By Rupert Walker, Managing Editor, GlobalTrading
New products, the extension of China Connect and service upgrades are strengthening HKEX’s role as a leading financial hub.
Hong Kong Exchanges and Clearing (HKEX) continues to develop its markets infrastructure and introduce new products across asset classes to meet the requirements of investors and issuers. In addition, it is consolidating its position as the global offshore renminbi (CNH) hub, and facilitating further trading linkages with Mainland China through an extension of the Connect programme.
HKEX’s Data Centre plays a key role for all market participants through the range and quality of its technology, with around a half of cash equities and derivatives trading now transacted through its co-location facilities, said Jonathan Leung, Senior Vice President and Head of Hosting Services at HKEX, to delegates at the HKEX Hosting Services Ecosystem Forum 2017 held on 25 May.
The hosting part of the Data Centre’s capabilities include tier 4 data centre specification, low latency direct market feeds for cash and derivatives trading, an interactive ecosystem environment supporting trading, broad telecommunications carrier access and flexible power and space packages offering both racked and caged environments.
Prudent technology investment
Indeed, HKEX has a long history of technological innovation, although it is always cautious about introducing unproven systems, preferring a prudent approach, according to Richard Leung, Deputy Group CIO and Chief Technology Officer at HKEX. It first created an electronic central clearing and settlement system in 1992 and in the following year set up a first-generation order matching and execution platform for cash transactions, extending it to derivatives in 1995. HKEX is upgrading its platform to deploy the latest open systems technology, but with a minimum of disruption for users.
In 2011, HKEX Orion, a major technology upgrade programme that enabled HKEX to offer hosting services, was launched, and now the next generation systems are being developed and deployed.
HKEX is naturally examining fintech innovations, but is aware of their risks so is wary about adopting them, said Leung. Distributed ledgers might improve post-trade operations and HKEX is reviewing its possibilities, but is concerned about the security risks of selecting a blockchain system when there are competing designs and encryptions available that could make its choice redundant.
There are several applications of the Cloud that exchanges could use and HKEX introduced virtualisation six years ago, but there are data sovereignty concerns. Big data is actually quite easy to collect, but acquiring and applying the right analytical tools is the challenge.
There is no first mover advantage from adopting these new technologies in the financial market infrastructure space; instead there are dangers from moving too quickly, argued Leung. Retaining customers’ trust and ensuring data security must be HKEX’s priority, he added.
Nevertheless, HKEX is continuing to expand the scope and quality of its hosting services as an ecosystem for participants, rather than as a commercial enterprise.
HKEX hosted as of August 2017 a historical high of 592 trading participants on its securities market. The momentum of southbound Stock Connect trading has increased significantly. Products such as Exchange Traded Funds (ETFs) have added to market turnover, and HKEX is keen to further promote Leveraged and Inverse Products (L&I Products).
Meanwhile the average daily turnover of securities market turnover for the first seven months of 2017 was HK$77.4 billion ($9.9 billion), an increase of 16% compared with HK$66.7 billion for the same period last year.
New products and services
The roadmap for 2017/2018 includes the potential launch of the “Next Generation” Orion Trading Platform for the securities market by at the end of this year, and continued development of the Stock Connect schemes to potentially include more products, said Kenneth Kok, Head of Cash Trading, Markets Division at HKEX.
The recently implemented phase 2 of the closing auction session (CAS) includes regulated short-selling. For those participants concerned about the risks, it is important to note that CAS phase 1, launched in July 2016, caused no increase in price volatility, despite warnings by critics, noted Kok. Instead, it led to a substantial take-up by institutional investors allowed to execute trades at closing prices.
Julien Martin, Head of FIC Product Development, Market Development at HKEX explained three main pillars of HKEX’s strategy. First, the growth of the cash market through Mainland and international investors and the implementation of Bond Connect; second, the development of exchange-traded rates and credit derivatives and of deliverable futures; and third, the expansion of over-the-counter (OTC) clearing capabilities, especially for renminbi, he said.
Bond Connect, which was launched in July, strengthens Hong Kong’s role in offshore renminbi, making the territory an even more relevant international financial centre.
The initial focus of Bond Connect is on northbound investment into Mainland China’s vast domestic bond market. The objective is to minimise inconvenience for international investors through cooperation with Mainland China’s foreign exchange authorities, the implementation of a nominee structure, no quotas and eligibility similar to the existing investor access to the interbank bond market.
The onshore Rmb10 trillion interbank bond market is set to overtake Japan as the world’s second largest bond market within 10 years, yet foreign investors own less than 2% of it. The People’s Bank of China has a target of 10-15% foreign ownership, and there are strong policy incentives, such as a stable renminbi (now benchmarked against a basket of 24 currencies) and liquid short-dated bonds with attractive yields.
