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 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 lists1 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.
Quick Recap: 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:
- 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.
- Southbound trading
- Mainland institutional investors and eligible individual investors (i.e. individuals holding an aggregate balance of not less than RMB500,000 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 RMB42 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 differences2, 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.
How an ETF will be included in ETF Connect – the Eligibility criteria
ETFs satisfying the following criteria at any regular semi-annual review can be accepted as eligible ETFs for trading under Stock Connect.
|
Northbound
|
Southbound
|
Example
uses 2
|
|
|
Trading Currency
|
RMB |
HKD |
|
|
AUM Threshold
|
Daily average AUM of ≥ RMB1.5 billion in the past 6 months |
Daily average AUM of ≥ HKD1.7 billion in the past 6 months |
|
|
Listing Duration
|
Listed for ≥ 6 months |
Listed for ≥ 6 months |
|
|
Benchmark Index History
|
Launched for ≥ 1 year |
Launched for ≥ 1 year |
|
|
Type of ETF
|
-- |
Not a synthetic ETF or L&I Product[3] |
|
|
Underlying Basket of Securities
|
|
|
|
|
Applicable Benchmark Index
|
|
|
|
Regular reviews will be performed to determine the eligible ETFs for Northbound trading every six months. SSE-listed and SZSE-listed ETFs will be included and excluded as ETFs eligible for Northbound trading based on the relevant data as of the regular review data cut-off dates.
It is important to note though, that in instances where an eligible ETF trading under ETF Connect subsequently fails to meet certain threshold benchmarks, such ETF may be designated as sell-only securities and will be restricted from accepting further buy-orders under ETF Connect. This poses potential risks for investors in the affected ETF. We anticipate ETF Connect brokers and product issuers utilising ETF Connect for its investments may need to include appropriate risk disclosures to address the potential impact to investors in such circumstances. For further details on these specified criteria, please refer to the circular issued by Hong Kong Stock Exchange (“HKEX”).
Who are the lucky winners?
At this stage, only a small handful of Hong Kong listed ETFs have been included in the list of ETFs eligible for Southbound Trading, as compared to the comparatively longer list of Shanghai and Shenzhen listed ETFs eligible for Northbound Trading. It is anticipated that this list will continue to be expanded as more ETFs are able to fulfill the eligibility criteria and also hopefully with further relaxations to these eligibility criteria in the days to come.
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.
Contact us, anytime
Our team has been actively advising clients ranging from ETF issuers, market makers, participating dealers, service providers and investors on product issuance, cross-border regulatory and compliance issues. Please contact us if we can assist you in any way. We would be delighted to help.
*Any reference to "Hong Kong" or "Hong Kong SAR" shall be construed as a reference to "Hong Kong Special Administrative Region of the People's Republic of China".
[1] For the list of ETFs eligible for Northbound trading, see https://www.hkex.com.hk/-/media/HKEX-Market/Mutual-Market/Stock-Connect/Reference-Materials/Inclusion-of-ETFs-in-Stock-Connect/Initial_List_of_ETFs_Eligible_for_Northbound_Trading.xls. For lists of ETFs eligible for Southbound trading, see http://www.sse.com.cn/services/hkexsc/disclo/announ/c/c_20220628_5704774.shtml and http://www.szse.cn/disclosure/notice/general/t20220628_594377.html
[2] Please refer to questions 1.15 and 4.1 of the FAQs issued by HKEX for further details on the differences, available at https://www.hkex.com.hk/-/media/HKEX-Market/Mutual-Market/Stock-Connect/Reference-Materials/Inclusion-of-ETFs-in-Stock-Connect/Inclusion_of_ETFs_in_Stock_Connect_FAQ_Eng.pdf
[3] i.e. Leveraged and Inverse Product, a leveraged ETF that seeks to achieve short-term investment results that correspond to the daily leveraged (2x) or daily inverse (up to -2x) of the underlying benchmark.
[4] Broad-based index refers to an index whose constituent selection is not limited to a specific industry or investment theme but reflects the performance of a certain market or a certain size of stocks.
[5] i.e. average daily turnover.
