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Shanghai-Hong Kong Stock Connect paves way for Shenzhen Scheme
On June, 24, Charles Li, the CEO at HKEx, announced that the Shenzhen-Hong Kong Stock Connect will likely be launched by the end of 2015, bringing into focus issues that continue to face institutions using, or wishing to use, the Shanghai-Hong Kong Stock Connect (SHSC)
Matthew Chan 17 Aug 2015
 
   
On June, 24, Charles Li, the CEO at HKEx, announced that the Shenzhen-Hong Kong Stock Connect will likely be launched by the end of 2015, bringing into focus issues that continue to face institutions using, or wishing to use, the Shanghai-Hong Kong Stock Connect (SHSC).
 
While Shenzhen is a different market to Shanghai, the operational challenges for both Stock Connect initiatives are likely to be similar. Many of these challenges revolve around how industry participants reconcile differences in the operational and legal frameworks on either side of the link, and forge global market practices from outside China with systems and procedures inside China – and make them work. I would expect regulators are studying the SHSC very closely as they prepare to launch the new Stock Connect initiative in the not too distant future.
 
Indeed, to date significant efforts have been made to resolve many of these issues with the SHSC. While the first Stock Connect remains in its infancy, there is much riding on its success, including China’s program to internationalize its currency.
 
Key obstacles to increased usage of the SHSC include limited support for short selling, the use of renminbi as the sole settlement currency and the hybrid (T+0/T+1) settlement cycle.  Institutional investors’ hesitancy is compounded by lingering uncertainty over asset fungibility, shareholder rights and reporting.
 
Regulators and the Hong Kong and Shanghai stock exchanges are working to resolve these complex issues and to address a unique requirement to ‘pre-deliver’ shares for all sell orders. Improvements around these issues will certainly encourage greater participation, pave the way to more A-share representation in global equity benchmark indices and ultimately open up this significant market to more trading strategies and investors globally.
 
A recent study by Celent, commissioned by the Depository Trust and Clearing Corporation (DTCC), estimated that resolving these issues will drive international holdings of A-shares to US$428 billion by 2017, up from US$68 billion in 2013.
 
A key consideration for market participants over the next few years, as China increasingly becomes a strategic market for mainstream institutional investors, is the need for firms to ensure their post-trade systems and operations can scale to meet increased volumes and that best practices are employed to minimize operational risk.
 
This is particularly true of middle- and back-office operations, where to date many stop-gap and ad hoc procedures have been adopted to meet the scheme’s unique settlement cycle. Additional systems and operational enhancements will be required — on an ongoing basis — as trade volumes steadily rise.
 
SHSC looks like an idiosyncratic exchange scheme now. But as other stock connect programs, including the Shenzhen scheme, emerge in Asia and possibly link this region to the West, the model is likely to be refined over time. It is equally important that participants also refine their processes and standards if they are to minimize inefficiencies and operational risk, doing their bit in paving the way forward for financial integration of key markets with others in the region.
 
Matthew Chan is head of strategy at DTCC’s institutional post-trade business, Omgeo.

    

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