HKEX is gaining market share in offshore renminbi from banks, because of restrictions and costs. The USD/CNH futures contract on the exchange is one of the most active in the world, traded by numerous clients and supported by eight market makers. Plans are being prepared for it to trade overnight, and three new indices have been introduced in partnership with Thomson Reuters. In addition, HKEX was the first exchange to launch physical USD/CNH options .
Benefits of Hong Kong ETFs
The global ETF market eclipsed $4 trillion in assets in the second quarter of this year and is expected to grow to over $6 trillion in the next five years. ETFs have grown enormously in popularity among long- and short-term retail and institutional investors attracted by their liquidity, quick access and cost efficiency.
While Asia Pacific’s ETF market is in the earlier stages of development, Hong Kong has been a leader since 1999. Asia-based investors are becoming increasingly aware of the diversity and the tax advantages of ETFs listed in Hong Kong, but more education is needed, said Brian Roberts, Head of ETPs, Market Development at HKEX.
ETFs make up between 6 and 7% of HKEX’s average daily cash market turnover, which is impressive considering ETFs make up less than 2% of Hong Kong’s equity market capitalisation. As more institutional and retail investors become aware of the advantages of ETFs, HKEX could experience further growth, according to Roberts. Retail investor participation in ETFs is around 10% compared with 15%-to-20% of the cash market, so their involvement in ETFs should grow as they learn more about their advantages.
Interest in ETFs and the size of the market are growing in Asia, not least because of the tax benefits of Hong Kong-listed products, agreed Sean Cunningham, head of capital markets for iShares and index investing APAC at Blackrock. Clients have gone to the US and Europe for liquidity, but there has been an increase in the number of Hong Kong products that overseas investors can trade in their own time zone, he said.
The current HKEX ETF strategy has three principal components. HKEX aims to encourage product diversity through expanding ETF and L&I listings; improve market access, delivery and liquidity; and focus on regional and international education about the tax efficiency and other benefits of Hong Kong-listed ETFs.
Hong Kong should grow its share of global ETF listings and trading and firmly establish itself as the Asia hub. It has a supportive ecosystem made up of sophisticated investors, ancillary financial services and, of course, access to Mainland China.
China Connect expands
The Connect programmes are continuing to evolve in order to attract investors. Although the Connect scheme is a closed loop for purchases and sales of securities, repatriation of northbound capital is much easier than from investments made through the Qualified Foreign Institutional Investor and other schemes, because there is no lock-in period, said Christopher Hui, Head of Project Management at HKEX.
Moreover, since Shenzhen Stock Connect there are no longer aggregate quotas, and planned enhancements include the introduction of real-time delivery versus payment (RDVP) settlement, which will help address concerns about potential counterparty risk.
In the future, Mainland insurance companies are likely to be substantial southbound investors in order to diversify portfolios, find liquidity and enhance yields, noted Vernon Willis at Haitong Securities in a panel discussion chaired by Jessica Morrison, director, equity trading at Deutsche Bank.
Blackrock’s Cunningham pointed out that trade execution reliability in A-shares is essential, perhaps especially for index houses. He and his fellow speakers agreed that the inclusion of A-Shares with the MSCI’s global emerging market index would be major boost for the schemes – and which subsequently occurred in June.
Chris Lee, Senior Vice President, Client and Marketing Services, Market Development at HKEX pointed out that there have been several changes to Connect since the scheme was first launched and noted RDVP settlement will be available by the end of the year. Already, HKEX has improved the comfort factor for beneficial ownership and there has been considerable success working with the regulators of Irish and Luxembourg funds.
Nick Ronalds, managing director, equities at ASIFMA agreed that RDVP is a very significant development, especially for UCITs as European regulators had expressed graves concerns about counterparty risk. But, there are other problems, such as holiday trading and meeting T+0 deadlines for CNH settlement.
According to Andy Maynard, head of Asia Pacific execution services at HSBC, the CNH’s lack of liquidity is a big concern and a limiting factor, causing trading ebbs and flows. Pre-funding has become difficult and the renminbi was very volatile during the past year.
Global long-only emerging market funds dominate northbound flows, but even they don’t consider Mainland China a great investment prospect at present. It’s not so much the restrictions within the Connect programme or even the index status of A-shares that account for muted volumes, but rather that the strategic investment case is not compelling.
Nevertheless, the Connect schemes are expanding Hong Kong’s role as a gateway to Mainland China, and HKEX is keen to strengthen its position as a leading global financial centre.
We’d love to hear your feedback on this article. Please click here