Attempt to fix Stock Connect pre-trade checking goes live

A reformed trade settlement system was rolled out to Stock Connect investors yesterday in a bid to address concerns over the pre-trade checking requirement.

Commentators said the changes would better facilitate trades under the cross-border link, which has been criticised since its launch over cumbersome procedures which were deterring investors.

However, concerns over beneficial ownership issues have still not been resolved, with restrictive Stock Connect requirements on ownership and asset segregation still in place.

Yesterday Hong Kong Exchanges and Clearing rolled out the special segregated accounts system (SPSA) in its central clearing and settlement system (CCASS), which it has touted as a way of addressing investors’ concerns over pre-trade checking requirements under the Shanghai-Hong Kong Stock Connect scheme.

Investors such as fund managers can now open an SPSA account in CCASS through custodian participants or general clearing participants (GCPs), so they can place sell orders under Stock Connect without first delivering shares to their brokers. Investors are now only required to deliver the shares they are selling for settlement after those sell orders have been executed by their brokers.

“This model enables managers to use multiple execution brokers any time and is conducive to best execution,” said Sally Wong, chief executive of the Hong Kong Investment Funds Association (HKIFA).

Under previous rules, investors had to deliver sell-order shares to their broker at least one day before order execution. This pre-trade checking issue, or pre-trade delivery, has been a key investor concern since the trading link launched in November last year.

An HKIFA survey in January showed 65% of managers saw it as the key problem, after beneficial ownership. The industry trade body Asia Securities Industry & Financial Markets Association and fund managers such as Singapore-based Lion Global Investors have also expressed concern that pre-trade checking could increase settlement risk. Part of the reason for this is that some regulators forbid managers from delivering stocks to a broker before a trade, or investors often decide to make a sell trade on the same day as they want to execute the transactions.

The Hong Kong bourse soft-launched SPSA on March 30 and has allowed custodian participants, non-exchange participant GCPs and brokers to set up SPSA accounts with investors over the past three weeks. According to the HKIFA, managers that have opened SPSA accounts or that plan to open accounts are in close dialogue with their brokers, custodians and sub-custodians to work out the flow and finalise operational details.

“SPSAs will make it easier for investors to minimise counterparty risk in A-share settlement and to maintain compliance with asset segregation and safekeeping requirements for institutional funds,” said Calvin Tai, HKEx’s head of global clearing (Asia).

However, another key concern over beneficial ownership has not been solved. Under current rules, stocks owned by foreign investors are held in a separate account controlled by the Hong Kong Securities Clearing Company (HKSCC), a subsidiary of HKEx, but Luxembourg's Ucits funds regulator CSSF has strict requirements on ownership and asset segregation. Nearly 85% of managers have cited beneficial ownership as their top concern in Stock Connect participation.

The Hong Kong bourse amended its Stock Connect “FAQs for investor” document in late March in response to the issue of beneficial ownership. HKSCC will assist the CCASS participant or its client in bringing legal action in China if a CCASS participant requests it.

“HKEx outlined its role regarding the issue of beneficial ownership the first time,” said HKIFA’s Wong. “Having clarity and certainty about beneficial ownership is pivotal as it is the cornerstone of investor protection.”

AsianInvestor has reported that Stock Connect’s beneficial ownership problem is close to being resolved with both HKEx and the China Securities Regulatory Commission (CSRC) attempting to make changes to the trading link’s rules.

Luxembourg’s financial regulator has given at least four funds approval to invest through Stock Connect and more approvals may be granted soon, local media reported in early March.

Stock Connect trading has picked up quickly in recent weeks amid a strong demand for China equities. Northbound trades yesterday reached a total of Rmb123.4 billion ($19.9 billion), or 41% of the aggregate quota.

Southbound trades have also surged after the CSRC gave Chinese mutual funds permission to trade via Stock Connect in late March. Total southbound trades last Friday reached Rmb71.3 billion, or 29% of the aggregate quota.