Further details emerge on QDII2 stocks link

Further details have emerged on the trading and settlement arrangements under the Shanghai-Hong Kong stock connect, covering securities financing and the use of proceeds from stock sales, among other things.

The trading, settlement and clearing mechanism of the scheme will broadly follow a reciprocal structure for China onshore and offshore participants, says Bryan Chan, co-head of equities and fixed income and currencies at Hong Kong Exchanges and Clearing (HKEx).

However, differing trading rules in China and Hong Kong mean an investor’s home regime will ultimately dictate whether it can engage in margin financing, short-selling and other activities in either market.

For example, mainland investors are allowed to do margin financing and stock borrowing and lending, but Hong Kong and overseas investors cannot do so in respect of mainland shares via the Shanghai-Hong Kong link, says Chan. Yet there is no rule preventing offshore investors holding A-shares from short-selling these securities in Hong Kong via the trading link.

Importantly, for risk management purposes, all cash proceeds from stock sales must remain in the clearing participants’ account for the sole purpose of equities trading, notes HKEx. This is to prevent cross-border fund flows leaking out of the China and Hong Kong securities markets to fund other asset purchases.

However, while investors are allowed to trade freely the pool of eligible securities, they cannot sell securities to use the proceeds to immediately buy another stock listed on the same exchange.

While some trading arrangements have been clarified, there are still outstanding details that officials are ironing out. Taxation is one. Hong Kong officials are still seeking clarification from the Chinese tax bureau on the rate at which dividend and capital gains tax will be applied to A-share trading.

Another concerns risk management – namely whether Hong Kong brokers participating in the link must contribute to the mainland risk clearing fund to be paid to China’s securities regulator and Ministry of Finance.

The scheme – announced on April 10 and also known as QDII2 – is expected to go live around mid-September. It will allow Hong Kong and offshore investors to trade all SSE 180 and SSE 380 stocks directly through HKEx without needing quota.

Likewise, mainland investors will be able to trade all 266 stocks of the Hang Seng Composite Large Cap and Hang Seng Composite MidCap indices directly through the Shanghai Stock Exchange (SSE).

As previously announced, there will be an initial aggregate quota of Rmb300 billion ($48.8 billion) and a daily quota of Rmb13 billion imposed on ‘northbound’ trades – that is, trading of SSE shares by Hong Kong and overseas investors. The equivalent figures for southbound trading of Hong Kong stocks are Rmb250 billion and Rmb10.5 billion. The aim is to control the pace and size of cross-border fund flows.

All the renminbi conversions for northbound trades are done in Hong Kong, while all fund flows into and out of China will be in RMB.

Meanwhile, HKEx confirmed that qualified foreign institutional investors (QFIIs) and renminbi-quaified foreign institutional investor (RQFIIs) can benefit from the link because they do not have to apply for quota again from Chinese authorities. Their ability to trade A-shares will be on a first-come, first-serve basis, as they are free to put in orders so long as the daily quota is not exceeded.