Shanghai-Hong Kong stock connect - what it means for investing in China

Stock Connect will allow foreign investors (those not resident in mainland People’s Republic of China (PRC)) to trade A-shares listed on the Shanghai Stock Exchange (SSE)** via the Hong Kong Stock Exchange (HKSE). In return, mainland PRC investors will be able to trade in listed shares on the HKSE via the SSE.

Stock Connect allows access to over 568 A-shares listed on the SSE, representing over 90 per cent of the SSE’s market capitalisation. Investors will be able to invest a total of 300bn renminbi through Stock Connect. Aggregate daily net purchases (calculated net of sales) are limited to a cap of 13bn renminbi***. There is no corresponding cap on net sales, so the cap should not restrict investors wanting to sell.

Currently, foreign investors can only directly purchase A-shares by way of a licence through either of the Qualified Foreign Institutional Investor (QFII) or Renminbi Qualified Foreign Institutional Investor (RQFII) programmes.

Trading A-shares via Stock Connect has two significant advantages over QFII/RQFII:

• Broad participation: Stock Connect is open to all investors and no licence is required to participate. By contrast, QFII/RQFII are primarily aimed at institutional investors and require a licence to use.
• Lock up/repatriation restrictions: There are no restrictions to lock up the proceeds of sale or delay repatriation of those proceeds. Under QFII/RQFII both of these restrictions exist.
  
  

However, Stock Connect will not supplant QFII/RQFII, as QFII/RQFII are available for a broader range of investments, including bonds, investment funds and IPOs. Further, while each of Stock Connect, RQFII and QFII are subject to aggregate investment caps, each cap is independent of the other, meaning that it may be possible to invest via QFII or RQFII if a Stock Connect cap were reached.

Stock Connect is being offered to clients by brokers in Hong Kong either through physical trading of A-shares or by economic exposure to A-shares via synthetic access (such as trading through derivatives or in note form). The documentation to cover this is currently being circulated by a number of brokers, and ISDA has published certain additional provisions (available here) to cover aspects of trading through Stock Connect on derivative. Across the different products, there are a number of issues to consider, including:

• Tax: The application of PRC tax on Stock Connect holdings remains unclear, despite efforts to clarify this in recent months. How and to what extent this risk is passed on to clients should be carefully considered.
• Trading quotas/restrictions: The treatment of client orders subject to caps or individual restrictions on brokers needs to be agreed with the broker.
• Share settlement: Differing settlement cycles between Hong Kong and Shanghai mean that the day prior to the trade a seller of A-shares must transfer the shares to be sold to its HKSE broker so that they are available for sale. Some brokers have bespoke custody offerings to mitigate the impact on trading and counterparty risk that this causes.
• FX conversions: Shares will trade at onshore renminbi (CNY) prices on the SSE but settle in offshore renminbi in Hong Kong (typically labelled CNH). CNY and CNH typically trade with minimal difference in price, but a transparent mechanism for FX conversion should ideally be recorded, more so if trading a synthetic product with the proceeds converted out of renminbi into another currency.

*By the Hong Kong Securities and Futures Commission, the China Securities Regulatory Commission, the Shanghai Stock Exchange, and the Hong Kong Stock Exchange.

**The Shenzen Financial Service Office and Shenzen Stock Exchange have said that they are in discussions to create a second stock connect between the Shenzen Stock Exchange and HKSE. Further, should Stock Connect be successful, it is hoped that it will be widened to include bonds and other products.

*** All quotas and restrictions are subject to change.