A comprehensive whitepaper published by Celent and commissioned by The Depository Trust & Clearing Corporation (DTCC), the premier post-trade market infrastructure for the global financial services industry, reveals that the long-term success of the Shanghai-Hong Kong Stock Connect (SHSC) hinges on removing the many barriers to participation, including features of the program that restrict trading strategies, introduce risk and create operational complexity. 

Institutional investors continue to cite issues such as limited support for short selling, using Renminbi (RMB) as the sole settlement currency and the hybrid (T+0/T+1) settlement cycle as obstacles to increased usage of SHSC. This hesitancy is compounded by remaining uncertainty over asset fungibility, shareholder rights and reporting. Despite this, the paper notes that the initiative, which is supported by the China Securities Regulatory Commission (CSRC) and Securities and Futures Commission (SFC), has achieved significant in-roads in the gradual opening up of China’s capital markets to international trading.

Regulators and the Hong Kong and Shanghai stock exchanges are working to resolve these complex issues as well as to address a unique requirement to ‘pre-deliver’ shares for all sell orders. The paper explains that improvements in these areas should enable greater participation; pave the way to more A share representation in global equity benchmark indices (maintained by MSCI and FTSE Russell), which will in turn unleash substantial further investment in A shares longer term; and ultimately open up this significant market to more trading strategies and investors globally.

“We estimate these ‘workarounds’ will drive international holdings of A shares to US$428 billion by 2017. Because they are committed to opening China’s capital account, regulators can be expected to expand quotas to meet investor demand,” said Dr. Neil Katkov, Senior Vice President in Celent’s Global Asian Financial Services Group. “The success of the SHSC, despite the challenges, is inspiring a wave of cross-border exchange initiatives involving China, Asia and beyond. Already, a Shenzhen-Hong Kong Stock Connect is slated to start later this year. Observers debate the extent to which this will be followed by links between Shanghai or Shenzhen and Taiwan, Singapore, Tokyo, New York and London. SHSC has also inspired a number of proposals for links between Asian markets outside of China.”

Last month, Shanghai Stock Exchange, China Financial Futures Exchange and Deutsche Börse AG agreed on a strategic cooperation to launch a joint venture. It has the objective to develop and to market financial instruments based on Chinese underlyings to international investors outside mainland China, therefore, products will be offered in RMB.

Matthew Chan, Head of Strategy at DTCC’s subsidiary Omgeo, the global standard for institutional post-trade efficiency, said, “What’s driving demand for SHSC is the fact that it opens up a market previously difficult to access. Links providing access to other relatively new or untapped markets are likely to be the most successful ones. We look forward to today’s challenges being resolved, and to SHSC achieving its potential. Over the next few years, as China becomes a core market for mainstream institutional investors, participants need to ensure their post-trade systems and operations can scale up to meet increased volumes and that best practice is employed to minimize operational risk. And that’s where Omgeo, an established player in Asia and in automating and streamlining post-trade operations for more than a decade, can play a significant role.”