The Central Bank of Ireland (“CBI”) issued an update to its Q&A documents on 15 July 2015 for both UCITS and AIFMD FAQ (“Q&A”) which clarifies how Irish funds can invest in Chinese shares via the Shanghai-Hong Kong Stock Connect Scheme (“Stock Connect”). Stock Connect is a trading link between the Hong Kong and Shanghai Stock Exchanges that allows non-Chinese investors to buy certain Shanghai-listed equities without a foreign investor quota.
This green light for Stock Connect by the CBI follows a detailed engagement by it with the funds industry in Ireland, the Hong Kong Stock Exchange and depositary firms and comes months after the November 2014 launch of Stock Connect. During this period, nearly a hundred U.S. 1940 Act funds have amended their disclosure documents to permit Stock Connect investments and in Luxembourg, where approval for Stock Connect is on a fund by fund basis, more than twenty funds have been approved to invest in Mainland China via Stock Connect.
The engagement by the CBI was not concerned with the approval of the market infrastructure but rather with understanding how depositaries of Irish authorised funds could carry out their safe-keeping duties.
The framework of Stock Connect is complicated and comprises a multi-tiered central securities depository, including both the Hong Kong Securities Clearing Company Limited (“HKSCC”) and China Securities Depository and Clearing Corporation (“ChinaClear”); HKSCC holds the Stock Connect securities of all Hong Kong participants in a special account with ChinaClear. As a result, the records maintained by ChinaClear reflect only the nominal interest of HKSCC—and not the beneficial interests of Hong Kong exchange participants who act on behalf of funds and other investors. The key concern has always been whether and how these beneficial interests would be recognised under the laws of Mainland China. However, HKSCC expressly disclaimed any beneficial interest in Stock Connect securities and agreed to otherwise protect the interests of its exchange participants, and the Chinese regulator ultimately issued its own statement affirming that beneficial ownership would be respected in the Mainland.
Clarifications such as this are helpful in allowing the CBI to permit the use of Stock Connect by Irish UCITS and AIFs. The CBI Q&A simply places an onus of the depositary to ensure that its legal and regulatory obligations can be met through Stock Connect and, at a minimum, expects the depository (or their local sub-custodians) to be a HKSCC participant and that the Stock Connect arrangements are kept under review.
It is expected that a significant number of Irish funds will seek to use Stock Connect as soon as possible and that the depositaries of these funds will be able to provide the level of comfort required by the Q&A . Based on Stock Connect’s market volumes, the recent turbulence in the China market does not appear to have significantly affected foreign investors’ interest in investing in Shanghai-listed securities. Furthermore, the market decline has spurred Chinese regulators into action and may accelerate further opening of Stock Connect to both additional Shanghai-listed securities and shares listed on China’s growth-oriented exchange in Shenzhen.