Institutions 'take the A train' for arbitrage profits

An investor checks share prices at a securities firm's outlet in Qingdao, Shandong province. China's benchmark share index ended flat on Tuesday, following a six-day gaining streak.YU FANGPING/CHINA DAILY

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Institutional investors are positioning themselves to take advantage of arbitrage opportunities that the Shanghai-Hong Kong Stock Connect program, known as the "through train", is expected to offer.

Some have already profited from narrowing price gaps between Hong Kong-listed H shares and Shanghai-listed A shares even before the program's scheduled launch in October.

In recent weeks, many Hong Kong-based hedge funds are reported to have been hoarding H shares that are trading at substantial discounts to their equivalent A shares. The narrowing price gaps have already yielded handsome returns for these investors.

While holding the H shares, they are also selling short corresponding A shares in cases where prices of the mainland-listed stocks are higher than those in Hong Kong. A short sale involves selling a financial instrument that an investor does not yet own, usually in the expectation that the market price will decline and the seller can make a profit by purchasing the asset at a lower future price.

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Investors doing this in the H- and A-share markets are betting that prices will decline during the convergence process, stock analysts in Hong Kong said.

"Theoretically, there are indeed arbitrage opportunities. You can buy H shares in Hong Kong that are being traded at a big discount to the A shares. And simultaneously, you short-sell A shares in the mainland market," said a managing partner at a leading hedge fund based in Hong Kong, who asked not to be identified. "Retail investors can do this too, but short selling in the mainland is very expensive, as securities brokers charge very high interest rates" for such transactions, he said.

Wang Xinyi, chief executive officer of Shanghai-based CR Assets, a hedge fund, said the firm has "made some arrangements" based on the stock program and has already made "some profits".

However, Wang does not think these operations can be defined as "real" arbitrage, as shares in Shanghai and Hong Kong market are remaining in their own markets, rather than being allowed to freely circulate across the two markets under the stock connect program.

"The significance of the Shanghai-Hong Kong Stock Connect program is that it will mean cash flows across the two markets up to a certain quota and be restricted to selected shares. But it won't completely change the investment styles of the two markets," he said.

Wang also noted that there is no mechanism for mainland investors to short-sell H shares.

Similar transactions are being based in anticipation of price convergence after "through train" launches. But the A-H premium of some shares has expanded even in recent months.

Most institutional investors said they are not betting on total price convergence, as shares in the two markets cannot be mixed, and onshore and offshore investors have different preferences. In addition, transaction costs are high, tax policies are uncertain, and the two markets have different levels of liquidity and volume.

The stock connect program will add new investment channels in the Hong Kong and mainland markets, in addition to the qualified foreign institutional investor, renminbi qualified foreign institutional investor and qualified domestic institutional investor programs, said Larry Wang, marketing manager of CSOP Asset Management, the largest RQFII manager.

"Our RQFII quota has been almost used up as overseas investors have become increasingly interested in A shares. With the stock connect channel, we can free up some RQFII quota and improve our products," he said.