The China Securities Regulatory Commission (CSRC) and the Securities and Futures Commission (SFC) have announced the inclusion of exchange-traded funds (ETFs) into the Stock Connect program.1 The ETF Connect scheme aims to link the ETF markets of Hong Kong and Mainland China and will expand the variety of products that are traded through Stock Connect.
The May 27, 2022, announcement outlines the requirements for ETFs to be included within the Stock Connect mutual market access program, which will allow mainland investors to trade Hong Kong listed ETFs, and give Hong Kong and overseas investors the ability to trade ETFs listed in the mainland.
With increased interest in ETFs from Greater China investors, BBH’s Head of ETF Services for Asia, Chris Pigott, breaks down key takeaways for ETF issuers from this long-awaited announcement.
Product Eligibility Requirements for inclusion in the ETF Connect Scheme (Southbound trading – ETFs listed on HKEX and primarily regulated by the SFC sold to mainland investors):
|Type of ETF:
|Not a synthetic ETF or Leveraged and Inverse Product
|Listed for at least 6 months
|Benchmark Index History:
|Live for at least 1 year
|Average daily AUM of HK$ 1.7 billion (approximately USD 220 million) over the past 6 months
|Underlying Basket of Securities:
a. 90% or above weighting of SEHK listed stocks in the benchmark index
|Benchmark Index Either:
|a. Broad-based indices – a constituent stock must not be more than 30% of the index’s weighting
b. Non broad-based indices
i. Number of constituent stocks must not be less than 30;
ii. A constituents must not be more than 15% of the index’s weighting and the total weight of the top 5 constituents must not be more than 60%;
iii. The constituent stocks that account for not less than 90% of the index’s weighting must be the top 80% shares by ADT ranking in the relevant stock exchange in the past 12 months.
What ETF Issuers Can Expect
Existing ETF issuers with products that meet the requirements will be able to participate in the program later this year as the official launch date will be announced separately. These requirements provide ETF issuers with valuable guidance for product development planning and the initiative creates an important channel for global or regional asset managers to access mainland capital.
All ETF trading will be executed through the secondary market and by leveraging the existing Stock Connect infrastructure. As a result, minimal operational impact is expected. The settlement cycle for ETF trading in the respective local markets already align with the equity settlement cycle and will enable a seamless settlement process.
Focusing on the secondary market eliminates the need for ETF issuers and their service providers to evaluate the impact to the primary market creation/redemption workflow which still has opportunities for automation and streamlining in the mainland as well as in Hong Kong.
It is expected that this inclusion will create a more efficient option than the Hong Kong-Mainland ETF Cross-listing Scheme that was launched in 2020 and operates through a master-feeder structure.
What to Watch - Scope of Product Eligibility
In anticipation of this new program, industry participants have tried to predict the scope of product eligibility, given Stock Connect operates under “home market” rules and investment eligibility. With the addition of ETFs as a new product type, the hope was that a wider set of products would be eligible, which would have been especially impactful for the Southbound trading given the increasing product diversity in the Hong Kong ETF market.
In Hong Kong, only a limited number of the 150 ETFs listed on HKEX are currently eligible under ETF Connect. In our 2022 Greater China ETF Investor Survey, which captured the investor behaviours from more than 150 ETF investors in Mainland, Hong Kong, and Taiwan, BBH found that U.S. equity and high yield fixed income exposures are in demand by mainland investors when asked what ETF strategies they would be interested in buying in Hong Kong. 47% of the respondents were interested in accessing Hong Kong equity exposure, which provides an indication of potential demand for the first phase of the program. ESG was also noted by 47% of mainland investors as the top product strategy.
While the initial eligible product set isn’t as comprehensive as many in the market would have preferred, the program is designed to have a rolling review period based on data from the end of March and September where regulators consider all products for eligibility on an ongoing basis. After launching with a finite number of eligible products, the expectation is that regulators will expand product eligibility over time.
The expected launch later this year follows a surge in ETF assets and demand in Greater China. With the region having reached $300 billion of ETF assets under management in 2021,2 the inclusion of ETFs within Stock Connect will provide investors broader access to products outside their home market and further validates the importance that ETFs play in the creation of cost effective and efficient portfolios. While we expect the scheme’s evolution to be consistent with Stock Connect’s overall development, the evolution of the ETF Connect program, especially given the regular review process for a product set that is in high demand, will be eagerly anticipated.
1 Stock Connect is a Mutual Market Access programme through which investors in the Mainland China and Hong Kong can trade and settle shares listed on the other market via the stock exchanges and clearing houses in their home market.
2 Source: ETFGI, December 31, 2021
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