On June 10, the China Securities Regulatory Commission (CSRC) released a ministerial order to amend the Several Provisions on the Interconnection Mechanism for Transactions in the Mainland and Hong Kong Stock Markets (hereinafter referred to as “Provisions”), six months after its announcement requesting public comments on the intended changes (CSRC, June 10; CSRC, December 17, 2021). The amendment outlines eligibility to participate in the Shanghai-Hong Kong Stock Connect (沪港通, Hu Gang Tong) and Shenzhen-Hong Kong Stock Connect (深港通, Shen Gang Tong), restricting Chinese nationals from purchasing and selling domestic shares (also known as A-shares, or A股, “A” gu) with Hong Kong accounts. The amended Provisions, which went into effect on July 25, give investors currently in violation of the new stipulations a one-year grace period to sell off their shares.
Launched by the CSRC in November 2014 and 2016, the two Stock Connects created four channels between stock exchanges in mainland China and Hong Kong. Two northbound connect links allow foreign investors to open brokerage accounts in Hong Kong and trade stocks listed in Shanghai and Shenzhen. The two southbound connect links, on the other hand, enable domestic investors in China to access Hong Kong’s stock market. To maintain government control over cross-border capital flows, both northbound capital (北上资金, beishang zijin) and southbound capital (南下资金, nanxia zijin) are kept within closed loops (Caixin, November 17, 2016). This means that after the transactions are settled, money is automatically debited from or credited to investors’ accounts denominated in local currencies—the renminbi in mainland China and the Hong Kong dollar in Hong Kong—thereby preventing investors from exploiting the Stock Connect to transfer capital into and out of China.
Closing the Stock Connect Loopholes
The Stock Connect system, however, is not without loopholes. In its explanation of the proposed amendment, the CSRC revealed that over 170,000 domestic investors have opened brokerage accounts in Hong Kong to exercise the northbound connect and trade A-shares (CSRC, June 10). Although only 39,000 domestic investors have utilized the Stock Connect services in the past three years and the total volume of these transactions accounts for only 1 percent of all northbound transfers, these “fake foreign capital” transactions increase the risks of illegal cross-border activities and contravene the original purpose of the Stock Connect systems. The CSRC also stated that over 98 percent of these investors have domestic brokerage accounts through which they can trade A-shares.
In 2014, news reports appeared in mainland China that discussed the appeal of the Hong Kong financial market and highlighted the Securities and Futures Commission (SFC)’s more relaxed rules on margin trading and the city’s lower interest rates (Ifeng News, November 18, 2014). These accounts occurred at a time of strong stock market performance in China, high domestic enthusiasm following financial relaxation, and unprecedented market opportunities after the launch of the Shanghai-Hong Kong Stock Connect. In the early 2010s, the CSRC loosened several financial regulations, allowing investors to sell short and trade on margin. Under the new rules, investors can take out loans at a 50 percent margin (2:1 leveraging), and some channels provide loans at a 20 percent margin (5:1 leveraging) (China News Service, November 21, 2014). These new financing opportunities, which allowed domestic investors to expand their market exposure and to dramatically increase their returns, partially contributed to the stock market bubble and economic turbulence in 2015. At the same time, many Hong Kong brokers offered leveraged trading at a 15 percent (20:3 leveraging) to a 10 percent margin (10:1 leveraging), allowing investors to reap 6.7 times and 9 times more profit respectively (discounting interest expenses) (Ifeng News, November 18, 2014).
The appeal of the Stock Connect system does not end there. Under the rules of the closed loop system, domestic investors who trade A-shares in Hong Kong see their earnings transferred directly to their Hong Kong accounts after transactions are settled. Given China’s tightening of foreign exchange control measures, the Stock Connect systems thus create an unintended channel through which the tech- and financial-savvy Chinese nationals can bypass government-imposed limits and transfer money abroad. This arguably poses a much more serious problem for the Chinese government and the CSRC than the risks posed by “fake foreign capital” that still only account for a very small portion of capital flows through the Stock Connect systems.
Chinese Foreign Exchange Control
In 2007, the Chinese State Administration of Foreign Exchange (SAFE) introduced the Measures for the Administration of Individual Foreign Exchange (hereinafter referred to as “Measures”), stipulating $50,000 as the maximum for the domestic individual purchase of foreign exchange per person per year (SAFE, December 25, 2006). In 2017, SAFE required all Chinese nationals purchasing foreign exchange to fill out the Application Form for Personal Purchase of Foreign Exchange (People’s Daily, January 3, 2017). The application form asks applicants to specify the purpose of their purchases and distinctly bans using foreign exchange for investing in properties, securities, and dividend-paying insurance products (SAFE, July 28, 2017).
Under tight foreign exchange controls, many Chinese citizens have utilized a method called “ants moving” (蚂蚁搬家, mayi banjia)—“borrowing” quotas from friends and relatives—to circumvent the annual quota. In order to crack down on these violations of official regulations, SAFE outlawed “split settlements” (拆分购汇, chaifen gouhui) in 2009 and placed suspicious “ants moving” activities under its watch list in 2017 (SAFE, April 29, 2019; People’s Daily, January 3, 2017).
