15 September, 2016
Following from the launch of Shanghai-Hong Kong Stock Connect (Shanghai-HK SC) in November 2014, the Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) made a joint announcement on 16 August 2016 about their in-principle approval for the establishment of mutual stock market access between Shenzhen and Hong Kong (Shenzhen-Hong Kong Stock Connect (Shenzhen-HK SC)).
The much anticipated Shenzhen-HK SC is one of The Stock Exchange of Hong Kong Limited’s (SEHK) major strategic initiatives to expand mutual connectivity with the Mainland, and is expected to further promote the development of capital markets in both jurisdictions. It is expected to be launched in around November 2016.
This article provides an overview of the key features of Shenzhen-HK SC and compares it with some of the key features of Shanghai-HK SC, which we outlined in our e-bulletin of 1 September 2014.
1. EFFECT
Similar to Shanghai-HK SC, Shenzhen-HK SC will allow investors to conduct cross border trading and access more sectors.
Through the Northbound Shenzhen Trading Link, investors (through eligible brokers and a securities trading service company to be established by SEHK in Shenzhen) will be able to trade eligible shares under Shenzhen-HK SC listed on the Shenzhen Stock Exchange (SZSE) by routing orders to SZSE’s trading platform for matching and execution on the SZSE.
Conversely, through the Southbound Hong Kong Trading Link, investors (through eligible Mainland securities firms and a securities trading service company established by SZSE in Hong Kong) will be able to trade eligible shares under Shenzhen-HK SC listed on SEHK by routing orders to SEHK.
Eligible shares that investors will have access to under Shenzhen-HK SC as compared to Shanghai-HK SC are set out in the following table:
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Northbound Shenzhen |
Southbound Hong Kong |
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Shenzhen-HK SC |
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|
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Northbound Shanghai |
Southbound Hong Kong |
|
Shanghai-HK SC |
(see the list of eligible stocks published by SEHK from time-to-time) |
(see the list of eligible stocks published by SEHK from time-to-time) |
The calculation of the above-mentioned market capitalisations of certain constituent stocks for the purpose of determining their eligibility for trading under Shenzhen-HK SC generally follows the same methodology and review period adopted by the compiler of the relevant index. A proposed methodology (subject to regulatory approval) is attached to SEHK’s circular of 26 August 2016.
2. KEY FEATURES
A. Quotas
Previously, there was a maximum cross-boundary investment quota (Aggregate Quota) of RMB 300 billion for Northbound trades and RMB 250 billion for Southbound trades under Shanghai-HK SC. This meant that the absolute amount of fund inflows and outflows was capped according to an Aggregate Quota Balance calculated at the end of each trading day.
However, SEHK has announced that the Aggregate Quota has been abolished with immediate effect, and that there will be no aggregate quota under Shenzhen-HK SC.
According to Charles Li, the Chief Executive of Hong Kong Exchanges and Clearing Limited (HKEX), the Aggregate Quota has been removed to give institutional investors more confidence that the A share market is open for investment on a large scale.
The other Shanghai-HK SC investment quota (ie, the maximum net buy value of cross-boundary trades each day
(Daily Quota)), which remains in place for risk management considerations and will also apply to the Shenzhen-HK SC, has effectively been doubled. The current Daily Quota is now RMB 13 billion for the Northbound Trading Link and RMB 10.5 billion for the Southbound Trading Link.
B. Exchange participants and investors
All investors outside Mainland China can participate in Shenzhen-HK SC Northbound trading, other than in respect of shares listed on the ChiNext Board of the SZSE which will initially be limited to institutional professional investors (as defined in the relevant Hong Kong rules and regulations). However, in order to participate, investors will have to trade though brokers who are registered as an exchange participant of SEHK and are eligible to participate in Shenzhen-HK SC.
SEHK exchange participants have been advised to assess whether they need to increase their bandwidth of Securities and Derivatives Network (DSNet) before participating in Shenzhen-HK SC. They should also submit end-to-end China Stock Connect System testing results by 30 September 2016.
C. Trading, clearing and listing rules
The 16 August 2016 announcement by the SFC and the CSRC stated that other issues concerning Shenzhen-HK SC not described in the announcement shall be dealt with by reference to the SFC and the CSRC’s joint announcement dated 10 April 2014 regarding Shanghai-HK SC. Such issues include applicable trading, clearing and listing rules, clearing arrangements, investor eligibility, and cross-boundary regulatory and enforcement cooperation and liaison mechanisms.
Accordingly, the trading and clearing arrangements for Shenzhen-HK SC are expected to follow the Shanghai-HK SC model, which means they will be subject to the regulations and operational rules of the market where the trading and clearing takes place, ie, “home market” rules. As a result, listed companies will continue to be subject only to the listing and other rules and regulations of the market(s) where they are listed.
Shenzhen-HK SC will also only operate on a day which is a trading day of both the SZSE and the SEHK and where the clearing arrangements are in order.
