The Impact Of Stock Connect
An edited transcript with Charles Li, Chief Executive of Hong Kong Exchanges and Clearing.
This is probably the first time ever that the two markets, the international market and Chinese domestic capital market can be said to be truly connected. It’s not an artificial program where there will be a lot of restrictions in place, although there will be restrictions, for example, quotas. This will allow investors to feel that the wall that has artificially divided these two markets is beginning to come down. I think the true significance of this program is probably not going to be fully understood and appreciated for months and maybe years to come when people will start to look back and see this event as the beginning of the end of China’s real capital closeness.
The mechanics: how the Connect will work
The most important feature to understand about this program is that the market itself is not actually connected at a fundamental level. The connection is really exchange to exchange and clearing house to clearing house. The investors still sit behind their respective trading systems and clearing systems. The premise behind this program is not to fundamentally change the respective markets: we all know that China and the international market have important differences in terms of regulatory environment, market structures and culture of investment. It will take years to facilitate full integration of trading. We said we need to see if we can significantly accelerate that process by not changing too much too quickly.
We will have an exchange-exchange system where all the orders will actually go through the home exchange routed through to the other exchange, and at the end of the day of trading, the clearing and settlement will happen in the home market. The buy and sell will be netted out: only the clearing house of the investor originating market will have a net position of either net cash or net securities. That way, the actual fund flows will be reasonably small because the buy and sell will already be netted in the respective home market before the clearing house has to actually settle the net clearing positions. You could actually have a very significant trading activity going on in both markets but have really a very minimal actual cross border fund flow.
One key distinctive feature of this whole program is that business will all be conducted in Renminbi. Every day when the Chinese investors come into Hong Kong to invest in the Hong Kong stocks, China Clear will take that Renminbi out into Hong Kong and then convert it into Hong Kong dollars to trade Hong Kong counters. When they sell the Hong Kong dollars they will revert back to Renminbi. Meanwhile, the international investors will all be converting their US dollars or other foreign exchange in Hong Kong into Renminbi which then go into the system. Significantly this program will make Renminbi an investment currency for the first time ever.
A Super Highway or Bridge to Success
We are not trying to promote the program as a product as we see ourselves as road builders and bridge builders. As such, you know what capacity it should ultimately be able to withhold and so you build it strongly, on solid foundations. You make sure that it’s of great quality, it’s smooth, it’s wide enough and it has enough controls built into the systems. As long as we build great infrastructure I’m not terribly obsessed as to who is going to run on it, how fast people are going to go or how much traffic we will have during the first week or two. I will leave that to the market. What we wanted to be sure of is that the road, the bridge is there for a long time to come and that traffic will come once people feel that travelling along it works. The purpose of the roadshows was to explain how the bridge/road works and how the road conditions are different, where they are different, from anything else that they are familiar with, an example might be RQFII. Perhaps we can call them ferries and tunnels: they have their own issues. People need to understand whether the bridge is fundamentally more convenient, faster, or cheaper and whether there are other things that they want to do that the bridge is not yet able to do. So, the purpose of the roadshow was not really to promote the program’s use, but simply inform participants what it is and how convenient it could be to use. Feedback has been very positive so far and the momentum has been building. People have really started to fully appreciate the impact this could create in the marketplace. We started to see a massive uptake in interest.
Elephants in the room: taxation, T-1 and short selling
I am quite confident that by the time of the launch, the issue of taxation, currently at the top of the list of concerns for investors, will be completely resolved or clarified. I don’t want to speculate right now before the announcement as to exactly how this question will be resolved but, it will be resolved or clarified so that people won’t need to speculate or operate under a cloud of uncertainty. The T-1 issue really arises as you have to have shares in your account before you are able to execute a sale order in the Shanghai market. This requires people to move their securities before the trade day: so that’s why people call this T-1. In fact, the Hong Kong exchange has already built a system where you won’t have to do a T-1. You will be able do it on T day before 7:30 in the morning. After the launch, we will earnestly look for a solution to provider people with greater convenience. We are also going to be able to do short selling largely according to our own way of doing it here. We will however need to incorporate certain restrictions and certain reporting requirements that the Chinese market has.
Pressure for Predictions, Quotas and Scalability
Inevitably there is pressure to project this and predict the traffic flow and how fast the initial take up is going to be. I resist the temptation to do this because nothing like this has ever been tried before. The quota is in place purely to regulate the initial pace of the take up because we don’t want to create too much momentum or short term surge in activity. This is a long term program: it’s not meant to be just some sort of short term arbitrage, a gold digging opportunity. If that objective is achieved and everything is considered successfully launched, I believe we and our colleagues in China will very quickly begin to evaluate the necessity of quotas on an ongoing basis. I will also work with them to begin to look at other natural extensions. The product level currently is only cash equity with only 80% of the market cap included, but we could expand it into ETFs, bonds, and other possibilities.