The 37% Arbitrage Trade in Chinese Stocks Is About to Get Easier

  • Price gaps between China and Hong Kong persist even after link
  • New futures from HKEx would simplify wagers on dual listings

One of the world’s most obvious -- and elusive -- arbitrage trades is about to get a whole lot easier.

Investors have long argued that valuation differences between dual-listed stocks in Hong Kong and China are unjustified, but betting that they’ll narrow has proven tricky because of China’s capital controls and, more recently, restrictions on executing bearish trades in the mainland. A plan by Hong Kong’s exchange to introduce futures on the price gaps, revealed in an interview on Thursday, would give investors a simple way to place their wagers. 

“There will clearly be demand for this type of product not only from a risk management perspective, but as an arbitrage tool given the current disconnect,” Robert Buckley, a managing partner for Asia at Aviate Global LLP in Hong Kong, said by e-mail.

While valuation differences were expected to narrow after the Shanghai-Hong Kong exchange link opened a channel for cross-border investment a year ago, the gaps have instead widened amid a lack of participation by Chinese investors and curbs on short sales in the mainland. Dual-listed shares are 37 percent more expensive in China than in Hong Kong, according to the Hang Seng China AH Premium Index.

The new futures will be introduced in the first quarter of 2016, Kevin Rideout, head of business development at Hong Kong Exchanges & Clearing Ltd., said in Singapore on Thursday. HKEx shares climbed 1.4 percent to HK$210.80 at the close in Hong Kong.

“Investors have been vigorously asking for adequate risk management tools,” he said. “We’ve got good feedback on the A-H spread futures contract.”

Arbitragers shouldn’t count on the gaps narrowing any time soon, Mark Mobius, chairman of the emerging-markets group at Franklin Templeton Investments, said earlier this month. Valuation differences between the two markets are likely to remain “in the near or medium term” as long as China maintains restrictions on money flows across its borders, he said.

While many Chinese investors now have access to cheaper shares in Hong Kong through the exchange connect, they’ve yet to pile in. About 63 percent of the 250 billion yuan ($39.2 billion) quota for net inflows in the city has gone unused.

For international investors keen to bet on narrowing price differences, selling short expensive shares on the mainland has become increasingly difficult in the wake of a $5 trillion crash in Chinese stock from this year’s peak in June.

Trading Curbs

China’s two main exchanges introduced measures in August that restrict short sellers’ ability to sell and buy back shares in a single day, while some of the nation’s biggest brokerages have stopped executing the trades for clients. Volume in China’s onshore futures market, ranked the world’s busiest as recently as July, dried up after a series of regulatory curbs meant to discourage bearish bets.

The new futures contract from HKEx may help boost cross-border volumes by providing a new tool for hedging and betting on changing price relationships between the two exchanges, said Ronald Wan, chief executive at Partners Capital International in Hong Kong.

“The futures contract will help stimulate trades in the Shanghai-Hong Kong connect,” Wan said. “This is a trade on the inefficiencies between both markets.”

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