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The exchanges will forge links bringing the mainland and the outside world closer together

China’s Hong Kong and Shanghai stock exchanges are poised to build a major new link that will open up mainland China’s capital markets to foreign investors and vice versa.

A pilot programme was announced by Chinese Premier Li Keqiang in a keynote speech at the Boao Forum for Asian Annual Conference 2014 this week.

Called the Shanghai-Hong Kong Stock Exchanges Connectivity Mechanism,  the link will allow traders on either exchange to entrust local brokers to trade eligible shares listed on the other’s market through an order-routing service to be provided by the two exchanges.

Clearing institutions of both sides will establish a direct link for cross-boundary clearing. Each will become the other’s clearing participant and provide clearing services for the pilot programme as a nominal holder of the stocks to be purchased by investors of both sides.

“We will actively create conditions to establish a Shanghai-Hong Kong Stock Exchanges Connectivity Mechanism, and further promote two-way opening-up and sound development of the capital markets in China’s Mainland and Hong Kong,” said Premier Li Keqiang.

The idea is to introduce international investors to the Shanghai market and bring in more foreign capital. The SSE will negotiate with relevant parties for reaching cooperation agreements on trading and clearing as soon as possible and make preparations for relevant rules, business lines, and technologies, with an aim to officially launch the business of the SHSECM pilot program within six months.

The move is being promoted as an important breakthrough in opening up the tightly-controlled and restricted mainland China market to international investors. It is also seen as an important way to realise the goal of promoting two-way opening-up of the capital markets, which was put forward by the Central Committee of the ruling Communist Party of China in 2012.  The plan is for the project to help push the development of the capital markets in mainland China and Hong Kong and to support the ongoing internationalisation of China’s official currency the renminbi.

“The programme is not only a major breakthrough for the opening up of China’s capital markets but also a great milestone for the development of Hong Kong as an international financial centre,” said C K Chow, chairman at HKEx.  “Hong Kong will again act as a bridge connecting the Chinese economy and the rest of the world.

“We believe that this development would pave the way for the further opening up of Mainland China’s capital markets and help promote the internationalisation of Renminbi,” added Charles Li, chief executive at HKEx. “We also believe this development would provide a new opportunity and create momentum for the further development of the Hong Kong capital market.”

The China Securities Regulatory Commission and the Securities and Futures Commission of Hong Kong have already approved the project in principle. The project will be led by the SSE, HKEx and the China Securities Depository and Clearing Corporation.

Access to China is currently tightly regulated. Foreign investors are required to register under the qualified foreign institutional investors scheme, which operates under a quota system closely guarded by the state. Relatively few licences have been granted in recent years. Direct investment in China shares is closely controlled and restricted, and companies must have a subsidiary based in China before they can make direct investments.