[HONG KONG] Hedge funds may drive initial demand for Shanghai-listed stocks through a linkage of the city's bourse with that in Hong Kong, which opens up a new route for foreign investors to buy Chinese shares, according to Goldman Sachs Group.
The link will tap into pent-up demand from hedge funds to buy yuan-denominated class-A shares traded in Shanghai, said Shane Bolton, head of Asia prime brokerage at the New York-based bank. Long-only managers may grapple with pre-requirements that are different from their usual practice at the beginning, he added.
Foreign investors so far can only buy yuan shares listed in Asia's second-largest stock market through the qualified foreign institutional investors, or QFII, and the renminbi QFII programmes. The link, set to start next month, will allow investors, with or without their own QFII licences, to buy as much as 13 billion yuan (S$2.7 billion) of Shanghai-traded yuan stocks a day, according to a Sept 4 statement posted on the Hong Kong stock exchange's website.
"Stock connect will be a game changer for most hedge funds, allowing them to access A shares for the first time without having to use banks' QFII quota," Mr Bolton said.
Few hedge funds have been able to win their own QFII licences, which are typically reserved for long-term investors such as mutual fund managers, endowments and sovereign wealth funds. Instead, hedge funds have been borrowing QFII quotas from banks to buy A shares with such quotas in short supply when demand is high.
Shanghai-listed stocks accessible to foreign investors through the link will account for about 90 per cent of the bourse's total market value and 80 per cent of average daily turnover, according to a May presentation posted on the Hong Kong exchange's website.
Investors have been betting the link will help narrow the pricing gap between the two exchanges. The Hang Seng China AH Premium Index advanced to a high of 97.7 in May after the plan's initial announcement. The gauge trades at 100 when prices between dual-listed shares are equal and has averaged 95.5 in the year to Sept 19.
"We have seen an increase of interest in A shares after stock connect was announced in April," Mr Bolton said. "The interest is coming from both relative-value funds keen to exploit the price differences between A and H shares, and also fundamental stock pickers."
The bourse connect rules require an asset manager to transfer shares held in a custodian bank account to the broker the day before a sell order is executed, according to information posted on the Hong Kong exchange's website.
In most other markets, long-only managers can have the securities delivery and payment between the custodian bank and the broker done on the settlement day, after the trade has been executed. Long-only managers may struggle with the rule in the beginning, as it may signal to the market their sell intention.
Hedge funds are spared the problem by using prime brokers that can act as custodian and execute trades, as well as providing synthetic products, said Mr Bolton. Synthetic products are created artificially to simulate another instrument. For example, a synthetic stock can be created with simultaneous trades of call and put options.
China has granted US$59.7 billion of QFII quota to 254 financial institutions, according to an Aug 26 update posted on the website of the State Administration of Foreign Exchange. Goldman Sachs has US$300 million of QFII quota and holds another US$600 million quota through its asset management arm. - Bloomberg