China Pushes for Arbitrage Cap on London Stock Link

(Bloomberg) -- China wants to impose restrictions on the London-Shanghai Stock Connect that would help authorities curb capital outflows but may reduce the program’s appeal to investors, people familiar with the matter said.

The proposed restrictions would limit investors’ ability to swap a dual-listed company’s shares in one market with those in the other, a feature known as fungibility, the people said, asking not to be identified because the discussions are confidential and no final decisions have been made. Fungibility was a key selling point in a London Stock Exchange Group Plc presentation outlining plans for the connect in May.

While other countries have similar restrictions and there’s no indication that China’s proposal will derail plans for the connect to start this year, limits on fungibility would likely dampen interest in the project. The rules would, under certain circumstances, make it harder for investors and arbitragers to react when prices in one market drift too far away from those in the other. A lack of fungibility is one reason why dual-listed stocks often trade at wildly different valuations on exchanges in Hong Kong and mainland China.

China’s proposal highlights the balancing act faced by authorities as they try to boost the country’s integration with global financial markets without giving up control over cross-border money flows. While a government clampdown has helped stem three years of capital flight, China’s slowing economy and trade war with the U.S. have fueled concerns of a renewed exodus in recent weeks.

The China Securities Regulatory Commission and the Shanghai Stock Exchange didn’t reply to requests for comment. LSE Group declined to comment.

In the works since at least September 2015, the London-Shanghai connect will allow companies from China to sell global depository receipts in the U.K. and enable London-traded firms to list similar securities in Shanghai, according to an LSE presentation seen by Bloomberg News.

The main beneficiaries of the proposed link will be fund mangers whose mandates restrict them to investing in London-traded securities, said Danny Dolan, a managing director at China Post Global, the international asset-management unit of China Post & Capital Fund Management Co.

The CSRC wants to be able to suspend share swaps between the two markets if the depository receipts of a London-listed Chinese firm move outside a certain price range relative to the company’s Shanghai shares, the people said. The regulator is also pushing for a quota system that caps the amount of shares traders can exchange between the two markets over a set period, they said, adding that talks on the rules are still ongoing.

Chinese regulators want the inflows without accompanying capital-outflow risks, but they can’t have it both ways, said Fraser Howie, who has two decades of experience in China’s financial markets and co-authored the book “Red Capitalism.” Any move to restrict the exchange of shares between the two markets would deter investors, Howie said.

For Shanghai and Shenzhen’s trading links with Hong Kong, capital outflows aren’t an issue because the systems employ a “closed loop” architecture where trades are closed out in the currency where the investor account is held. For example, a trader in Shanghai who sells a Hong Kong-listed stock would collect the proceeds in yuan.

©2018 Bloomberg L.P.