Rickety rails

ZHOU LIBO, a famous Shanghai comedian, spoke for many long-suffering investors when he observed that the Chinese word for stockmarket, gushi, ought to be reversed. As shigu, it sounds more like the word for accident. Since peaking seven years ago, Chinese shares have been among the world’s best means of separating investors from their wealth. The main stock index, consistently one of the worst performers in Asia, is nearly two-thirds below its 2007 high even after a recent rally. Insider trading is rampant. Fund managers with strong track records elsewhere trip up in China. Many locals have given up on stocks altogether.

Despite all these horrors, global investors still hunger for Chinese shares. Foreigners willing to chance it have had few opportunities to do so due to China’s strict capital controls. That will begin to change in October when the Hong Kong and Shanghai stockmarkets launch a scheme called Shanghai-Hong Kong Stock Connect or “the through-train”. It will allow any foreign investor, from hedge funds to day traders, to buy and sell stocks listed in China directly for the first time. Valuation gaps between shares listed in Hong Kong and Shanghai have narrowed in anticipation (see chart). The Chinese units of global brokers say the demand for their services has increased dramatically as their customers request information about obscure firms listed in Shanghai. “Theoretically, all of our clients can now invest in China,” says Yang Xia of UBS, a Swiss bank.

There will be big speed bumps. Quotas will cap the flow of funds from Hong Kong to Shanghai at 13 billion yuan ($2.1 billion) a day and at 300 billion yuan in total. From Shanghai to Hong Kong, the ceilings will be 10.5 billion yuan a day and 250 billion yuan in all. But these limits are net, so when one investor sells, another can buy. Trading volumes can thus exceed the caps, and probably will, especially from Hong Kong to China. Any investor with a brokerage account in Hong Kong can participate.

Until now, the only foreigners with access to Chinese stocks were institutional investors such as pension funds, and only with special approval. They have been subject to strict individual quotas and have had trouble getting their money out again because of the capital controls. China’s financial reforms are often touted as steps towards the freer movement of capital; the through-train is a bigger one than most. If all goes well, a similar through-train could connect Hong Kong and Shenzhen, where more of China’s start-ups are listed.

But investors who dare to catch a ride will struggle with the many oddities and dysfunctions of the Shanghai market. The Chinese government has for years failed to clarify whether foreigners should pay capital-gains tax. Administrative controls are heavy-handed: stocks cannot be bought and sold on the same day, and regulators determine the timing of initial public offerings. Individuals account for 80% of stock turnover and institutions just 20%, the opposite of most markets in the rich world; this can make for a wild ride. Corporate governance is often appalling. Chinese officials hope the through-train will bring more professionalism to its stockmarket, which is another way of saying there are lots of derailments at present.