Introduction
The Joint Announcement by the Securities and Futures Commission (“SFC”) and China Securities Regulatory Commission (“CSRC”) on 10 April 2014 (“JointAnnouncement”) “Stock Connect” (or “through train”) marked an important milestone in the liberalization of China’s capital markets and in the development of Hong Kong as an international financial centre.
1. Effect
Through Stock Connect, Hong Kong and overseas investors will be able to trade certain securities listed on the Shanghai Stock Exchange (“SSE”) through the Stock Connect (“Northbound Trades”). Conversely Mainland institutional investors and individual investors who hold an aggregate balance of not less than RMB500,000 in their securities and cash accounts will be able to trade securities listed on The Stock Exchange of Hong Kong Limited (“SEHK”) (“Southbound Trades”).
2. Key Features
i. Establishment of mutual order-routing connectivity and clearing links
SEHK and SSE will establish mutual order-routing connectivity and related technical infrastructure to enable investors in Hong Kong and mainland China to trade shares listed on the other’s market.
The Hong Kong Securities Clearing Company Limited (“HKSCC”) and China Securities Depository and Clearing Corporation Limited (“ChinaClear”) will also establish clearing links to provide arrangements for the clearing and settlement of trades under Stock Connect.
ii. Eligible Stocks
Initially, Stock Connect will only encompass secondary market trading. Primary market activities, such as initial public offerings, will not be supported.
(a) Northbound Trades
In the initial phase, Hong Kong and overseas investors will be able to trade certain stocks listed on the SSE market (“SSE Securities”). These include the constituent stocks from time to time of the SSE 180 Index and the SSE 380 Index, as well as all the SSE-listed A shares that are not included in these indices but which have corresponding H shares listed on SEHK. A list of the eligible SSE Securities has been published on the SEHK’s website but it will be updated upon launch of Stock Connect.
SSE Securities will not include SSE-listed shares which are not traded in RMB and SSE-listed shares which are included in the “risk alert board”.
(b) Southbound Trades
Mainland investors will be able to trade certain stocks listed on the SEHK market (“SEHK Securities”), which include constituent stocks of the Hang Seng Composite LargeCap Index and Hang Seng Composite MidCap Index, and all H shares that are not included in these indices but which have corresponding A shares in the form of SSE-listed shares.
Hong Kong shares that are not traded in Hong Kong dollars, and H shares which have corresponding shares listed on Mainland China other than SSE (i.e. Shenzhen Stock Exchange) will not be included in Southbound Trades.
Similarly, SEHK has published a list of eligible stocks for Southbound Trades which will be updated when Stock Connect is launched.
iii. Exchange Participant
To participate in Stock Connect, investors will have to trade with their brokers, being persons registered in SEHK as an exchange participant eligible to trade stocks through Stock Connect (“SCEP”).
To facilitate Northbound Trades, the SEHK will establish a “SEHKSubsidiary” in Shanghai to receive orders to trade in SSE Securities from SCEPs, and route them onto SSE’s trading platform for matching and execution on SSE.
Similar reciprocal arrangements will be adopted for Southbound Trades. The SSE will establish a “SSE Subsidiary” in Hong Kong to receive orders to trade in SEHK Securities and route them onto SEHK’s trading platform for matching and execution on the SEHK.
iv. Trading Rules
Northbound Trades executed by SCEPs through Stock Connect will follow the trading rules of the SSE market. Similarly, all Southbound Trades will in principle follow the trading rules of the SEHK market.
Click here to view table.
v. Clearing and Settlement
ChinaClear and HKSCC will establish clearing links to enable the two clearing houses to become a participant of each other and undertake the settlement obligations in respect of Northbound and Southbound Trades.
For Northbound Trades, the HKSCC will, on the one hand, settle with ChinaClear in Shanghai on behalf of participants to the Hong Kong Central Clearing and Settlement System (“Clearing Participants”), and on the other hand, it will settle with Clearing Participants under the Continuous Net Settlement System (“CNS System”) of the Central Clearing and Settlement System operated by HKSCC for the clearing of securities listed or traded on SEHK (“CCASS”). New risk management measures and settlement processes and procedures will be incorporated into the CCASS Rules to align Clearing Participants’ obligations with the operation and requirements of the SSE market.
For Southbound Trades, ChinaClear will assume the settlement obligations of the SSE Subsidiary and settle directly with HKSCC under the CNS System. ChinaClear will also act as a central counterparty and in turn settle the Southbound Trades with its participants in Mainland China.
vi. Quota
To maintain stability in Hong Kong and Mainland markets, trading under Stock Connect will initially be subject to certain quotas calculated on a “net buy basis”. In simple terms, the quota will not be affected if the value of shares bought is the same as the value of shares sold, but if the value of shares bought exceeds the value of shares sold, the quota will decrease. These quotas will be used on a first-come, first-serve basis. There are no restrictions on sell orders.
