All About the U.K.-China Plan to Link Stock Markets

(Bloomberg) -- The U.K and China are planning to link their stock exchanges. The London-Shanghai Stock Connect, as it will be known, will allow companies listed on one venue to issue shares on the other. It’s the latest cross-border push by China to increase access to its financial system and broaden the reach of its companies and currency. But don’t expect a surge in late-night trading.

1. So it’s not a trading link?

Correct -- time zones and rule differences make that all but impossible. The tie-up between the London Stock Exchange and the Shanghai Stock Exchange will, however, give Chinese companies the ability to raise capital in Europe’s largest equity market. London-listed companies will be able to issue shares, but not raise fresh capital, in China. Both sides have said it will start in 2018.

2. Which companies will use it?

That’s the big question. To date, the shortlist of possibles was headlined by Huatai Securities Co., China’s No. 3 brokerage by market value. It’s planning to sell at least $500 million of global depositary receipts, or GDRs, in London. (GDRs are types of bank certificates that are backed by a domestic share of a foreign company). Bluestar Adisseo Co., an animal-nutrition firm, was also said to be weighing a London listing. While there are no confirmed U.K. listings heading eastbound, Goldman Sachs Group Inc. analysts expect some blue-chip brand names with a long trading history to take up the opportunity.

3. Why does China want stock links?

Its strict capital controls limit the funds that people and companies can move in and out of the country. Access to its financial markets is possible only through official channels such as trading links and investment quotas such as the Qualified Foreign Institutional Investor program that began in 2002. China’s flagship link is its stock connect with Hong Kong that opened in 2014. That tie-up allowed investors to trade mainland-listed stocks through Hong Kong, and vice versa. A similar link that opened in July 2017 permits investors to buy Chinese bonds through Hong Kong, though not the other way around.

All About the U.K.-China Plan to Link Stock Markets

4. What will the London-Shanghai Connect mean for investors?

That’s another big question. For Chinese traders and fund managers, it’s a chance to buy into some globally renowned companies and broaden their investment universe. The appeal to investors in London is less clear, since many companies that will list in the U.K. are already available to buy through the Hong Kong link. That said, there is a draw for U.K. fund managers who are restricted to purchasing London-listed stocks. Index compilers MSCI Inc. and FTSE Russell have recently warmed to mainland-listed shares, which should translate into higher demand from funds in London. If the link succeeds, it could serve as a template for projects between China and other markets. To be sure, Germany’s China Europe International Exchange has seen only light trading in Chinese-linked securities.

5. What are the rules?

The connect is restricted to shares in companies with a market value of at least 20 billion yuan ($2.9 billion). U.K. candidates must have been listed for at least three years and will be able to issue depositary receipts in Shanghai, according to Chinese state-run media. Chinese investors with a minimum 3 million yuan in securities and fund accounts will be able to buy the U.K. GDRs. As for Chinese companies seeking to raise funds from new shares in the U.K., they will be allowed to issue a maximum 15 percent of their share capital.

6. What about China’s capital controls?

There will be constraints, such as a cap on the number of GDRs a company can issue. Investors looking to swap London-listed depositary receipts for company stock in Shanghai won’t be allowed to for at least six months after a new listing. And conversions will be subject to as yet undefined quotas, according to draft rules from Chinese regulators. The limits stem from China’s desire to keep its capital controls in place and not have investors freely exchange yuan-denominated shares for stocks in another currency, according to Fraser Howie, author of “Red Capitalism.” However, any move to restrict the exchange of shares between the two markets would deter investors, Howie said.

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