Central Bank update to Stock Connect Q&A following settlement system enhancements21 November 2017
The Central Bank of Ireland has updated its Q&A (UCITS ID 1015 and AIFMD ID 1094) relating to the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect programmes (“Stock Connect”). The Q&A has been updated to coincide with the roll-out of a real-time delivery versus payment (“RDVP”) settlement system under Stock Connect, which has been approved by the Securities and Futures Commission of Hong Kong (“SFC”) and officially went live on 20 November 2017.
Move from an integrated broker-custodian model to a multi-broker model
The Central Bank’s original Q&A had the effect of imposing an integrated broker-custodian model under Stock Connect by stating that “arrangements where the broker of the investment fund is a participant of HKSCC but not an entity within the depositary's custodial network, will not satisfy the provisions of the relevant legislation”. This condition was intended to mitigate against the counterparty risk exposure to a broker which arose due to a time lag in settlement between the delivery of shares to a broker and receipt of cash for the shares. However, deployment of this integrated model in practice meant that trading could only take place via a broker affiliated to a custodian bank, resulting in the use of a narrower selection of brokers than would otherwise be available. The roll-out of RDVP under Stock Connect was devised to address the counterparty risk exposure and is to be used in conjunction with Special Segregated Accounts (“SPSAs”), which were introduced in April 2015 under an earlier operational enhancement. It is intended that the use of RDVP together with SPSAs will facilitate a move from an integrated to a multi-broker model, subject to the depositary being satisfied that it can meet its safekeeping obligations under such arrangements.
Compliance with the Q&A
Accordingly, and following a submission by Irish Funds (member login required), the Central Bank has now relaxed the aforementioned restriction to acknowledge the availability of RDVP. The Central Bank has chosen in its Q&A to highlight arrangements that it does not view as compliant rather than to prescribe what it deems compliant, noting that it is incumbent on the depositary to ensure that its legal obligations can be met at all times. In this regard, the Q&A now highlights that where RDVP is not being availed of and where the broker is not within the depositary’s custodial network, compliance would not be achieved. Consequently, the changes to the Q&A will enable depositaries to determine that it is appropriate for the fund to deal with brokers outside the custody network under Sto ck Connect when RDVP is being used under the SPSA model. However, if no action is taken to utilise RDVP, then the Q&A will continue to apply as before, with the need to maintain an integrated broker-custodian model.
Conclusion and next steps
Irish Funds advocated for a complete removal of the Stock Connect Q&A in light of the enhancements that have been made to the infrastructure. While the Central Bank has decided to maintain the Q&A, the above changes provide scope for Irish domiciled funds and their depositaries to avail of these enhancements and to consequently determine that it is appropriate to move away from the integrated broker-custodian model. Further details on the operational arrangements are available in a circular from the Hong Kong Securities Clearing Company Limited (“HKSCC”).
Bond Connect update
Bond Connect is a new mutual market access scheme that allows investors from Mainland China and overseas to trade in each other's bond markets through connection between the respective Mainland Chinese and Hong Kong market infrastructures. The “Northbound”, or international trading link into Mainland China, officially commenced on 3 July 2017.
While Bond Connect is part of the overall “China Connect” initiative, it is distinct from Stock Connect and a number of matters need to be addressed in order to facilitate access to Bond Connect for Irish domiciled funds. Further clarification, including an FAQ on Bond Connect, are anticipated in the near future. Irish Funds is in contact with various parties involved in Bond Connect and discussions have also taken place with the Central Bank in relation to Bond Connect. An industry submission to the Central Bank will be required to demonstrate that the depositary’s obligations can be met under Bond Connect and is planned once all of the necessary confirmations and clarifications have been provided.