Long-only buy-side managers could face operational, credit and execution risks when trading A-shares from Hong Kong via the pending HK-Shanghai Stock Connect programme because it is being set up to fit China’s settlement cycle, fear industry participants.
In China, shares are settled on the trade date (T) and the cash for trades is settled on T+1, while in Hong Kong both are settled both on T+2.
To ensure Stock Connect users in Hong Kong do not sell shares they do not own, the exchange will check that the shares have been placed with a broker one day prior to each trade (T-1). (The clearing house in Hong Kong will hold A-shares on behalf of clearing participants in the city.)
But moving shares to a broker for the pre-trade check would telegraph to the market the seller’s position and intention to trade, Dean Chisholm, Invesco’s head of operations for Asia Pacific, told AsianInvestor. “There is a real danger of market impact if you sell through Stock Connect,” he said.
The link between Hong Kong and Shanghai is expected to go live before November, as reported.
Industry participants say the morning window is too early and short, which would make it impractical and risky for custodians and brokers to move shares then.
Meanwhile, end-investors could face counterparty credit risk because shares would be placed with a broker the day before the trade.
This could affect retail funds and pension products because long-only managers usually keep assets at qualified custodians to protect investors.
Another issue is operational risk, which could arise if a sell-order does not reach the designated price on the trading date. Brokers would then be obligated to move the shares back to the custodian account within the 30-minute slot, which some participants said could be difficult.
As Stock Connect is subject to a daily quota, it is unlikely that managers would use the link for exchange-traded-fund trades because of the risk that trades may not be completed if the quota is reached.
However, where there’s risk, there are ways to make money.
Some custodians that operate clearing and brokerage businesses in Hong Kong are sizing up the opportunities presented by Stock Connect, and have in recent weeks been touting their respective solutions.
Citi is offering a service that allows investors to sell shares at any time when Stock Connect is open without going through the pre-trade check.
The rub is that investors would need to keep the shares with Citi as their custodian, and the brokers that the investor executes with must also clear the A-shares through Citi.
“Because we are both the custodian for the end-investor and the clearer for the local brokers, the assets are kept safe on our book,” said Cindy Chen, Citi’s head of Hong Kong securities and fund services.
“All we do is move the shares internally on our books … and deliver the shares to the market when the selling order is executed on the trade date.”
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