By Michelle Price and Denny Thomas
HONG KONG (Reuters) - China has yet to explain why the Hong Kong-Shanghai stock trading link-up missed its expected launch on Monday, but the landmark scheme to give investors in Hong Kong and the mainland direct access to each others' market had failed to reconcile critical tax differences.
The Stock Connect scheme, considered a milestone in the liberalisation of China's capital markets, would allow global investors for the first time to trade China shares via Hong Kong, while giving mainland investors access to Hong Kong-listed stocks.
Despite huge foreign appetite for Chinese stocks, and estimates that the scheme could generate more than $3 billion of additional trade a day, banks and brokers had complained to regulators last week about the lack of clarity over the scheme rules.
On Sunday Charles Li, chief executive of Hong Kong Exchanges and Clearing Ltd , said it had not received regulatory approval but was unable to say why, or when it might get the green light.
While investors remain hopeful that the link-up will eventually go ahead, market professionals speaking at a Reuters China Summit said resolving the capital gains tax issue was critical.
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Hong Kong does not charge capital gains tax, but China levies 10 percent, as well as 5.6 percent tax on business profits, and it is not clear how gains would be treated under the proposed scheme.
"This is a significant issue that perhaps was underestimated," said Brian Ingram, Chief Investment Officer at Russell Ping An Investment.
"If you don't understand the cost of liquidity, i.e. the capital gains tax you are expected to pay, your ability to weigh the benefits of those decisions, to decide what type of arbitrage trades to place, and, just as importantly, your ability to try to hedge that tax exposure, is very, very limited."
That would hit trading volumes, said Mark Austen, Chief Executive Officer of the Asia Securities Industry & Financial Markets Association (ASIFMA), an industry body.
"A lot of investors will be reluctant to use the link because they are not sure what their tax liability will be and how it will be calculated," he said.
ASIFMA had said back in August in a letter sent to China's State Administration of Taxation that lack of transparency on the tax issue would limit participation.
For the Chinese government, however, an exemption from capital gains tax for Stock Connect could undermine other cross-border investment schemes.
And though China's 10 percent gains tax on non-resident institutions is low compared with other major financial centres, collecting the tax could be complicated.
Xiaofeng Zhong, CEO for North Asia at Amundi Asset Management, said his fund managers were interested in the programme but would want to monitor operations before using the trading system.
Shelly Painter, Regional Managing Director for Asia at Vanguard, said that once the tax regime was known, investors could make an informed decision: "It's the uncertainty that is a problem."
Some banks had been hiring traders in anticipation of the extra business, but were now having to temper their expectations.
Lee Cook, head of cash equity for Asia Pacific at BNP Paribas , which was among those hiring in recent months, said: "What irks me, and the rest of industry, is the lack of a roadmap towards a launch date."
Cook said the bank had trained people for the stock connect and they were now being directed to work on other things.
(Additional reporting by; Anne Marie Roantree and Lawrence White in Hong Kong; and Pete Sweeney in Shanghai; Editing by Lisa Jucca and Will Waterman)