Shanghai-Hong Kong Stock Connect to boost cross-border financial flows

And also uphold its reputation in investment.

It has been noted that the Shanghai-Hong Kong Stock Connect, which allows investors to purchase stocks listed on either exchange from the other exchange, is credit positive for Hong Kong.

According to a research note from Moody's Investors Service, this is because the facility reinforces Hong Kong's position as a gateway to investment in the mainland and will increase cross-border financial flows.

Beijing’s decision to allow Stock Connect to go forward despite seven weeks of pro-democracy demonstrations in Hong Kong is likely to alleviate investor concerns that the protests would damage Hong Kong’s political, economic and financial relationship with the mainland as well as to capital market activity in Hong Kong.

Stable market sentiment is crucial for an international financial center like Hong Kong. Stock Connect creates a hybrid exchange whose combined capitalization rivals that of NASDAQ and will exceed that of the Tokyo Stock Exchange.

Capitalization of the Hong Kong Stock Exchange was $3.1 trillion and the Shanghai Stock Exchange was $2.5 trillion as of year-end 2013.

Here's more from Moody's Investors Service:

Until now, foreign purchases of Shanghai-listed stocks were only open to institutional investors under the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investors (RQFII) quota systems.

On the day of the Stock Connect announcement, benchmark equity indices rose 0.8% in Hong Kong and 2.3% in Shanghai, reflecting market expectations that cross-border flows will increase as foreign investors seek access to Chinese equities and mainland investors diversify into Hong Kong-listed equities.

Hong Kong’s financial sector, which accounts for about 16% of GDP, will benefit from an increase in inflows.

Also, in order to handle the increased demand for renminbi (RMB) once Stock Connect is launched, the Hong Kong Monetary Authority will remove its daily cap on settlements in RMB.

This will further strengthen Hong Kong’s position as the dominant source of offshore RMB liquidity, a position that will benefit over the next several years from China’s strategy of developing an offshore RMB market as a means to gradually liberalize its capital account.

Greater financial integration will marginally increase Hong Kong’s already large exposure to financial risks in the mainland.

However, the chances of a sudden escalation in flows (and risks) are limited since daily inflows into the Shanghai market through Stock Connect are capped at $2.1 billion, and the total investment allowed into Shanghai is capped at $49 billion and that allowed into Hong Kong at $40.8 billion.

Stock Connect also benefits Hong Kong’s credit profile because it affirms the mainland’s view that the political demonstrations that began in late September in Hong Kong pose limited financial or political risks.

Furthermore, we do not believe the political demonstrations pose significant risks to Hong Kong’s fundamental credit metrics. Hong Kong’s economy was resilient amid past shocks and has formidable financial buffers.

Hong Kong’s fiscal reserves are equivalent to about 20 months of government expenditure and 718% of government debt in 2013. For the fiscal, financial and corporate sectors as whole, net international assets were equivalent to an exceptionally high level of 280% of GDP at the end of 2013.

Moreover, the Hong Kong dollar, which is pegged to the US dollar, was stable in October throughout the demonstrations, and Hong Kong’s interbank market has continued to operate smoothly.