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Market matters Asian trading and microstructure commentary December 2014

Where is it cheaper to trade the dual listed names – Shanghai or Hong Kong?

Prior to the launch of the Hong Kong Shanghai Connect program in mid-November many traders focused upon the premium of the 72 dual listed names. CLSA fielded several questions from clients trying to understand the potential impact arbitrageurs may have upon premiums once they had the ability to exploit the dual listing. This speculation possibly contributed to a contraction of the premiums from over 12% in the first quarter to a low of 4% in the third quarter. As details of the program emerged and the rules to be applied became clearer, the market understood the difficulties associated with creating the necessary cross border infrastructure for profitable arbitrage between the A and H share names. The premiums once again expanded and exceeded pre-launch levels possibly aided by domestic Chinese investor speculation of significant northbound flow and subdued southbound flow.

As many investors now have access to the Shanghai market utilising both the QFII structure and the Shanghai Connect structure and of course the dual listed H shares in Hong Kong CLSA wanted to explore the relative cost of trading in each market, or the relative theoretical market impact. We wanted to answer the question many clients posed, ‘Is it cheaper to buy the dual listed in Hong Kong or Shanghai?’. CLSA worked with Markit, the provider of an independent trading cost model who ran over 350,000 simulated trades across the 72 dual listed names using actual historical market data in both markets from January through mid-November of 2014 to simulate the relative trading costs.

Dual listed – overall trading costs

0%

4%

8%

12%

16%

20%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Total Absolute Premium

(120)

(100)

(80)

(60)

(40)

(20)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_LCE SH_LCE

The cost of trading has increased significantly in both markets leading into the launch of the program with the MARKIT cost model showing an average market impact of 110bps in Shanghai and 65bps in Hong Kong.

Where is it cheaper to trade the dual listed names – Shanghai or Hong Kong?

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The results illustrate that in the period leading up to the launch, there was a significant expansion in the average cost of trading in both markets from circa 30bps to 70bps in Hong Kong and 110bps in Shanghai. Contrary to the normal expectation that greater liquidity would reduce the cost of trading, prior to the launch date the opposite has proven to be the case, probably driven by the unknowns in the early stages of the programme or domestic speculators in both markets entering into speculative positions, taking liquidity from the market, increasing the volatility and driving up the cost of trading.

Analysing further, breaking the trades into average daily volume buckets highlighted some divergence. While trades of under 10% ADV had markedly increased in cost in Hong Kong, in Shanghai they became cheaper. Larger trades more consistent with institutional order size, became significantly more expensive to trade in both markets with Shanghai costs overtaking those of Hong Kong and exceeding 100bps when trading in the 10% to 20% of the ADV.

(80)

(60)

(40)

(20)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_5% - 10% SH_5% - 10%

(150)

(100)

(50)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_10% - 25% SH_10% - 25%

(150)

(100)

(50)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_25% - 50% SH_25% - 50%

(200)

(150)

(100)

(50)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_50% - 100% SH_50% - 100%

Where is it cheaper to trade the dual listed names – Shanghai or Hong Kong?

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Average trading costs by Market Capitalisation

The cost of trading large capitalisation names in Shanghai increased dramatically by 100bps, and resulted in the cost of trading closing to similar levels in both markets.

When viewed by sector the models illustrate clearly that in the banking sector the cost of trading H shares is far more expensive than trading the equivalent A share.

(150)

(100)

(50)

0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

HK_Large Cap SH_Large Cap

(150)

(100)

(50)

0

Jan Feb Mar AprMayJun Jul AugSep Oct Nov

HK_Mid Cap SH_Mid Cap

(150)

(100)

(50)

0

Jan Feb Mar AprMayJun Jul AugSep Oct Nov

HK_Small Cap SH_Small Cap

(300) (250) (200) (150) (100) (50) -

Banks

Capital Markets

Insurance

Property

Consumer

Industrial

Basic Material

Energy

UtilitiesShanghai

HongKong

Where is it cheaper to trade the dual listed names – Shanghai or Hong Kong?

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Conclusion

There is more to consider than the just premium when determining the optimal market to trade in. While each investor’s total transaction costs are unique to themselves and their investment structure, significant implicit trading cost differentials exists between the Shanghai and Hong Kong markets which should be considered in trading decisions. The trading cost differential between the markets has shown to be a very significant factor which should not be ignored in particular in those individual names where the premium is low.

Generally speaking, for the dual listed stocks it has been cheaper in terms of market impact to trade the H share in Hong Kong with the notable exception of banks where investors could pay up to 100bps more in market impact. For further detail or analyses please contact CLSA or Markit.

This material has been prepared by Markit and CLSA. This document is for information and illustrative purposes only and does not purport to show actual results. It is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. Opinions expressed herein are current opinions as of the date appearing in this material only and are subject to change without notice. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those discussed, if any. No part of this document may be reproduced in any manner, in whole or in part, without the prior written permission of Markit and CLSA. You may not rely on the statements contained herein