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UPDATED: November 25, 2014 NO. 18 MAY 1, 2014
Connecting the Capital Markets
As trade between Shanghai and Hong Kong bourses expands, China will align with global markets
By Lan Xinzhen

QFII not affected

China has launched QFII, RQFII and the qualified domestic institutional investor (QDII) program with the aim of providing more cross-border investment options and enhancing the opening up of capital markets while the capital account remains not fully open in China. Shanghai-Hong Kong Stock Connect shares something with QFII, QDII and RQFII, because domestic and foreign capital can flow through these programs. But will Shanghai-Hong Kong Stock Connect affect these programs?

Zhang believed that it will have no impact. He explained that Shanghai-Hong Kong Stock Connect is quite different from QFII, QDII and RQFII in terms of mechanism arrangements. Under Shanghai-Hong Kong Stock Connect, the two exchanges act as service carriers to establish mutual market access for routing orders in order to achieve cross-market investment; while under QFII and other systems, asset management companies act as service carriers to raise funding by offering financial products to investors.

The methods of investment the two systems offer are also different. Shanghai-Hong Kong Stock Connect allows two-way investment, while QFII and others are all one-way investment.

Additionally, they use different trading currencies. Shanghai-Hong Kong Stock Connect allows only yuan as the trading currency; while QFII investors may invest with the U.S. dollar and other foreign currencies.

Furthermore, they adopt different controls for cross-border capital flow. Under Shanghai-Hong Kong Stock Connect, capital flow is controlled in a closed path where proceeds from trading securities must be repatriated along the original route and cannot be retained in the local market; while under QFII and other programs, proceeds from trading securities can be retained in the local market.

Finally, Shanghai-Hong Kong Stock Connect will open an investment channel for investors of both markets, by which investors can freely choose the eligible stocks under the pilot program for direct investments; while under QFII and other programs, quota applications, investment decisions and information disclosure are all conducted by asset management companies, and investors invest indirectly in the other market without being able to freely choose the underlying assets.

Zhang said Shanghai-Hong Kong Stock Connect will have better synergy with QFII, QDII, RQFII and other existing mechanisms, and will provide investors with more flexible cross-border investment options.

Regulatory cooperation

Protecting the legitimate rights and interests of the investors is the responsibility of every market, a responsibility Shanghai-Hong Kong Stock Connect will not shirk. Since it involves two markets, future cooperation between regulatory authorities of the two locations will be particularly important.

Early in 1993, the CSRC and the SFC signed a memorandum of regulatory cooperation. Based on the memorandum and the side letters, regulatory authorities of the two locations will further enter into supplemental agreements on specific cross-border regulatory issues involved in Shanghai-Hong Kong Stock Connect, which provides for specific arrangements in respect of the addressing of differences in the definition of illegal trading practices such as insider trading and market manipulation, regulatory information sharing mechanisms, referral and information exchange mechanisms concerning violations, assistance in investigation and evidence collection and cooperation for the enforcement of the relevant regulatory measures.

Zhang said that with regard to the regulation of market players, the CSRC will follow the general principle that the existing laws, rules and investors' trading practices in the two markets should not be changed. The regulatory authority of the listing venue should be responsible for the regulation of a listed company. Local regulators where the license is granted should be responsible for the regulation of a securities company. If a securities company is engaged in cross-border trading activities on behalf of investors under Shanghai-Hong Kong Stock Connect, overseas regulators may regulate its cross-border trading activities.

Email us at: lanxinzhen@bjreview.com

Shanghai-Hongkong Stock Connect Mechanism

Shanghai-Hong Kong Stock Connect is comprised of two trading links. Under the Northbound Trading Link, investors, through Hong Kong brokers and a securities trading service company to be established by Stock Exchange of Hong Kong (SEHK), investors can trade by routing orders to Shanghai Stock Exchange (SSE). Under the Southbound Trading Link, investors can do the same by routing orders to SEHK through mainland securities firms and a corresponding SSE securities service company.

SSE and SEHK have set ceilings for trade quotas and eligible shares. The northbound link is limited to an aggregate quota of 300 billion yuan ($48.7 billion) and a daily quota of 13 billion yuan ($2.11 billion), and the southbound link to an aggregate quota of 250 billion yuan ($40.58 billion) and a daily quota of 10.5 billion yuan ($1.7 billion). Mainland investors are limited to institutional investors, and individuals who hold 500,000 yuan ($81,170) in securities and capital accounts. The number of eligible mainland investors represents 2.5-3 percent of all A-share investors.

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