Unclear tax rules and quotas may hinder through train
Institutional investors, especially those that already use other schemes, are also put off by daily quotas and tight settlement requirements
Unclear tax rules, daily quotas and restrictive settlement arrangements could derail the upcoming through train stock scheme as international institutional investors hesitate to join the initiative.
Hong Kong Exchanges and Clearing conducted a connectivity test at the weekend with almost 100 brokerages for the through train scheme that from October will link stock markets in Hong Kong and Shanghai to facilitate cross-border trading.
But it is unclear which big players will join the scheme as many of them are institutional investors that can already invest in the mainland market through qualified foreign institutional investor and the renminbi qualified foreign institutional investor quotas.
The QFII quota was introduced in 2002 to allow banks, insurance companies and fund houses to convert US dollars to yuan for investment in mainland stocks. The RQFII quota was introduced in 2011 for them to use offshore yuan to trade mainland shares.
Eleanor Wan Yuen-yung, the chief executive of BEA Union Investment Management, said her firm had no plans yet to join the stock connect programme.
"We have our QFII quota and are in the process of applying for RQFII. We will continue to use these programmes for accessing the mainland market," Wan said.
"The through train scheme is more for retail investors who now have no access to the A-share market. Institutional investors may take this as a new channel to enter the mainland market.
"However, there are certain technical issues that need more clarity before institutional investors can use the system. They are particularly concerned over issues such as tax and ownership rights."
The daily quota was cause for concern, Wan said.
The scheme allows overseas investors to trade up to 13 billion yuan (HK$16.3 billion) a day, or 300 billion yuan in total, of Shanghai-listed stocks while mainland investors can trade up to 10.5 billion yuan a day, or 250 billion yuan in total, of Hong Kong-listed stocks.
Once the daily quota is reached, investors cannot buy but can only sell for the rest of the day.
"It's a problem for an institutional investor if it needs to buy a certain amount of stocks on a day to meet portfolio requirements," Wan said.
"What does it do if the quota is reached before its target? The QFII quota has no daily restriction, which makes it more flexible and provides more certainty to institutional investors."
Mark Konyn, the chief executive of Cathay Conning Asset Management, said the tax issue and the 7.30am pre-check settlement rule were also key concerns.
Overseas investors who want to sell A shares on a given day must put the stocks on the Hong Kong clearing house before 7.30am, failing which they will not be able to sell the shares that day. Hong Kong, however, allows investors to settle trades even two days after the transaction.
"The main issue with the 7.30am pre-check requirement is that there is still counterparty risk if we transfer our funds or stocks to our broker overnight prior to the day of execution since our custodian may not be able to support transferring funds or stocks before 7.30am," Konyn said.
According to Nasdaq OMX Asia-Pacific head of business development Michael Karbouris, the 7.30am requirement will require many to make adjustments to their internal systems.
One issue from transferring stocks to the clearing account before trading was it could open the door to prior knowledge of a large seller's intentions, potentially facilitating insider dealing, Karbouris said.
"Institutions would need to increase vigilance in monitoring for front-running and insider trading activities, and in many cases upgrade internal control and compliance systems," he said.
He said the difference in trading rules between Hong Kong and Shanghai "may pose challenges for exchange participants and require them to adjust their internal procedures, systems and processes".