Hong Kong-Shanghai Arbitrage Is Broken in Stock Market

Chinese stock arbitragers are backing away from the Hong Kong-to-Shanghai price convergence trade.

While the markets’ valuation difference narrowed more than 4 percent in the first month after officials said April 10 that they would link share trading in the two cities, it has since widened to levels last touched before the agreement.

With the change not expected to take effect until October, Shenyin & Wanguo Securities Co. and Principal Global Investors say it’s too early to bet prices will converge.

“This will happen over time,” Gerry Alfonso, a trader at Shenyin & Wanguo in Shanghai, said by e-mail yesterday. “Doing an arbitrage trade right now based on that might be premature.”

Hong Kong Exchanges & Clearing Ltd. and the Shanghai Stock Exchange agreed to allow as much as 23.5 billion yuan ($3.8 billion) of daily trading, opening up the mainland market to foreign investors while giving wealthy Chinese investors a route to buy Hong Kong stocks.

The Hang Seng China AH Premium Index, a gauge of the price difference between A-shares in Shanghai and H-shares in Hong Kong, fell as much as 1.5 percent to 93.69 yesterday after climbing to 97.67 on May 9, the highest close since the cross-border trading channel was unveiled. A reading of 100 would show valuations on the two markets had converged. The measure, which has averaged 96.84 this year, rose 0.2 percent today.

Zhejiang Shibao Co., a maker of car steering systems that surged 65 percent in Hong Kong on April 10, traded yesterday at a more than 400 percent premium on the mainland, according to data compiled by Bloomberg. Chongqing Iron & Steel Co. was about 150 percent more expensive in Shanghai.

‘Matter of Time’

While Anhui Conch Cement Co. sank the most in 2 1/2 years in Hong Kong the day after the trading link known as the so-called “through train” was announced, the shares of China’s No. 1 producer of the building material still cost 32 percent more than their mainland counterparts, the data show.

“It’s a matter of time before the gap between the two markets narrows,” said Wang Weijun, a strategist at Zheshang Securities Co. “We’re five months away from the official launch of the exchange link program and not many investors are focused on the play yet. There’s really room for arbitrage.”

The through-train allows individuals to buy Hong Kong equities via the Shanghai exchange and investors to buy mainland shares through Hong Kong’s bourse. China Premier Li Keqiang is pushing to reduce capital controls after policy makers last year pledged the biggest expansion of economic freedoms since the 1990s.

The link boosts efforts by Hong Kong bourse head Charles Li to position the city as the investment gateway to the mainland economy. A 2007 plan to allow Chinese to invest directly in Hong Kong stocks, which was later scrapped, helped push the Hang Seng Index to a record that year.

Stocks Slump

This time round, neither market has been kind to investors. Since the plan was announced, the Shanghai Composite fell 4.7 percent while the Hang Seng China Enterprises Index of mainland shares listed in Hong Kong, also known as the H-share index, slid 2.9 percent as data from China signaled a deepening economic slowdown. The H-shares gauge rose 0.1 percent today, while the Shanghai measure gained 0.7 percent.

The Bloomberg index of the most-traded Chinese stocks in the U.S. fell 0.6 percent to 101.60 at 9:56 a.m. in New York. The iShares China Large-Cap ETF, the largest Chinese exchange-traded fund in the U.S., added 0.1 percent to $36.37.

’No Rebound’

“It seems like stocks can’t rebound with a lack of liquidity and weak fundamentals, so playing the A-H gap won’t really help,” Zhou Lin, an analyst at Huatai Securities Co., said by phone in Nanjing. “The interest in the through-train among investors now isn’t very strong -- they don’t see many benefits now unless there are new details and catalysts.”

For Binay Chandgothia, a Hong Kong-based portfolio manager who helps oversee about $250 billion at Principal Global Investors, the caps on trading through the link will stop the price differences from disappearing entirely.

The 250 billion yuan aggregate cap on Hong Kong stock investments is equivalent to about 1 percent of the value of shares listed in the city, according to data compiled by Bloomberg. The 300 billion yuan limit for the mainland equates to about 2 percent of the Shanghai Composite.

“It ultimately depends on how they modify the quota regime,” Chandgothia said. “If they move to unlimited flows eventually that is something that will help in taking out discounts completely.”

Shares of Shanghai Fosun Pharmaceutical (Group) Co., a maker of modern drugs and traditional Chinese medicine, cost 23 percent more in Hong Kong yesterday than on the mainland, from a 1.1 percent discount the day before the through train was announced, data compiled by Bloomberg show. The discount on Great Wall Motor Co.’s Hong Kong stock has doubled, the data show.

“People overplayed this somewhat,” said Francis Lun, the Hong Kong-based chief executive officer at Geo Securities Ltd. “The A-share market has also been weak during this period. There is still a market-arbitrage opportunity here.”

— With assistance by Adam Haigh, and Shidong Zhang

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