Stock Connect attracts users despite volatility

The number of global fund houses to have joined the Shanghai-Hong Kong Stock Connect has leapt significantly in the past year, suggesting they had been concerned about the readiness of the trading link and have not been put off by recent short-term market volatility, according to new research.

A Hong Kong Investment Funds Association (HKIFA) survey of 39 fund houses* running a total of $22 trillion found that around eight in 10 had invested in China A-shares via the trading link so far. That compares to only 31% to have done so at the time of the first such survey, conducted in November and December, soon after the scheme went live on November 17, 2014.

This is because some key technical issues, such as clarity around beneficial ownership – which had hindered firms from getting internal approval to use the link – have been addressed, said Sally Wong, chief executive of HKIFA.

In May last year the China Securities Regulatory Commission confirmed the validity of the nominee shareholding structure for offshore investors holding A-shares through Stock Connect under the name of the Hong Kong Securities Clearing Company.

Just 35% of the respondents said beneficial ownership was an issue, down from 80% in the first survey. But managers believe it would be helpful if the concept were embedded in the relevant regulations, said the HKIFA.

Currently, true delivery vs payment (DVP) tops the list of issues to be sorted out before managers start to invest via Stock Connect or use it more extensively, as cited by 59% of respondents.

Hong Kong’s Central Clearing And Settlement System does not currently offer fully fledged DVP for transactions as securities settle on trading day (T) while cash settles on T+1. This poses a challenge for regulated funds, such as Ucits, which are not allowed to take counterparty risk whereby they sell shares but do not receive payment until the next day, HKIFA said.

“Resolving the DVP issue is top of Hong Kong regulators’ agenda, and the relevant enhancements are expected to roll out next year,” Wong told AsianInvestor.

Other issues cited by managers include disclosure of interest and the short-swing profits rule, with 21% and 18% of respondents, respectively, indicating that these two requirements pose compliance challenges. These figures were similar to those seen in the survey last year.  

Meanwhile, global fund houses’ keenness to join the Stock Connect doesn't seem to have been affected by the recent stock market volatility. Eighty-two percent indicated they will continue using or start to use the link in the next 12 months.

Four in 10 (39%) of respondents said the development had not affected their market outlook while 32% indicated that they had seen some negative short-term impact but had not changed their medium- and longer-term outlook.

Global fund firms are under-allocated to China, Wong said, and further structural enhancements will help boost investments through the Stock Connect.

While there has been a big increase in the number of firms investing through the scheme, most are not using it on a fully fledged basis. Typically they only do so for certain categories of funds – for example, unauthorised funds – or a limited range of authorised funds and/or institutional mandates. 

The limited usage can be is down to the fact that some managers are in trial mode, said the HKIFA.

Meanwhile, nearly 90% of firms cited Shenzhen stocks as a key addition they want to see added to the scheme.

Terry Pan, chairman of HKIFA, said: “Fund managers see the Shanghai and Shenzhen markets as complementary, since they offer different opportunity sets. The Shanghai market has more “old economy” companies that come from traditional industries and more large caps; whereas Shenzhen has more “new economy” companies offering access to small- and mid-cap growth stocks, which represent interesting investment opportunities over the longer term.” 

Further, 63% of managers wish to see the expansion of the Shanghai pool to cover all A-shares listed there. The link now allows foreign investors to access 568 Shanghai stocks, 53% of the total number of A-shares in Shanghai and 20% of those listed across Shanghai and Shenzhen.

*More than 90% of respondents were global fund houses, with local players making up the rest.