Hong Kong Exchanges and Clearing (HKEx) has fleshed out the preparatory infrastructure of the Shanghai-Hong Kong Stock Connect, the new mechanism whose introduction was announced in late April.
Updating the industry on the changes, HKEx has said that whilst some matters remained to be finalised, 80-90% was now done and the project was on schedule for delivery in six months time.
“In theory this is a brilliant piece of evolutionary development within the Hong Kong and China universe,” said Andy Maynard, head of trading at CLSA. “It is good to see markets evolving and a potential start to a number of exchanges eventually becoming one bigger exchange. It is a recognition that we are getting closer to the concept of a Greater China exchange.”
In its formative stages, information about the Stock Connect had been clearer on Chinese money coming to invest in Hong Kong, rather than about Hong Kong money going into China.
There remain numerous ways that an institution can express a portfolio view on Chinese stocks, including the quotas available under schemes for ‘qualified foreign institutional investor’ (QFII) and ‘renminbi qualified foreign institutional investor’ (RQFII).
“It seems the Stock Connect is more relevant from a retail point of view than for institutions,” added Maynard. “Institutions, big international funds and money managers – if they are serious about the asset allocations they want to make to China, are still definitely going to be using other access products such as QFII or RQFII. I don’t see how this announcement – at the moment – can accommodate all the business from a big fund looking to invest in China. What it has done is to change the dynamics of the stocks that are involved, in terms of the spread differential between the A share listing and the H share listing. People are, in a way, feeling euphoric about it.”
Exchange and clearing members in Hong Kong are now undergoing several rounds of briefing in order to be ready for participation, although those who are not ready on time can join the project at a later date.
In terms of the nitty-gritty of the Stock Connect’s rules, HKEx said that the order routing will be grossed up, to achieve maximum price discovery. Clearing and settlement will be netted to minimise cross-boundary fund flow.
Renminbi conversion will be done in Hong Kong. HKEx said that the boundary fund flows would be a closed-loop, meaning that shares cannot be rapidly disposed of and cash pulled out in order to – as HKEx put it,‘ buy a car’.
Bryan Chan, HKEx’s co-head of equity added that Chinese investors would need to comply with market misconduct rules in Hong Kong and would have to acquaint themselves with those rules. He also said that the Hong Kong investor compensation fund would not cover any northbound trading activities on the mainland.
At present, the number of stocks earmarked for the scheme are the constituent stocks of the SSE 180 and SSE 380, meaning 568 Chinese stocks in aggregate. In Hong Kong the stocks of the HS large cap and mid cap indices will be available. That adds up to 265 Hong Kong stocks. This represents 90% and 82% the market capitalisations of Shanghai and Hong Kong respectively.
There will be an aggregate quota of RMB 300 billion for northbound stock purchases (RMB 13 billion per day) and RMB 250 billion (RMB 10.5 billion per day) for southbound trading of Hong Kong stocks. The quota only applies to buy orders, and sell orders will always be allowed regardless of quota levels.
There are actions that are permitted domestically in both Hong Kong and Shanghai markets, that will not be allowed within the Stock Connect. In Hong Kong, short selling and stock borrowing and lending will not be open to mainland investors in the link. Vice-versa, Hong Kong investors in the mainland will not be allowed to undertake naked short selling and will not be allowed to participate in mainland margin trading and securities lending. Hong Kong investors will also be forbidden to carry out block trading on the mainland.
One unresolved matter is that of fees and taxes that apply to Hong Kong traders in Shanghai. Whilst transfer fees, stamp duties and securities management fees have been determined, clearing fees, dividend taxes and, significantly, capital gains tax liabilities, have not yet been figured out.
All exchange and clearing members in Hong Kong are allowed to participate in northbound trading, as well as institutional and retail investors.
In terms of readiness requirements, participants need to be prepared with systems for end-to-end testing in a rehearsal, (scheduled to take place in September). They also have to re-examine risk management measures, educate staff on trading of Shanghai stocks, develop procedures for issuing client documentation and amend existing agreements in relation to trading in Shanghai. They will have to essentially confirm that they are fully ready to deal with RMB securities.