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CNH Tracker-Stocks surge before share connect plan, issues remain

By Michelle Chen and Saikat Chatterjee HONG KONG, Aug 21 (Reuters) - Stocks in Hong Kong and China's bourses have rallied ahead of a deadline to put down an investment pipe between the two markets, but issues around capital gains tax still remain to be cleared. The landmark stock-connect scheme between Shanghai and Hong Kong - another step in China's efforts to open up its markets - is set to launch in October and regulators and market participants are racing around the clock to test mechanisms to ensure market readiness. While China's investors are anticipating a wave of institutional money will flow into the mainland's relatively undervalued markets, Hong Kong's stock punters are hoping Chinese money will boost trading volume and lift stocks. The Shanghai Composite Index rose to eight-month highs this week, and Hong Kong's Hang Seng Index also jumped to more than six-year highs, in a catch-up to strong global markets. "The Shanghai-Hong Kong stock connect scheme is the catalyst of the recent market rally, and risk-on sentiment globally amid ample liquidity also helps," said Ben Kwong, chief operating officer at securities firm KGI Asia. Both markets underperformed global markets for the past year and valuations are low compared with other markets, enticing some investors to switch their asset allocations now, Kwong said. Despite the recent rally, the price-to-earnings multiple of China's stock market remains well below a 10-year median indicating the extent of the undervaluation of the markets. The demand to purchase shares have seen available quotas under China's existing dual schemes becoming scarce in recent weeks with the gap between mainland listed A-shares and Hong Kong listed H-shares of Chinese companies narrowing. ETFs under an investment scheme in the Chinese currency recorded net inflows of 8.2 billion yuan ($1.33 billion) in July, the highest since December 2012 and nearly doubling from June, according to Morningstar data. While market participants are bullish on the prospects of the success of such a scheme, issues such as taxes in both these markets have yet to be resolved making some investors wary about rushing headlong when the scheme launches. "We haven't got any clarity on the tax issue yet from the regulators but we hope it will be resolved by the time the stock connect scheme launches," said Lilian Leung, a fund manager at JP Morgan's A-share Opportunities Fund earlier this week. It also remains to be seen how flows will affect yuan liquidity in the offshore market, though it is widely believed that it will become more volatile given that settlement for the scheme will be in Chinese currency. Under the requirements, mainland investors who buy Hong Kong shares will convert their RMB in the offshore market, while overseas investors will need to obtain their yuan funding in the former British colony before they invest in China. The launch of the long-awaited programme has entered the final stage with both exchanges busy testing their systems. The Hong Kong Stock Exchange said it would kick off its first connectivity test on Saturday with several rounds of market rehearsals to follow in the coming weekends. Its Shanghai counterpart already started tests last week with the first batch of 25 local brokers trading 14 selected shares listed in Hong Kong, as reported by Chinese media. WEEK IN REVIEW: * JP Morgan announced on Monday the launch of China A-share opportunity fund, the first SFC-authorised and actively managed Renminbi Qualified Foreign Institutional Investor (RQFII). The fund will allocate at least 70 percent of the portfolio to A-shares. * Long positions in the Chinese yuan hit a near seven-month high as investors piled up long positions on the currency amid signs of stabilisation in the Chinese economy, but sentiment on most emerging Asian currencies slightly deteriorated in the last two weeks, a Reuters poll showed. * Taiwan's yuan deposits rose to 293 billion yuan by the end of July, up 0.9 percent from a month earlier, statistics from the island's central bank showed. * DBS Bank said it had extended a cross-border yuan loan worth 150 million yuan to S.F. Group based in the Qianhai Shenzhen-Hong Kong Service Industry Cooperation Zone. CHART OF THE WEEK: China's A-shares are still trading at discounts compared to their counterparts in Hong Kong, but the spreads are narrowing as investors bet on a convergence of dual-listed shares with a stock connect scheme set to be launched in October: http://bit.ly/1tpQhmN RECENT STORIES: CNH Tracker-South Korea's yuan business sees strong growth despite FX volatility Inflows to Hong Kong ETFs soar as foreigners bet on Chinese stocks Central bank and traders briefly see eye-to-eye on yuan More stories about the CNH market Daily onshore yuan reports Daily China money market reports Offshore yuan rate Onshore yuan rate Offshore yuan dealt Onshore yuan on CFETS THOMSON REUTERS SPEED GUIDES (Editing by Jacqueline Wong)