trading hub for the renminbi. The Chinese central bank upgraded its currency swap facility with Hong Kong to a permanent agreement, and expanded the size by 60 per cent to 800 billion yuan.

The move, the PBOC's first standing swap agreement, is aimed at providing long-term liquidity support to the Hong Kong market, help stabilise market expectations and promote the city's development of its offshore yuan market, the central bank said.

Renminbi-denominated investment "is attractive for many reasons," and the volume of China-related investments "will continue to grow ... in the medium to long term" despite the Covid-19 pandemic, said Orient Securities Company Limited's president Lu Weiming.

"China has kept its policy focused on national development, [so] the renminbi's exchange rate remained stable compared to other emerging market currencies," Lu said. "The renminbi can better meet the needs of investors for asset management."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2022 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2022. South China Morning Post Publishers Ltd. All rights reserved.