IFIA January Hong Kong Seminar
Over 150 participants including Hong Kong’s top fund management houses and the Hong Kong Exchange (HKE) participated in the IFIA’s Hong Kong Seminar – Stock Connect: New Opportunities, New Challenges. The event explored the current and future state of the program and the leading role Ireland is playing as Hong Kong and China’s leading fund services platform and innovator in Chinese fund products such as RQFII UCITS.
Opening the seminar, Simon Harris, Irish Minister of State at the Department of Finance, Public Expenditure and Reform noted, “The Funds Industry in Greater China presents the largest market opportunity within fund management for this decade and the next. I welcome the IFIA's work in assisting fund managers globalise their businesses.”
Mr. Harris also looked forward to the Hong Kong Exchange’s (HKE’s) forthcoming visit to Ireland, “I look forward to welcoming and facilitating the HKE when they visit Dublin in the coming weeks. The Irish leg of their consultation roadshow is a great opportunity for the industry to gain further insight, and provide essential practitioner feedback as Stock Connect continues to evolve into a pre-eminent conduit and hub for the global funds market."
The Opportunities and status of Stock Connect
Sean Darby, global strategist for Jefferies, highlighted the positive impact that Stock Connect has made upon the Chinese capital markets and suggested the surge in the use of the RMB will effectively create a dual currency system in Hong Kong. Darby also remarked that the use of Stock Connect for the bond market will be significant in enabling China to open the door to international investors. “China needs a yield curve to price assets, so this bond market move will be hugely beneficial for the country’s financial system” he noted.
With a 1000+ A class shares and a daily market trading value of over $10m, the opportunity for alpha is substantial according to Darby. “Analysts covering Chinese A shares is the lowest in the world” he said, and his analysis suggests that a value strategy has not been implemented for China, offering a huge opportunity for investors. Darby has analyzed 67 Chinese companies where cash flows have improved, dividends increased, and margins healthier. Yet, this basket of stocks has fallen in absolute terms despite good value characteristics suggesting a level of mispricing in Chinese securities. Tae Woo and and Christine Wong from HKE, Patrick Wong, HSBC and Lisa O’Connor, Standard Chartered agreed that Stock Connect’s launch signified the day when China internationalized the RMB capital account. Additionally, the FX activity involved in converting foreign currencies into RMB and RMB into HKD should cause the CNY and offshore CNH quotes of the RMB to converge. More information on RMB FX activity can be found here.
According to Yoo and Wong, turnover velocity on the Shanghai Stock Exchange (SSE) was 566% in December 2014. Since the Stock Connect launch on 17 November 2014, overall turnover has increased by 101% for the SSE and up 24% for the Stock Exchange of Hong Kong (SEHK).
The Cumulative Northbound quota (Hong Kong to Shanghai) is already RMB80bn (as at Jan 9th 2015), with a total quota of RMB300bn at present. At this current pace, the Northbound quota will be full by the end of Q1 2015.
Dean Chilsholm COO of Invesco suggested international fund managers need a guarantee that there will be sufficient capacity to invest in the programme. He said “It’s not possible (for example) for a fund to launch a pure ETF in the market without confidence that there is ample liquidity and no limit, as they need this for daily rebalancing”.
The data also suggested that there is a broader participation in Northbound trades, but most is still from hedge funds and brokers.
Yoo considers the use of quotas a short-term restriction. However, some Hong Kong fund managers with RQFII limits shared concerns in how fast the quotas will be increased or removed altogether.
The Southbound quota (Shanghai to Hong Kong) on the other hand is currently RMB14.9bn compared to a total quota of RMB250bn and while the retail flows are lower, they are having an impact according to Yoo. “In the last hour of daily trading in HK, there is a noticeable spike in volume. That is from Southbound investors trading on the HK market when mainland stock markets have already closed for the day.”
Patrick Wong from HSBC made the point that we can view activity of QFII and RQFII as a proxy for Northbound flows and QDII for Southbound. That would suggest Northbound flows should prove more popular than Southbound for some time, as the level of activity on QFII has been increasing while demand for QDII has decreased in recent years. He believes Southbound can be boosted over time with better investor education, relaxation of some limits to allow more retail investors and by widening the list of stocks these investors can buy in Hong Kong.
Overcoming the challenges for UCITS
Contrary to recent suggestions made in the press, the challenges faced regarding UCITS products and their use of Stock Connect is consistent across all domiciles that have yet to be resolved. Christine Wong of HKE outlined those key issues that are preventing UCITS funds from participating and thanked the IFIA for the proactive consultation which has allowed them to identify and publish an FAQ which can be found here.
Wong also noted that the HKE has been in dialogue with the Central Bank of Ireland (CBI) and at this point it’s important to give the CBI, custodians and depositories the time to gain comfort around the ideas outlined before submitting applications. Michelle Lloyd from Maples & Calder made it clear the CBI is in exactly the same situation as the Luxembourg regulator, and that it is in principle ready for applications subject to the same issues being addressed.
Hurdles do not just apply to the regime and UCITS regulations though according to Dean Chisholm, Invesco. He also highlighted the significant work fund managers need to do in terms of documentation, KIID and risk procedures before they can launch Stock Connect funds. “Funds need to update their investor prospectus and KIID documents. It would be better for everybody if Shenzhen came sooner rather than later so documentation only needs to be updated once”.
Wong confirmed the Exchange is already working on a Shenzhen Connect project, but there is no firm timing. The two Connect programmes should follow similar rules where possible to minimize further complexities.
Dean also suggested. “It is no surprise long only funds aren’t involved as their prospectuses are normally updated twice a year to be submitted to the regulator. Nobody was in a position to even start this work until December, so it will still take some time for the documents to be adjusted”.
“The feedback from the CBI is focused on eligibility and the safekeeping of assets. The board of directors of the fund need to determine eligibility and it’s up to the custodian to assure the CBI that is has confidence on the safekeeping of assets” said Michelle Lloyd from Maples and Calder and confirmed that custodians are not doing this independently,
“There is a working group of custodians and depositories at the IFIA In Dublin who will all make a joint submission to the CBI once they are comfortable with risk factors”. Lloyd also confirmed that the CBI is in the same position as Luxembourg, once they get a letter from custodians saying they have confidence on the safekeeping of assets, the CBI will be ready to approve funds.
In closing, Jeremy Ngai tax partner at PWC suggested the temporary relief on tax for Stock Connect is a strong positive. While some investors worry what will happen after the temporary relief ends, he pointed out that most tax announcements introduced in China are announced as temporary measures, so the tax relief should continue into the future.
The IFIA would like to thank all the speakers and participants for making the event so successful and thought provoking.
Conor O’Mara, IFIA Representative, Hong Kong