D. Clearing arrangements
Similarly, if Shenzhen-HK SC follows the Shanghai-HK SC model as proposed, China Securities Depository and Clearing Corporation Limited (ChinaClear) and Hong Kong Securities Clearing Company Limited (HKSCC) will likely 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.
Currently under the Shanghai-HK SC arrangements for Northbound trades, ChinaClear acts as the host central counterparty and HKSCC is a participant of ChinaClear. HKSCC takes up settlement obligations of its clearing participants in respect of Northbound trades and settles the trades directly with ChinaClear in the Mainland.
For Southbound trades, HKSCC acts as the host central counterparty and ChinaClear is its clearing agency participant. ChinaClear takes up settlement obligations of its clearing participants in respect of Southbound trades and settles the trades with HKSCC in Hong Kong.
3. REGULATORY FRAMEWORK
The SFC and SEHK have previously stated that any Northbound or Southbound trading under Shanghai-HK SC will not be covered by Hong Kong’s Investor Compensation Fund and the same is likely to apply for Shenzhen-HK SC.
However, the CSRC and the SFC have committed to establishing an effective regime to respond to misconduct in either or both markets on a timely basis in order to protect investors.
Specifically, the CSRC and the SFC indicated when they jointly announced Shanghai-HK SC in April 2014 that they would 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 exchange and training; and
- enhancement of general standards of cross-boundary enforcement cooperation.
They subsequently entered into a memorandum of understanding in October 2014. They are likely to have a similar arrangement for Shenzhen-HK SC.
The Secretary for Financial Services and the Treasury, Professor K C Chan, stated, in his reply to the Legislative Council on 10 December 2014, that SEHK and SSE have agreed to require simultaneous trading suspension of companies with A and H shares listed in the two markets if the company has any unpublished inside or material information or where there is a false market concern. The same is likely to apply for Shenzhen-HK SC.
Professor Chan also noted that sections 274 (false trading) and 295 (offence of false trading) of the Securities and Futures Ordinance(SFO) cover false trading in securities of any relevant market outside Hong Kong or by means of authorised automated trading services. As such, a Hong Kong investor may commit the aforesaid market misconduct by manipulating Mainland securities through either Shanghai-HK SC or Shenzhen-HK SC.
There are also likely to be repercussions for Hong Kong investors who conduct insider dealing in Mainland securities. As noted by Professor Chan, even though the insider dealing provisions under Parts XIII and XIV of the SFO do not expressly cover non-Hong Kong stocks, the fraudulent nature of the insider dealer’s conduct may amount to a contravention of section 300 (offence involving fraudulent or deceptive devices, etc) of the SFO.
Professor Chan also stated that in the unlikely situation where the markets cannot continue to be operated in a fair, orderly and transparent manner, the exchanges and clearing houses will discuss with the regulatory authorities to consider whether corresponding actions are required, including temporary suspension of Shanghai-HK SC. A similar arrangement will likely apply for Shenzhen-HK SC.
4. TIMELINE
According to the SFC and the CSRC, the formal launch of Shenzhen-HK SC will only take place after preparation for the relevant trading and clearing rules and systems has been finalised, all regulatory approvals have been granted, market participants have sufficiently adapted their operational and technical systems, and all necessary arrangements for cross-boundary regulatory and enforcement cooperation, as well as investor education, have been put in place.
The 16 August 2016 joint announcement stated that it will take approximately four months from the date of the announcement to complete the above-mentioned preparations. More recently, it has been reported that the launch will likely take place earlier, in November 2016. A separate announcement will be made with respect to the formal launch date.
5. FUTURE PLANS FOR SHANGHAI-HK SC AND SHENZHEN-HK SC
The SFC and the CSRC have stated that to further enrich the variety of traded products and provide more investment opportunities and convenience for domestic and overseas investors, they will be including exchange-traded funds (ETFs) as eligible securities under Shanghai-HK SC and Shenzhen-HK SC. A launch date will be announced after Shenzhen-HK SC has been in operation for a period of time and upon the satisfaction of relevant conditions.
Charles Li has also indicated that SEHK will continue looking at ways to broaden the Stock Connect initiatives, including new asset classes and building more bridges so that investors will have more opportunities and choices.
6. CONCLUSION
Both Shanghai-HK SC and Shenzhen-HK SC play an important part of HKEX’s Strategic Plan 2016-2018 to build an effective platform for cross-border market access and to develop a unique destination market in Hong Kong for products with both Chinese and international relevance.
HKEX continues to look ahead and has declared that its next step in the equity space is to launch “Primary Equity Connect” to enable investors to subscribe to primary market offerings, and to expand its derivatives suite to help cross-border investors manage their risks.
For further information, please contact:
Will Hallatt, Partner, Herbert Smith Freehills
will.hallatt@hsf.com
