Hong Kong gets set for China Connect
The China Connect programme give access to mainland China by allowing offshore investors to trade Shanghai listed shares via the Hong Kong market and vice versa
Firms in Hong Kong are ramping up system roll-outs in anticipation of the forthcoming Shanghai-Hong Kong Stock Connect, scheduled to go live in mid-October.
But the proposed link, sometimes called China Connect, will face a number of problems, according to the chief executive of Hong Kong Exchanges and Clearing, Charles Li. In a blog column on the HKEx website, Li writes that the reaction to the link has been positive, with many brokerages signed up to use the service and participate in scheduled market readiness tests staring this month.
The China Connect programme will open up access to mainland China by allowing offshore investors to trade Shanghai listed shares via the Hong Kong market. It will also allow mainland China-based investors to trade in Hong Kong listed shares via the Shanghai market.
Until now, international access to the Chinese market has been strictly controlled via quotas and was limited to a small number of large institutional investment firms. China Connect aims to change this with new quotas for trading in Shanghai listed A-Shares being made available to a wider community of both retail and institutional offshore investors, and by allowing them to clear through the local Hong Kong clearing infrastructure.
But the opening up of the Chinese market will be a “long and challenging process”, he writes. “If we wait for the Mainland market to align with Hong Kong’s, we could be waiting a decade or longer. So we had to figure out a way to connect the markets while respecting the differences between the current regulatory regimes in the Mainland and Hong Kong. We needed to build a bridge connecting the two markets without fundamentally changing them. However, it’s not perfect.”
This has meant imposing constraints on the service that “are necessary to get it off the ground”. In particular there are quotas, holiday arrangements and trading mechanisms.
Quotas have been imposed to minimise “any potential unforeseen risk of excessive capital flows”. Li says that in the initial stages of the link they will regulate the pace of capital flow and ensure the scheme is rolled out smoothly, adding, “I believe the quotas may be expanded over time depending on market conditions, or removed altogether.”
The holiday and trading hours issue means that the link will only operate when trading and clearing arrangements are open in both markets – effectively meaning it is closed when either is closed.
This is further compounded by differences in trading practices between the two, particularly on pre-trade checking: Mainland investors can on sell shares that they held in their stock accounts at the end of the previous trading day, but Hong Kong uses T+2 settlement so they don’t have to transfer the stock to the executing broker until two days after execution.
The compromise under China Connect is that international investors must instruct their custodian to transfer the shares to their selling broker before 0730 on the trading day so that the Central Clearing and Settlement System can confirm they are with the selling broker before the market opens. Similarly, retail investors will have ensure that the shares are with their broker at the start of the day if they want to trade.
Li says that this will create an inevitable administrative burden for international investors, but hopes that it can be resolved some time after the introduction of the service. “Despite significant efforts, we will not be in a position to offer investors alternative solutions at the time of launch that will resolve this issue,” he says. “After the launch, however, we will begin to allocate resources to develop possible solutions to help investors minimise the inconveniences such a practice may cause.”
Meanwhile, firms continue to prepare for connection to the service. Five Hong Kong-based brokers, including ICBC International Securities and Standard Chartered Securities (HK) will be using systems from Fidessa to trade over China Connect.
“Fidessa recognised the potential for this early on”, says David Jenkins, head of product marketing at Fidessa in Asia Pacific. “But implementing this link successfully involves additional technology infrastructure, as well as new tools and processes right across the front, middle and back office, in order to take full advantage of the Shanghai market.”
Fidessa has been working with both exchanges and customers to develop a solution that addresses the complexities that brokers wanting to use China Connect face. This included designing the right algorithms to cater for the wider spreads, transient liquidity and volatility associated with trading the Shanghai market.
“The ability to balance retail and institutional positions was crucial for many of our customers also”, continues Jenkins. “As was providing the ability to manage positions across both QFII and China Connect to allow firms to use their quotas effectively.”
