Brace yourselves.
China’s about to open its “Wild West,” tech-heavy stock market to the world.
Last Friday, Beijing announced that the Shenzhen-Hong connect will go live on December 5. The link will give international investors access into China’s smaller, tech-heavy Shenzhen exchange.
Authorities toyed with the idea of launching the link last year, but the plan was delayed following the August 2015 market crash – back when China’s currency, the renminbi, was devalued.
The Shenzhen connect follows the November 2014 launch of the Shanghai-Hong Kong stock connect, which allowed international investors to access China’s larger Shanghai exchange.
Notably, the Shenzhen exchange is a bit of a wild card and is the second busiest in the world - despite being only the 7th largest. Most of the firms listed are small and unknown and their overall valuations are higher than those in Hong Kong, making them more expensive. Plus, the exchange is reportedly known for speculative trading.
China's cabinet originally approved plans for the Shenzhen link back in August, although, at the time, analysts were not expecting a huge inflow of funds.
The recent weakness of the yuan versus the US dollar "may temporarily deter foreign (dollar-based) investors' interest in the A-share market on FX loss concerns," a Goldman Sachs team led by Kinger Lau wrote in a note. "Also, Shenzhen A-shares are relatively less covered by foreign brokers than those in Shanghai, which is a key input into the international investors' stock selection process."
"The Connect will benefit Hong Kong stocks more, because more money will flow southward due to yuan depreciation worries, and the huge discount Hong Kong small-caps enjoy," David Dai, a Shanghai-based investors director at Nanhai Fund Management Co. told Reuters on Monday.
An interesting angle to the Shenzhen connect's inauguration is the timing: the link will be going live at a time when China struggles with ongoing capital outflows and a weaker renminbi.
"There are undoubted pressures on the capital account as the leakage from outflows caused by both a strong dollar and expectations of further RMB weakness, so the authorities are probably quite keen to open access to its capital markets through the connect and similar to the reason why the yuan's assimilation into the IMF's SDR occurred so quickly," a Jefferies team led by global equity strategist Sean Darby wrote in a note.
Notably, there will be a daily quota on the Shenzhen link: international investors can trade up to 13 billion yuan per day of A-shares in Shenzhen stocks, while mainland investors can trade up to 10.5 billion yuan per day of Hong Kong stocks, according to Jefferies.
Zooming out for the bigger picture, the decision to move forward with the Shenzhen exchange is seen as another play by China to slowly intermingle with global markets and to further advance its currency on the international stage. But it also happens to follow MSCI Inc.'s June decision to delay including China's domestic equities in the MSCI Emerging Markets Index for the third time.
At the time, Remy Briand, MSCI Managing Director and Global Head of Research, said that China had taken significant steps in "addressing the remaining accessibility issues [but] international institutional investors clearly indicated that they would like to see further improvements in the accessibility of the China A shares market before its inclusion in the MSCI Emerging Markets Index."
In other words, investors were still uncomfortable putting their money to work in China, at least in regards to concerns about accessibility.
And now, the Shenzhen connect could bolster the argument for including China's A-shares on global equity benchmarks, a Goldman Sachs team led by Kinger Lau argued in a note.
It's worth adding that there are differences between the Shenzhen link and the Shanghai link. While the Shanghai exchange is home to state-owned-enterprises - or SEOs-, financials, and energy, the Shenzhen is tech-heavy, and includes consumer-related and healthcare companies. (As an interesting side note: this somewhat mimics China's agenda of moving from and investment-based economy to a consumption-based one.)
This "could generate greater enthusiasm from international investors," argued a Societe Generale team led by Frank Benzimra, the head of Asia Equity Strategy, in a note to clients. Moreover, "there are fewer dual listed companies, which were not attractive value propositions at the time of the Shanghai connect launch due to the premium at which these stocks traded versus their offshore peers."
However, other analysts remain skeptical that the move will actually grab investor attention in light of China's overall economic slowdown. Plus, the fact that the exchange is known for speculative trading has kept some investors feeling "wary," according to the Wall Street Journal's Anjie Zheng.