By Steven Russolillo in Hong Kong and Shen Hong in Shanghai
Chinese regulators have succeeded in cooling the mainland's once-volatile stock markets this year. Now, their attention is turning to Hong Kong.
The year's surge in the city's equity market has sputtered out in recent days, as the benchmark Hang Seng Index has fallen about 6% since Nov. 22. The market dropped again Wednesday, closing down 2.1%.
Investors' desire to lock in profits after the market's 36% gain at its peak this year is one factor behind the slump, traders say.In addition, a global pullback in technology stocks has hit Tencent Holdings Ltd., the Hang Seng's biggest constituent by market capitalization--shares have dropped 17% over the past two weeks.
However, market participants said Beijing's recent regulatory actions have also ruffled Hong Kong. Late last month, China's securities regulator began delaying approval of new mainland funds seeking to invest in Hong Kong stocks after the rally raised concerns that inflows of speculative capital, or hot money, had caused the market to become overheated, according to people familiar with the matter.
"It's not an outright ban but the process is definitely slowing. The intention is to cool things down a bit in Hong Kong," said one of the people.
The measure has had a chilling effect on trading flows from mainland China into Hong Kong through the Stock Connect trading links with the Shanghai and Shenzhen exchanges. Flows through those links had been an important driving force behind the Hong Kong market's rise this year, with those from Shanghai accounting for around 11% of the exchange's weekly trading volume as recently as October.
Last week, though, flows from Shanghai represented only 6.9% of total trading volumes in Hong Kong, the smallest weekly percentage since January, according to brokerage firm Jefferies.
Some Hong Kong-based investors said the move to limit new mainland-based funds from investing through Stock Connect is a worrying sign that Beijing is prepared to intervene more directly in the city's market.
"Restrictions are going to get tougher in Hong Kong, we know that," said Andrew Clarke, director of trading at brokerage firm Mirabaud Asia Ltd. in Hong Kong. "China makes the rules and there's really not much we can do about it."
The China Securities Regulatory Commission didn't immediately respond to a request for comment.
Some market observers said one reason for the latest measures could be a desire to ensure more of investors' money stays in local markets. While Hong Kong stocks have soared 28% year to date, Shanghai shares are up just 6.1% and the Shenzhen market has fallen 4.5%.
"The rally in Hong Kong, in contrast to the recent sharp selloff in Shanghai, was a bit embarrassing for Beijing," said a person familiar with the regulator's thinking.
Other observers said China's regulatory actions reflect concerns that Hong Kong's market has become too speculative.
"Southbound flows are considered the hot money coming into the Hong Kong market," said Mirabaud's Mr. Clarke. "In some ways, it's not a bad thing that China is trying to cool down speculation. The market had gotten awfully speculative."
A representative for Hong Kong Exchanges & Clearing Ltd., the city's stock market operator, said it doesn't comment on media reports or rumors, and that interest in Stock Connect has been trending higher. Officials from Hong Kong's market regulator, the Securities and Futures Commission, weren't immediately available for comment.
Catherine Yeung, an investment director at Fidelity International, which oversees $441 billion in client assets,said mainland investors have been concentrating on a small selection of Hong Kong-listed consumer, real estate and technology companies, including Tencent, which last month became the first Asian tech company to hit a $500 billion market capitalization.
The CSRC's new restrictions on investing in Hong Kong follow a number of steps it has taken in the past two years to cool mainland markets. Its efforts intensified before a major Communist Party meeting in October: Investors and traders said regulators called many brokerage firms and funds in the months leading up to the congress, urging them to refrain from selling shares and to publicly remain bullish on stocks.
Some mainland-based investors share the regulator's nervousness about Hong Kong stocks.
"The Hong Kong market seems to be getting a bit too hot," said Dana Tang, a 35-year-old investor in Shanghai, who has put nearly $64,000 into Hong Kong shares in the past three years.
Still, Ms. Tang said Hong Kong remains attractive given the limits on ordinary investors sending money outside mainland China. "Many Chinese investors active offshore are reluctant to take the money back to the mainland. Hong Kong shares are among the few options we have," she said.
-- Yifan Xie contributed to this article
Write to Steven Russolillo at firstname.lastname@example.org and Shen Hong at email@example.com