The Chinese authorities’ efforts to contain leverage and reduce risk across the nation’s financial system took another step forward overnight with the ban on approvals for mutual funds that plan to allocate more than 80% of their portfolios to Hong Kong stocks. This looks like a response to surging capital flows into the territory from the mainland and the equity market euphoria in Asia, which saw the Hang Seng index cross the 30,000 mark last Wednesday for the first time in 10 years. As we noted in “Very Close To Irrational Exuberance: Asian Equities Break Above All-Time High As Hang Seng Clears 30,000”.
Ongoing southbound flows from the mainland exchanges in Shanghai and Shenzhen – via the connect trading scheme – helped to propel the rally.
The South China Morning Post has more:
China’s securities regulator will suspend the approval of new mutual funds that are meant for investing in Hong Kong’s equity market, putting a temporary cap on southbound capital that has boosted the city’s benchmark stock index to a decade high.
Chinese mutual funds which plan to allocate more than 80 per cent of their portfolio to Hong Kong-listed equities will no longer be approved for sale on the mainland, according to two state-owned funds familiar with the matter, citing an order by the China Securities Regulatory Commission. Only funds that allocate less than half of their portfolio to Hong Kong will be approved, the funds said, echoing a Monday report on the China Fund website, an industry news site.
The Chinese regulator ‘s latest instruction reflects the concern that Hong Kong’s key stock benchmark has risen too much too quickly to a level that was last attained in 2007, before the global financial crisis a year later caused the Hang Seng Index to plunge 33 per cent, and wiped out billions of dollars of value.
As the SCMP notes, the “Connect schemes” linking mainland stock exchanges to Hong Kong have led to a $100 billion inflow into Hong Kong equities so far in 2017.
Before this year, Hong Kong’s stock market was Asia’s cheapest in price-earnings terms, trading on average at less than 12 times historical earnings. With the introduction of the so-called Connect schemes -- whereby the stock markets of Shenzhen and Shanghai were linked to Hong Kong, allowing investors to trade in all three markets -- southbound funds from mainland China had been flooding into the city’s bourse in search of bargains.
Investments of Hong Kong stocks by mainland Chinese funds ballooned to HK$808.8 billion (US$103.6 billion) as at October 31, a 60-fold increase compared with 2014 before the first of the two Connect schemes was introduced, according to the Hong Kong Stock Exchange’s data.
The Hang Seng Index has risen almost 38 per cent this year to a decade high of 30,003.49 on November 22 , advancing 4.4 per cent in the past month alone to become the world’s 10th-biggest gainer among 96 indexes tracked by Bloomberg. Among major indexes, it was the second biggest winner, behind only the 4.7 per cent gain in the Nikkei 225.
The article speculates that Chinese regulators are concerned by the lack of circuit breakers on the Hong Kong exchange.
That is raising concerns among Chinese policymakers that any correction in Hong Kong would trap Chinese investors, particularly since the city’s market lacks the kind of 10 per cent limit down circuit breaker found in Shanghai and Shenzhen to limit single-day losses.
The Hang Seng was down marginally at 29,680, having traded as low as 29,365 earlier in the session. As we discussed overnight, there was a brief halt in the rout in mainland equity markets when trading opened on Tuesday, but Chinese indices reversed course on reports that some funds were being banned from selling more shares than they bought on the day.
However, that wasn’t the end of the story as the National Team road to the rescue as customary late in the session sending the Shanghai Composite up 0.3% on the day to 3333.7, having traded as low as 3301.4. As Reuters notes, markets are getting a “wake-up call from China’s post-congress deleveraging moves”.
The pace at which Beijing is announcing deleveraging reforms following last month’s Communist Party Congress is a wake-up call for investors in Chinese markets: risk just got real. Sweeping new rules for the asset management industry, a crackdown on micro loans and losses imposed on the creditors of the state -owned Chongqing Iron & Steel are not yet a “Big Bang” of reforms.
Some of the measures were well flagged and will only kick in 2019. But they are sending a signal to markets that policymakers are serious about deleveraging, something that has been urged by the International Monetary Fund and ratings agencies for years and flagged as a top priority by President Xi Jinping at the party congress.
Some of the measures were well flagged and will only kick in 2019. But they are sending a signal to markets that policymakers are serious about deleveraging, something that has been urged by the International Monetary Fund and ratings agencies for years and flagged as a top priority by President Xi Jinping at the party congress.
Still, Chinese authorities appear more determined in their reforms than the markets appreciate and measures taken today are another example. Meanwhile, investors have become complacent with regard to the risks from unraveling some of the worst abuses – Ponzi schemes in the $4 trillion wealth management products sector, for example. As we noted in “Chinese Stock Rout Resumes As Top Fund Sees "High Probability" Of Bond Carnage”.
Our sense is that the cascading, "snap sell-offs", such as the one seen overnight in China, are going to get worse before they get better, and equities will increasingly be drawn into the mix.
Finishing on a slightly more upbeat note, shares in China's biggest liquor company, Kweichow Moutai, saw their first daily rise since China’s state-run Xinhua news agency said on 16 November that the share price had been rising too fast - still it's more blatant evidence of intervention. We suspect that even China's central planners will struggle to micro-manage an orderly unwind.