More clarity tipped on Stock Connect this week

The chief executive of Hong Kong Exchanges and Clearing, Charles Li, has indicated that an announcement to clarify tax uncertainties surrounding the imminent launch of the Shanghai-Hong Kong Stock Connect scheme can be expected within days.

The Securities and Futures Commission (SFC) and China Securities Regulatory Commission (CSRC) jointly revealed yesterday that the scheme – to facilitate direct stock trading between Hong Kong and Shanghai within initial quota limits – would launch on November 17, providing just a week’s grace before the launch.

So far China’s State Authority of Taxation has failed to provide clarity on whether capital gains tax (CGT) will be levied on northbound trades (A-share trades made through Hong Kong).

In mainland China, investors are charged a 10% tax on capital gains made from trading A-shares, but Hong Kong does not impose a levy on trading of shares listed in the city.

But Li, speaking at a press conference convened at the Hong Kong Stock Exchange yesterday to coincide with the announcement, suggested clarification come this week in advance of the launch.

“My firm understanding is the issue is being resolved based on a clear understanding [by China’s State Authority of Taxation] of what investors needs and concerns are,” Li said. “My understanding is we are very close to that being announced.”

He noted that some large broker-dealers had been reluctant to open trading accounts in preparation for Stock Connect due to lack of clarity on the tax issue.

“If I were them, I would not really waste time agonising about it. I would be operating as if this [the tax issue] is going to get done. The last item yet to be announced is on the tax regime, but it will be announced before launch."

Unsurprisingly, Li expressed considerable optimism about the scheme, saying it had a compelling internal logic. He praised regulators for speedy efforts at market convergence.

“If it’s actually going to work, this represents a breakthrough, potentially cutting 10 years off the development time needed for the two markets to converge,” he said.

Separately, Nick Ronalds, head of equities at the Asia Securities Industry and Financial Markets Association (Asifma), described the scheme as a historic game-changer for China and for investors globally.

He said the initiative was a critical step in RMB internationalisation and in China’s reform process. But that did not stop him bringing up the tax issue.

“There have been indications that these issues will be clarified soon, but who knows what that means,” said Ronalds. “For some time there have been rumours that there will be no capital gains tax or business tax, and that is what we are all hoping for.”

He said the tax issue was a big one that, unless resolved, would cause long-only managers above all to hang back and wait for greater clarity.

Last month Asifma had sent a letter to Hong Kong’s Securities and Futures Commission (SFC) requesting up to a month’s notice to allow the market to prepare for launch.

And yesterday Ronalds suggested the speed of the scheme's implementation was not ideal. “We would certainly have preferred more than a week,” he told AsianInvestor.

But he, too, expressed confidence that the tax issue would be resolved, as had other operational issues, including pre-delivery requirements and provision for correcting errors.

He noted the market was aware that short-selling would not be available from day one, and stressed that people should be mindful this was a pilot scheme.

“There are restrictions that will make stock borrowing and lending difficult,” Ronalds said. “Of course, without borrowing and lending you can’t have short-selling.”

But Li suggested a system would be in place in Hong Kong by early 2015 allowing the short-selling of A-shares, while adding that rules on covered short-selling would not likely be released until a later date.

“From a technical standpoint, they [the two regulators] are as ready as they can be,” Ronalds added. “The remaining uncertainty around taxes is problematic for finalising paperwork for clients and that is why the extra time would have been desirable.

“That is part of the problem. Every firm has to decide what their process will be. Some might withhold pending further clarity.”