HONG KONG’S Exchange Square was rainswept and deserted last Tuesday night. Inside the exchange, however, over 100 reporters turned up to hear chief executive Charles Li talk through the go-ahead of a trading link with Shenzhen.

The Shenzhen Connect was duly splashed across local front pages on August 17. Stock trading is important in a city where 20pc of turnover is still generated by retail investors, and banks display live quotes outside their branches. For international investors, the Shenzhen link’s significance lies in opening access to a range of mainland companies considered far more exciting than much of the Shanghai market.

All three bourses were subdued in early trading last Wednesday as profit-taking set in after a rally in anticipation of the news, which lifted Shenzhen and Shanghai to their best levels since January and Hong Kong to its highest in nine months.

Hong Kong trading connection points to Beijing’s confidence as international buyers hover

Analysts, meanwhile, were looking at the broader implications. “The extension of connect to Shenzhen effectively creates the second-largest equity market by market cap and the largest by cash turnover globally,” said Kinger Lau at Goldman Sachs. “It offers international investors almost full access to the A-share market through Hong Kong.”

The timing of the announcement, including a statement from Chinese premier Li Keqiang, also suggested confidence by Beijing in its control of its markets and capital account after a year in which outflows surged and its market ructions triggered global turmoil.

“At the beginning of this year there was a lot of pressure on foreign exchange and the capital outflow was serious,” said Ming Ming, chief analyst at Citic Securities. “This situation is now starting to stabilise. . . so the pressures of capital outflows are not as high, which makes it a good time to launch [this].”

The link, due to be operational by year end, will add 880 companies to the 567 already available to northbound investors through the Shanghai link that opened in 2014. Combined, the connects will cover about 70pc of mainland market capitalisation.

Mainlanders trading southbound will have access to 417 Hong Kong-listed stocks; a third more than now as small-caps will be added. Southbound flows through the Shanghai Connect have totalled almost Rmb100bn ($15bn) so far this year, according to HSBC, helping narrow the premium of mainland A-shares over their Hong Kong H-share counterparts to about 25pc this week, the lowest since October.

Exchange traded funds are due to be added to the connect schemes in 2017, providing mainland investors their first direct exposure to global markets.

The current cap on aggregate quota for the Shanghai Connect was abolished on Tuesday. The Shenzhen southbound route will be subject to the same Rmb10.5bn daily limit as is Shanghai, although in effect that doubles the flow able to reach Hong Kong.

Strategists were busy publishing lists of stock suggestions yesterday, with key ideas involving picking Shenzhen names familiar to international investors and small-caps in Hong Kong likely to appeal to mainland money.

Dual-listed mainland companies have long traded at a discount offshore and valuation gaps are more obvious between Shenzhen and Hong Kong than with Shanghai.

The smaller they are, the higher the average premium, according to Citigroup. Some, such as Weichai Power, a car parts maker, trade at only a 6pc premium in Shenzhen compared with Hong Kong. But others are much higher, such as Zhejiang Shibao, maker of car steering systems, which trades at four times its offshore valuation.

The link will also open access to the 200 stocks listed on ChiNext, the start-up bourse.Those stocks, however, will be available only to fund managers for the time being. Nonetheless that leaves 700 stocks in Hong Kong and Shenzhen for investors.

Published in Dawn, Business & Finance weekly, August 22nd, 2016