There is a maximum cross-boundary investment quota (“AggregateQuota”) and a Daily Quota. Northbound Trades and Southbound Trades are subject to a separate set of quotas as follows:
Click here to view table.
The Aggregate Quota caps the absolute amount of fund inflow into Mainland under Northbound Trades and the absolute amount of fund outflow from the Mainland under Southbound Trades. This will result in the Aggregate Quota Balance (which is derived from Aggregate Quota – Aggregate Buy Trades + Aggregate Sell Trades) which will be calculated at the end of each trading day.
The Daily Quota limits the maximum net buy value of cross-boundary trades under Stock Connect each day. It will be calculated in real-time during trading hours and shown on the SEHK website at scheduled times. This will result in a Daily Quota Balance, calculated by Daily Quota – Buy Orders + Sell Trades + Adjustments (adjustments may arise from cancelled/rejected buy orders, and buy orders executed at a better price).
Where the Aggregate Quota Balance falls below the Daily Quota, Northbound buying will be suspended on the next trading day but investors can continue to sell SSE Securities which will increase the Aggregate Quota Balance. SEHK will re-open Northbound buying once the Aggregate Quota Balance returns to the Daily Quota level or above.
Similarly, where the Daily Quota Balance drops to zero or below, new buy orders will be rejected or suspended until such balance becomes positive due to increase in Sell Orders or cancellation of Buy Orders.
vii. Regulatory Framework
Hong Kong investors participating in Stock Connect through SCEPs will continue to be protected by Hong Kong laws (including the Securities and Futures Ordinance), but the current Investor Compensation Fund will not cover any Northbound Trades.
The CSRC and SFC have stated that they will establish an effective regime to respond to all misconduct in either or both markets to protect investors. Specifically:
- The CSRC and SFC will seek to strengthen enforcement cooperation in the following areas:
- Referral and information exchange mechanisms concerning improper activities;
- Investigatory cooperation in relation to cross boundary illegal activities including disclosure of false or misleading information, insider dealing and market manipulation;
- Bilateral enforcement and exchange and training; and
- Enhancement of general standards of cross-boundary enforcement cooperation.
- The CSRC and SFC will establish a dedicated liaison mechanism to deal with any issues arising as a result of Stock Connect which may require joint resolution.
At the exchange level, the market surveillance teams of the SEHK and the SSE will agree on information sharing and investigate assistance mechanisms in order to assist each other in monitoring their own markets.
In addition to its existing power, SEHK may require a SCEP to provide information on its clients’ profiles and the type and value of orders and trades of SSE Securities executed for such intervals and in such form as required by SEHK. SEHK can also publish such information as it considers appropriate to do so.
viii. Applicable PRC Regulations
When participating in Northbound Trades, the existing PRC regulations on shareholding applicable to foreign investors, including the 10% individual shareholding limit and the 30% aggregate shareholding limit in relation to A shares, remain applicable.
Similarly, the current PRC regulation which requires an investor who holds or controls not less than 5% of the issued shares of a Mainland listed company to disclose his interest applies to investors participating in Northbound Trades. This disclosure obligation also applies where such investor increases or decreases his shareholding by 5%, or if a change in his shareholding is less than 5% but results in the shares held or controlled by him falling below 5% of the issued shares in the listed issuer.
3. Proposed amendments to the Rules of the Exchange and the General Rules of CCASS
To facilitate the implementation of Stock Connect, SEHK published proposed amendments to the Rules of the Exchange, the General Rules of CCASS and the CCASS Operational Procedures on 25 August 2014 for market participants’ information. The draft amendments can be found here:
These proposed amendments may be further revised and are subject to the approval of Securities and Futures Commission.
4. Implementation and Expected Timetable
It has previously been indicated that the provisional launch date is 13 October 2014. However, launch of Stock Connect will not take place until the relevant trading and clearing rules and systems have been finalised, all regulatory approvals have been granted and market participants have had sufficient opportunity to configure and adapt their operational and technical systems.
SEHK completed the 2-day connectivity test on 23 and 24 August 2014 to assess participants’ system readiness for market rehearsals which were scheduled to take place on 30-31 August and 13 September 2013.
5. Implications
Despite the restrictions and quotas, Stock Connect is expected to further bridge the relationship between the capital markets in Hong Kong and in the PRC, and enhance a more direct exchange of capital funds between the two markets while respecting the differences between the current regulatory regimes in Hong Kong and in the Mainland.
