With the announcement date finally underway, I thought I might dig a little bit deeper into the structures of the underlying exchange mechanisms and try to summarize them for you. Digging into the details is always a worthwhile exercise when it comes to Chinese developments and data, and the Shanghai – Hong Kong Stock Connect (yes, I had gotten the city order wrong before) is no different. I will post new findings as I go along, but the current findings here serve as an appetizer on the document published here by Hong Kong Exchanges and Clearing Limited.
Be very aware that by-and-large, this is an opening of China’s capital account on China’s premises. In many cases, the rules for trading have been made so as to be as similar to whatever local market is traded as possible, but where conflicts have arisen, the needs of China have been prioritized.
- Market trading times are as done on their home exchanges, and there are few changes to that.
- All trade will essentially be handled in RMB yuan. As a Hong Kong investor, it will be your responsibility to gather the yuan, but for mainland Chinese there is an internal trade mechanism allowing the trade on their end to be processed in RMB even though the buying and selling is denominated in Hong Kong dollars.
- Anyone with an account in a bank that has been approved for participating in the Stock Connect will be considered an Eligible Participant and is allowed to trade using the cross-border functions.
- The only eligible instruments are those at the two biggest indices in China, the Shanghai A-shares listings (unless listed on a “risk alert list”) and the Hong Kong H-shares.
- There will be a few restrictions on the trading, which will be very important to keep in mind before getting all excited:
- Shorting of Chinese shares in any form is not possible straight out of the gate. However, covered shorts will be possible to enter into after the launch at an unspecified date, when the necessary infrastructure is handled. Naked short sellers need not apply, ever.
- Trading in mainland shares is only allowed on share positions that have been settled! This is done on a T+1 basis, and only shares that are in the account on the prior trading day are thus eligible for selling. Day traders in individual securities, please sod off! Mainland day traders will however get their first opportunity to try their chops as the southbound link will allow day trading.
- To enforce this day trading regulation, a pre-checking mechanism (essentially an “if [number of shares at t-1 > 0] then [allow selling number of shares]” statement) is included in the market mechanism between the EP financial institution and the stock connect system at the last stop before routing the order to China.
- Chinese shares will be possible to trade on margin, but this is a bit funny. As an investor, you are not allowed to participate in the Chinese margin system for stock lending or borrowing, but if a system exists locally in Hong Kong, then you can use that for your margin trading purposes. The Chinese arrangements for margin trading and shorting also do not reach into Hong Kong, and thus mainland investors will not be able to add margin to equity trades or go short Hong Kong shares.
- For northbound trades, only limit orders are allowed! You cannot put on a market order, and the limit only counts as valid if on or outside the nearest opposing order, last trade, or closing price, depending on availability of the entry. For southbound trades, enhanced limit orders are allowed, but not market orders.
- Market data will be possible to access on update every 5 seconds through standard broker procedures, and on an every-minute basis for most participants.
- There are a number of circuit breakers:
- The big ball-buster is the net buying in each direction: RMB 13 billion northbound, and RMB 10.5 billion southbound. If the circuit breaker is hit, then buying trades will be shut off for the rest of the day, irrespective of selling action. Thus Chinese shares can be bought for RMB 12.99 billion, and then pretty much every limit order of shares needs to be met RMB for RMB by sales, or the circuit breaker gets hit and only selling is allowed, meaning that the day could theoretically end up with net selling, as there is no selling restriction on aggregate. This circuit breaker gets reset if the cap is hit during the pre-open trading.
- Northbound aggregate buying is capped at RMB 300 billion, and southbound at RMB 250 billion, and the net buying circuit breaker will otherwise be hit, still allowing selling.
- A ±10% circuit breaker is applied on normal A-shares. A-share listings on the “risk alert list” have circuit breakers at ±5% and will not be eligible for buying through the Stock Connect.
- If foreign shareholdings through the QFII, RQFII and Stock Connect reaches 30% of an individual stock, there will be a forced selling requirement on a LIFO basis to be complied with within 5 trading days. A single foreign investor will be capped at 10% shareholdings.
- IPO trades will not be covered on the Stock Connect, as a “price settlement period” needs to be had before the shares are brought onto the link, irrespective of listed boards.
All in all, this is pretty interesting stuff, and it looks at this moment like the whole set-up will add a lot of liquidity to both markets, since only limit orders (which add to liquidity) will be allowed. (Market orders “use” the liquidity that limit orders provide.) This could mean that trading volumes in Hong Kong could go up a lot, since the whole world gets access to a more liquid exchange.
The initial launch is set to look rather “soft” as no margin trading, shorting or other meaningful position financing than cash settlement will be allowed. I do however expect a large contingent of mainland retail investors trying their hands at day trading in Hong Kong, and depending on the success of these experiments initially I could see more volatility in Hong Kong.