The “ants moving” tactic, despite its popularity, is time-consuming and cumbersome. More resourceful individuals and companies have resorted to underground banks (地下钱庄, dixia qianzhuang) to funnel money abroad, often via Hong Kong. For over a decade, the Chinese government has launched several national and regional campaigns to crack down on underground banks and halt illegal foreign exchange activities. For example, in 2005, public security organs reportedly destroyed 47 underground banks (ENorth News, February 14, 2006). In 2015, SAFE publicly announced plans to “firmly crack down underground banks” and joined four other departments and ministries to launch a nationwide special operation (China Forex, September 17, 2015; Global Times, April 16, 2015). In 2021 the Ministry of Public Security (MPS) commenced the “Annihilate 21” (歼击21, Jianji 21) special operation, breaking up 2,140 cross-regional criminal groups, solving over 10,000 cases, and recovering economic losses of 1.46 billion yuan ($208.57 million) (MPS, April 15).
In seeking to close any illegal channels or loopholes through which Chinese citizens have managed to evade the SAFE quota, the new CSRC amendment is a continuation of Beijing’s moves to strengthen control over foreign exchange.
China’s Capital Flight Problem
The timing of the CSRC amendment is also interesting. Why is the government moving to ban domestic investors from opening accounts in Hong Kong to buy A-shares when the size of such activity remains small and its impact very limited? While one may see this as a preventive measure to stabilize the market and strengthen the reputation of Shanghai and Shenzhen as financial centers amidst global economic downturn, the domestic and international political situations cannot be overlooked.
It is no secret that China has been confronting a capital flight problem for decades. Since the late 1970s, foreign direct investment (FDI) pouring into China has helped fuel the country’s miraculous economic growth, but at the same time, money has been leaving China at a rapid and accelerating pace. Moreover, recent capital flights are driven more by corruption, income inequality, and desires to migrate than “traditional” explanations such as overvalued exchange rates and relaxed capital controls—evident from the exposed overseas accounts and properties owned by Chinese officials and their relatives.  In recent years, the capital flight problem has only worsened by geopolitical shocks including rising US-China trade tensions, changes in US monetary policies, and the Russian invasion of Ukraine (South China Morning Post, April 27). While the Chinese government and the CSRC in particular are concerned about foreign investors pulling money out of China, capital outflows of Chinese nationals also constitute a grave and more difficult threat.
In 2022, a new meme, “runology” (润学, run xue)—“the study of running away”—went viral among Chinese youth (Netease, May 26). A generation previously known to be aggressively ethno-nationalistic and proud of China’s recent achievements seemed to have instantaneously become staunch critics of the party-state. The sudden popularity of “runology” corresponded with the start of the Shanghai lockdown in April 2022, as the often ineffective and problematic implementations of the party’s stringent “dynamic zero-Covid” policy severely disrupted the daily lives of millions of citizens and left them feeling helpless, disappointed, and in despair (Council on Foreign Relations, June 1; China Brief, April 8). Yet latent discontent of the difficult socio-economic environment—high living costs, gender inequality, intense pressure and competition, and lack of agency, autonomy, and assurance—has been bubbling for months, if not years.
“Runology,” which is most associated with the well-educated high-income middle class in large cities such as Shanghai, differs significantly from previous waves of capital flight and emigration of top financial and political elites. Compared to underground banks, less risky options such as the “ants moving” tactic and the Stock Connect loopholes present more viable options to the former group. With the new CSRC amendment and tightening SAFE supervision of any cross-border foreign exchange transactions, China is closing the remaining asset transfer channels for its financial-savvy middle class.
In an effort to eliminate “fake foreign capital” in the northbound connect, the CSRC is shutting down another channel through which Chinese nationals can bypass SAFE’s quota. This article argues that although CSRC’s explanations for the new amendment do not mention the capital flight problem, the further tightening of China’s foreign exchange control is not an unintended consequence but a direct objective. The timing of the policy change—rising domestic uncertainties and discontent coupled with mounting international pressure and challenges—coincides not with an increasing volume of “fake foreign capital” that directly threatens the stability of the Chinese stock market but rather with new threats of capital flight from the Chinese middle class. The CSRC’s new amendment thus joins existing SAFE regulations and ongoing MPS anti-underground bank operations as the most recent effort by Beijing to strengthen foreign exchange control and restrict capital outflows.
Harry He is an MA Candidate in Asian Studies at Georgetown University’s Walsh School of Foreign Service. His research interests include China’s local governance issues, domestic political economy, and state-society relations.
The author would like to express his gratitude for the support of the Georgetown University Asian Studies Program.
 Frank R. Gunter, “Corruption, Costs, and Family: Chinese Capital Flight, 1984–2014,” China Economic Review 43 (2017): 105-117.