Hong Kong-Shanghai Stock Connect: Irish Fund Access Confirmed
On 15 July 2015 the Central Bank of Ireland (the “Central Bank”) confirmed that it has, in principle, no objection to investment in the Hong Kong-Shanghai Stock Connect Program (“Stock Connect”) by Irish domiciled investment funds.
Stock Connect launched on 17 November 2014 and was established as a joint collaboration of the Hong Kong Stock Exchanges and Clearing Limited (“Hong Kong Stock Exchange”) and the Shanghai Stock Exchange. Stock Connect established mutual stock market access between Hong Kong and mainland China and has significantly expanded the options for persons wishing to invest in shares listed on the Shanghai Stock Exchange.
Prior to the introduction of Stock Connect, Irish domiciled investment funds could only access the securities markets of mainland China indirectly through the Qualified Foreign Institutional Investor (“QFII”) and Renminbi Qualified Foreign Institutional Investor (“RQFII”) regimes. Stock Connect effectively removes the requirement for Irish domiciled investment funds to acquire a separate QFII or RQFII quota and is one of the most significant developments to date in the opening up of mainland China’s capital markets.
Central Bank requirements for Irish domiciled investment funds
In order to access Stock Connect, the Central Bank requires that the relevant fund’s depositary must satisfy itself that the manner in which the shares are to be held allows that depositary to meet its legal obligations under the UCITS / AIFM Regulations 1 (and any conditions already imposed by the Central Bank).
In particular, the Central Bank requires that the depositary (or an entity within its custodial network), must ensure that it retains control over the shares at all times.
The Central Bank maintains that the legal obligations of a depositary can currently only be met where the depositary, or its local broker, is a participant in Hong Kong Stock Exchange and Clearing Limited (“HKSCC”), the clearing house of the Hong Kong Stock Exchange. The Central Bank has also confirmed that the broker must be an entity within the depositary’s custodial network (ie, a sub-custodian).
The Central Bank has confirmed that depositaries need to consider both the terms on which they or a sub-custodian can become participants in HKSCC and the arrangements in place from time to time between HKSCC and China Securities Depository and Clearing Corporation Limited, the clearing house of the Shanghai Stock Exchange.
The Central Bank has outlined the various levels of participation within HKSCC ie “General Clearing Participant”, “Direct Clearing Participant” or “Custodian Participant”. The Central Bank has further confirmed that it is not in a position to designate the appropriate level of participation. The Central Bank maintains that the appropriate level of participation may vary over time. The depositary (or a member of its custodial network) must identify one or more appropriate levels of participation which would be in line with its legal obligations as a depositary.
The Central Bank also requires the depositary to review and keep under review the Stock Connect infrastructure to ensure that its legal obligations can be met.
This is a very positive development for the Irish funds industry; investment managers of Irish domiciled investment funds now have the flexibility to significantly enhance their exposure to mainland China through direct investment in shares listed on the Shanghai Stock Exchange (in addition to any existing QFII or RQFII quota they may already have).
The Central Bank is very clear that the depositary is responsible for ensuring that it can meet its legal obligations to the relevant fund and we recommend early engagement with your depositary to ensure that they can facilitate access to Stock Connect.
Future enhancements for Irish funds
Irish Funds prepared a number of submissions with assistance from the Hong Kong Stock Exchange and engaged closely with the Central Bank in relation to the approval of Stock Connect. Irish Funds is best placed to continue to liaise with the Central Bank with respect to various Stock Connect enhancements which may further benefit Irish domiciled investment funds as well as any impact UCITS V 2 may have on Stock Connect. Two of the most important enhancements for Irish domiciled investment funds are summarised below:
1. Special Segregated Account (“SPSA Model”)
The SPSA Model was launched by the Hong Kong Stock Exchange in April 2015. Prior to the launch of the SPSA Model, investors either had to use an executing broker in the depositary’s custodial network or transfer the relevant shares to the broker the day before the intended sale. Under the SPSA Model, investors who have opened special segregated accounts with their depositary may place sell orders without first delivering the shares to their brokers. The SPSA Model also addresses any concerns around beneficial ownership of shares. When a special segregated account is opened, the relevant fund’s investment manager and the relevant fund’s name appear on the account and they are treated as the beneficial owners of the relevant shares in the account and this is certified by the Hong Kong Stock Exchange.
The SPSA Model is currently unavailable to Irish domiciled investment funds as the Central Bank maintains that the legal obligations of a depositary can currently only be met where the depositary, or its local broker, is a participant in the HKSCC. The Central Bank has also confirmed that the broker must continue to be an entity within the depositary’s custodial network.
Depositaries operating in the Irish market are currently in discussions with Irish Funds with respect to extending the Central Bank’s approval to the SPSA Model and Irish Funds is well placed to begin further dialogue with the Central Bank with respect to the use of the SPSA Model by Irish domiciled investment funds.
2. Hong Kong-Shenzhen Stock Connect
The Hong Kong Stock Exchange recently announced plans to link the Hong Kong and Shenzhen stock exchanges. Any extension of Stock Connect that allows greater access to mainland China will be welcomed by the investment managers of Irish domiciled investment funds. Irish Funds will monitor the progress of any Hong Kong-Shenzhen Stock Connect Program and will liaise with the Central Bank on behalf of its members to ensure that Irish domiciled funds can gain access.
Shay Lydon, Partner at Matheson
Daryl O’Brien, Associate at Matheson
1UCITS: European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations (SI No 352 of 2011); and AIFM: European Union (Alternative Investment Fund Managers) Regulations 2013 (SI No 257 of 2013)