It is hard to overstate the significance of the Hong Kong Shanghai Stock Connect. For the first time, investors can directly trade between the two markets and international investors can access China in a new, flexible way. It represents nothing less than a huge leap in the opening up of Chinese capital markets.</p> Stock Connect launched on 17 November 2014 to a great fanfare. This was a breakthrough initiative linking two major bourses to create one of the largest stock markets in the world. Two very different trading and clearing systems had to be brought into one, presenting challenges for service providers and participants alike. The rollout of the project moved fast as regulatory approvals were granted and short timelines were met. Since launch, the project has continued at a rapid pace and we have seen a flow of continued improvements in the wake of market response.</p> It is also worth remarking that there have been no major issues to date – problems have been tackled and the dialogue between market participants and the regulators has been productive. This mutual willingness has demonstrated the commitment from all sides to make Stock Connect successful and a key tool for the international investment community.</p> The programme has an initial quota in terms of the daily flows allowed both northbound and southbound to manage the levels of transactions, and some market commentators have said that take-up has been slow.</p> But this sentiment seems misplaced. With the previously launched methods of investing into China, QFII (Qualified Foreign Institutional Investor Scheme) and RQFII (Renminbi Qualified Foreign Institutional Investor Scheme), quota systems took a long time to fill. These are new and evolving methods for investors to understand and for home regulators to become comfortable with.</p> We are starting to see the optimistic view being proved right as more investors start participating from Hong Kong, and on 8 April 2015 the daily quota from Shanghai was used up for the first time on a surge of positive sentiment, doubling the previous high-water mark.</p> Who is benefiting so far?</strong></p> In the short term, alternative investment funds, having slightly easier mandates, have adapted quickly to the new changes and seized the opportunities. Certain stocks have also spiked as investors spotted opportunities to arbitrage on valuation differentials between A and H shares. The pick-up in flows from China brought the Hong Kong market to seven-year highs in April, but the volatility of this is yet to be witnessed.</p> Given the significance of the project and the pace of change, the odd bump in the track is only to be expected. One such bump is the issue of beneficial ownership: Stock Connect transfers shares from the seller for a delay without payment, which presents a trade risk. This is causing issues for some potential investors and their in-house processes, and is currently under market discussions.</p> But it is extremely encouraging that the regulators are doing everything necessary to iron the bumps out. This was seen to good effect in providing exemption on the mainland’s withholding tax for Hong Kong investments to bring it in line with the wider market.</p> As the weeks go by, investors are gaining a better understanding of the system and becoming more comfortable with using it. More new clients are coming on line and the prevailing trend is for fund managers to use the investment quota permitted through Stock Connect as a complement to their existing QFII or RQFII quotas; the new programme is a versatile tool to enhance returns by balancing options for investment in Chinese markets.</p> What can we expect next?</strong></p> Shenzhen stock exchange will be connected to the initiative in the near future, possibly as early as November 2015. This will open up the stock available dramatically and provide new investment options as the Shenzhen stocks are predominantly tech sector or ‘new China’; a developing sector of smaller cap stocks likely to attract different types of investor.</p> The idea of a ‘bond connect’ is also being considered. While doubtless presenting challenges in implementation, this would be exciting in terms of access to the huge onshore debt market.</p> The inclusion of China in the MSCI index was debated but has not yet won approval. However, the MSCI review might have influenced others as now The FTSE Group will include China in two indices. The FTSE Emerging Markets China A Inclusion indices could mean major change for the fund management industry, and would see significant allocation for benchmark purposes.</p> And given that the big question for index providers last year was whether to include Chinese A-shares, the indications are we will soon see more exposure to domestic Chinese stocks. There are three main reasons for this: the growing size of the market; its increasing openness; and the increasing internationalisation of the Yuan Renminbi.</p> As a result, Chinese capital markets will continue to open up, facilitated by the steady, successful launch of Hong Kong Stock Connect. </p>