ETF Connect Is Finally Here: Eligible ETFs to Join Stock Connect

Following years of discussions and planning, the long awaited and widely welcomed “ETF Connect” has finally arrived. Subsequent to the joint announcement by the China Securities Regulatory Commission (CSRC) and the Securities and Futures Commission of Hong Kong on 27 May 2022, the two Commissions have officially announced the launch of ETF Connect, along with the release of the lists of eligible exchange-traded funds (“ETFs”) that will be included in Stock Connect starting from 4 July 2022.

ETF Connect leverages the existing Stock Connect framework which offers mutual access to eligible ETFs by investors in China Mainland and Hong Kong, marking another milestone in the continual expansion of the mutual market access programmes connecting Hong Kong and China capital markets.

How Does Stock Connect Work?

Stock Connect is a mutual market access programme launched in 2014 through which investors in China Mainland and Hong Kong can trade and settle shares listed on the other market via the stock exchanges and clearing houses in their respective home market.

Stock Connect comprises:

1. Northbound trading

• Hong Kong and overseas investors can trade in eligible Shanghai and Shenzhen listed A-shares through participating local brokers.
• Northbound trading is currently subject to a Daily Quota of RMB52 billion for each of Shanghai Connect and Shenzhen Connect.

2. Southbound trading

• Mainland institutional investors and eligible individual investors (i.e. individuals holding an aggregate balance of not less than RMB 500,000 in their securities and cash accounts) can trade in the constituent stocks of certain Hang Seng indices and a selection of other H-shares through participating local brokers.
• Southbound trading is currently subject to a Daily Quota of RMB 42 billion for each of Shanghai Connect and Shenzhen Connect.

Stock Connect operates under a closed-loop two-way capital flow mechanism, which is designed to insulate the fund and securities flows in the closed loop of the two settlement systems. Resulting funds of Hong Kong and overseas investors from the sale of A-shares through Northbound trading under Stock Connect will flow back to their bank accounts in Hong Kong, ensuring that the funds cannot be deployed to invest in other types of onshore assets in China Mainland. This will also ensure that relevant investors remain subject to the Mainland’s capital flow management.

The Latest Development: Inclusion of ETFs in Stock Connect

Under ETF Connect:

• Southbound ETF trading?-?ETFs listed in Hong Kong that satisfy the relevant eligibility requirements (detailed below) will be included for Southbound trading in Stock Connect.
• Northbound ETF trading?-?Shanghai Stock Exchange (“SSE”)-listed ETFs and Shenzhen Stock Exchange (“SZSE”)-listed ETFs that satisfy the relevant eligibility requirements will be included for Northbound trading in Stock Connect.

ETF Connect forms part of the overall Stock Connect infrastructure and is subject to the arrangements under Stock Connect, with minor differences, such as:

• Difference between ETF spread and A-shares spread;
• Variations in daily price limit; and
• Absence of closing call auction session for SSE-listed ETFs.

There will also be favourable differences in fee and levy structures applying to the eligible ETFs, including:

• Reduced handling fee for ETFs as compared to that for A-shares;
• Waiver of securities management fee by the CSRC; and
• Waiver of transfer fee by ChinaClear.

With efforts to streamline the treatment for ETFs traded through Stock Connect, ETF Connect is an appealing development for both Hong Kong and Mainland ETF issuers and investors alike:

• Eligible ETFs can enjoy cross-border trading without being subject to dual regulation (as in the case of mutual funds authorised under the mutual recognition of funds arrangement).
• Mainland China’s?“look-through” approach with respect to foreign ownership in A-shares will not apply to ETFs traded on Stock Connect.

What Do We Anticipate?

Trading in Stock Connect has been active since its launch. According to the?figures?published by HKEX, the average daily trading volume of Northbound trading and Southbound trading reached RMB105.9 billion and HKD35.5 billion respectively in the first quarter of 2022.

For many, ETFs are a cost-efficient investment option and a popular choice for diversification. The inclusion of ETFs in Stock Connect will likely appeal to not only retail investors, but also institutional investors who wish to find an extra avenue for cross-border investment. It will also provide domestic and overseas investors access to a wider range of traded products, further consolidating Hong Kong’s role as a financial hub and as an important gateway between China and the rest of the world.

Source: King&Wood Mallesons