The rules governing beneficial ownership under Stock Connect will ultimately be determined in the courtrooms, while there is speculation there could be delivery versus payment (DVP) modifications to the scheme around April 2016.
Take up of Stock Connect, which allows investors with Hong Kong brokerage accounts to trade in China A Shares, and Chinese investors to transact in certain Hong Kong securities, has increased following a slow start in November 2014. One of the major factors behind the investor caution was the lack of clarity over whether China recognized the concept of beneficial ownership.
Stock Connect securities are held in nominee account structures on behalf of beneficial owners. This is in marked contrast to the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) schemes where securities are held in the name of beneficial owners in segregated account structures. However, the Chinese authorities have said they recognise beneficial ownership under Stock Connect.
Bernie Chew, regional head of network management at Northern Trust, speaking at NEMA Shanghai, said Chinese courts would ultimately determine who owns what in the event of an insolvency under Stock Connect. However, he praised Stock Connect for its handling of the recent market volatility.
There is also speculation that there could be enhancements to Stock Connect’s DVP process around April 2016. Franky Chung, senior vice president of the mainland division at Hong Kong Exchanges and Clearing Limited, said the market infrastructures were collecting feedback from industry participants. It is believed that a major announcement could be made early next year on DVP.
Any changes to the current system would be a much welcome development with many market professionals advocating China adopt same day delivery of cash and securities. The present model adopted by China has frustrated investors.
China has a T+1 trade settlement time for cash and a T+0 trade settlement time for securities. This contrasts with Hong Kong which uses a T+2 settlement time for cash and securities. As such, investors selling China A shares on the mainland must wait one day to receive cash after transferring the securities. This can expose them to counterparty risk and it was a major factor as to why UCITS funds were slow to embrace Stock Connect.
Nonetheless, many custodian banks have enabled clients to avoid pre-delivery of securities through the establishment of Special Segregated Account Model [SPSA]. It operates by permitting global custodian banks to park assets in sub-custody accounts where the quotas can be verified by the exchange in a manner just as efficiently as when assets are pre-delivered to the brokerage accounts.
Stock Connect is also expanding. Shenzhen is likely to have its own Stock Connect with Hong Kong while there is speculation London could also benefit. However, the likelihood of London having its own Stock Connect is slim given the time-zone differences which would cause problems around clearing and settlement, not to mention Chinese restrictions around short-selling and use of the Renminbi as the sole currency.
“Stock Connect is hugely exciting and we are looking forward to including more asset classes down the line. At present, Stock Connect applies just to equities but investors would like to see more derivatives and fixed income, currencies and commodities (FICC) being allowed,” said Chung.