The instigators behind China’s capital market reforms have a stellar track record of proving doubters wrong. In 2015, the then embryonic concept of Bond Connect was derided by some experts at an industry conference in Shanghai as being fanciful, an assumption which was discredited two years later.
Likewise, the premise of a London-Shanghai Stock Connect was until recently disparaged as unworkable by cynics, who were again outflanked, with the scheme expected to go live very shortly.
However, the operational impediments facing the latest cross-border trading scheme linking Hong Kong with mainland China – ETF (exchange traded fund) Connect – appear to have become excessively stifling for all parties involved, prompting Hong Kong’s Securities and Futures Commission (SFC) to postpone the initiative in December 2018.
The SFC said that ETF Connect, which was expected to launch last year, had struggled to overcome a number of technical issues concerning differences in trading and settlement mechanisms between Hong Kong and China.
“Access to cash equities via Stock Connect is straightforward while many of the brokers and custodians have found effective ways to enable T+0 stock settlement for clients in accordance with mainland practices. ETFs are slightly different. This is partly because the exchanges in China operate different settlement cycles for ETFs compared to Hong Kong, a technicality which many experts felt was quite challenging,” said Florence Lee, head of China sales and business development for EMEA at HSBC Securities Services.
Other factors have also slowed down ETF Connect’s progress. Lee said Chinese regulators had an exceptionally busy year with market liberalisation initiatives in 2018, adding they were working tirelessly to enhance China-inbound investment schemes including the Qualified Foreign Institutional Investor (QFII), Renminbi Foreign Qualified Foreign Institutional Investor (RQFII), CIBM (China Interbank Bond Market) Direct, Bond Connect, and Stock Connect.
She also said the regulators were heavily involved in the roll-out of London-Shanghai Stock Connect, something which may have contributed to fewer resources being allocated to the ETF Connect programme.
While postponing a project is certainly not the same as giving up on it, it is clear that both China and Hong Kong’s regulators are putting their energies into exploring alternative mechanisms to enable ETFs to be distributed cross-border.
One solution reportedly under consideration is to allow ETFs to list cross-border via the Mutual Recognition of Funds (MRF) model, a four-year old programme allowing Hong Kong and Chinese asset managers to distribute in each other’s jurisdiction.
“Global ETF players see China as an excellent distribution opportunity given the size of the mainland investor market,” said Lee. While larger ETF providers are roundly upbeat about China, smaller firms may find the cost of a dual listing in both Hong Kong and the mainland unpalatable. The time and effort required when obtaining authorisation to distribute in China through the MRF channel may also be off-putting for some ETF managers.
“Distributing ETFs under MRF requires product owners to obtain authorisation for each fund from the host regulators, which can be a rather less straightforward process while there are sometimes uncertainties in terms of the speed of approval. In past cases, there have been applications pending now for two to three years. The success of cross-listing will depend on the speed at which ETFs are approved, although it is important to note that the regulators have yet to announce the finer details about the rules,” commented Lee.