Nov. 15 (Bloomberg) — Exchange-traded funds tracking Chinese equities listed in Shanghai and Hong Kong rallied after the nation announced it will waive capital-gains taxes for foreign investors before a program linking the two bourses starts next week.

Deutsche Bank’s X-trackers Harvest CSI 300 China A-Shares ETF jumped 3.3 percent to the highest level since its U.S. debut last November. The iShares China Large-Cap ETF, which tracks 50 so-called H-shares of companies traded in Hong Kong, rose 1.9 percent to an eight-week high while a Bloomberg index of the most-actively traded Chinese companies in the U.S. extended its weekly gain to 2.8 percent.

Foreign investors using the unprecedented access under the Shanghai-Hong Kong connect to buy yuan-denominated A-shares will be “temporarily” exempt from capital-gains tax starting Nov. 17, the Ministry of Finance said yesterday. International money managers have been seeking a clarification of the policy before the link gives them a new route to access about $4.2 trillion in stocks. China is counting on foreigners to boost equity valuations, turn Shanghai into a global financial center and boost the global use of the yuan.

The policy “should ensure a positive start to the Hong Kong-Shanghai connect,” Tony Hann, the head of emerging markets at Blackfriars Asset Management Ltd. said by phone from London yesterday. “They seem to have made every effort to get this working and amenable to foreign investors pretty much within the deadline they set themselves.”

Luring Arbitragers

The CSI 300 A-Shares ETF rose to $28.25, extending its 2014 advance to 15 percent. The iShares China ETF reached $40.45. Futures on the Hang Seng China Enterprises Index rose 1.4 percent after the official close of Hong Kong’s stock exchange and contracts on the Hang Seng Index climbed 0.9 percent.

Institutions already investing in Chinese markets through the so-called QFII and RQFII programs will also get a “temporary” tax waiver, the finance ministry said, without giving a time frame on the new policy. Chinese individuals who buy Hong Kong equities through the link get a three-year exemption, while mainland companies using the link will be charged tax.

The Shanghai Composite Index has climbed 17 percent this year amid speculation government stimulus will boost economic growth and that the exchange link will lure arbitragers to mainland shares trading at a lower prices than their Hong Kong-listed counterparts.

Some Uncertainty

The policy should “benefit A shares more than the H-share market,” said Hann. People are investing in A-share ETFs on “expectation that the arbitrage between A and H will benefit A shares. If you want to play that game early, then you buy an ETF and you are front-running.”

Money managers who had previously wanted to avoid China’s tax regime could get exposure to the country by purchasing shares of mainland companies in Hong Kong, which has no capital gains tax. The Hang Seng China Enterprises index has climbed 17 percent since reaching this year’s low on March 20.

Yesterday’s announcement still left some uncertainty as it didn’t spell out how long the exemption for foreign investors will last, according to Z-Ben Advisors, a fund research firm. Z-Ben called it a “partial, but not wholly satisfying, solution to the CGT problem” in a report.

Policy Confusion

Tax policy was one of several market-structure shortcomings, including capital controls and rules against same-day trading, cited by investors when MSCI Inc. gathered views on mainland shares before keeping the shares out of its global indexes in June.

“Foreign institutional investors were worried about this issue,” said Benjamin Tam, a Hong Kong-based portfolio manager who helps oversee about $1.5 billion at IG Investment Ltd.

While the nation’s laws had suggested foreign equity investors were subject to a capital gains tax, the government has never collected it, according to PricewaterhouseCoopers. Confusion over the policy since China’s quota system for a limited number of foreign institutions began more than a decade ago has led to a mishmash of compliance, with some setting aside cash for the liability and others anticipating it won’t be implemented, according to HSBC Jintrust Fund Management.

The exchanges agreed in April to allow a net 23.5 billion yuan ($3.8 billion) of daily cross-border purchases, opening up the mainland market further to foreigners while giving wealthy Chinese investors a route to buy Hong Kong stocks.

For traders based in the mainland, the nation’s personal-income laws stipulate a 20 percent tax, though authorities have exempted them from the levy since 1994 to promote development of the stock market.

“Many people were hesitating to do this program because of the tax issue,” said Alex Wong, a Hong Kong-based asset-management director at Ample Capital Ltd. “Institutions would be OK to join after this. What people needed was a clear structure.”

To contact Bloomberg News staff for this story: Allen Wan in Shanghai at awan3@bloomberg.net ; Belinda Cao in New York at lcao4@bloomberg.net

To contact the editors responsible for this story: Michael Patterson at mpatterson10@bloomberg.net Marie-France Han, Nikolaj Gammeltoft