Brokers scramble to catch Through Train

Brokers gird for battle ahead of Hong Kong–Shanghai Stock Connect's October launch. A war for market share and China talent is brewing.

Brokers are scrambling to be ready for China's October launch of trading between Hong Kong and Shanghai in the hope of securing new clients and boosting revenues.

China’s latest reform, dubbed the Through Train or the Shanghai-Hong Kong Stock Connect mutual market access programme, will lay the groundwork for a unified China stock market.

It will allow foreigners to freely trade and settle eligible shares on the Shanghai bourse and at the same time mainland Chinese investors will be able to buy and sell stocks listed in Hong Kong for the first time.

“Many small or mid-sized funds out of the US and Europe have never traded A-shares before because QFII takes a lot of work. Stock Connect will be a lot simpler,” Michael Vrontamitis, head of trade and product management at Standard Chartered, told FinanceAsia.

Stock Connect integrates China A shares with Hong Kong creating the world's second largest stock market by capitalisation at $6.7 trillion and by turnover velocity which is the the ratio between share turnover and market capitalization. 

“Everybody is working around the clock to meet deadlines,” said Ali Naqvi, head of equities across the Asia-Pacific region at Credit Suisse, in an interview with FinanceAsia.

To date, any foreign investor has needed a scarce, restrictive and expensive license to trade mainland China A shares as a Qualified Foreign Institutional Investor (QFII) or Renminbi Qualified Foreign Institutional Investor (RQFII) investing offshore renminbi back into China. 

“It’s as if our clients have added a big elephant into their Asia-Pacific portfolio of markets they can access,” Rakesh Patel, HSBC’s co-head of equities for the Asia-Pacific region told FinanceAsia.
Patel was in the US in June meeting heads of dealing and chief investment officers running global funds to talk about Stock Connect and the opportunities it presents.

For brokers this reform, means more fees for processing a greater number of trades and a seat at the table as China opens its capital markets.

Goldman Sachs' analysts have estimated potential fees on the $3.9 trillion of primary issuance they think will happen over the next 15 years plus secondary market commissions. Conservatively these add up to about $360 billion of revenues over the next 15 years. Given the more profitable businesses that complement basic equity intermediary activities, the business opportunity for brokers could be several multiples of this figure, they said in a report.

To be sure they capture a slice of this growing business as it gets off the ground bankers are frantically travelling around the world meeting fund managers. They are marketing their new ability to easily buy Chinese shares as a proxy bet on the continued expansion of the world’s second-largest economy, as well as their ancillary trading services such as foreign exchange and custody.

Source: World Federation of Exchanges, Bloomberg, GS,

“We cannot not be ready. We will resource this as we need to,” said Lisa O’Connor, a transaction banker at Standard Chartered who has visited at least 20 countries so far this year, mostly to help clients get to grips with the details of Stock Connect.

Analysts see a war for talent brewing as brokers hunt for China market experts with language skills, from traders through to back office workers. Global brokers will face pressure to localise in China and the strongest mainland brokers will continue to internationalise. 

While costs look set to rise, banks still see China as a fillip for their hard-pressed equity businesses as volatility has slipped to a level last seen prior to the global financial crisis of 2007-08 and as the shift to electronic trading has crushed margins. Japan’s stock market boom last year helped offset some of the pain across trading desks but that crutch has since faded.

“Major brokers can’t afford to be out of a huge market that is finally opening up. This is a small step of many more to come,” said Credit Suisse's Naqvi. Credit Suisse is the No.1 broker in terms of market share on the Hong Kong stock exchange and is scaling up in line with the revenue opportunity.

China’s A shares already boast the world’s fourth-largest capitalisation at $3.9 trillion. Credit Suisse forecasts that the market will overtake the UK and Japan in size as liberalisation accelerates and foreigners pile in, forecasting a $54 trillion market value by 2030.

Teething trouble
This is the second version of the Through Train. The first version was announced on foreign exchange regulator SAFE's website in August 2007 with no coordination with Hong Kong. The project failed and was shelved in November 2007.

This time around there are more planning and the project will be more closely regulated but even so as the deadline approaches, some brokers fear teething problems could mar the kick-off and damage their reputations both with clients and in China.

China seems to have set too short a time frame for preparation, according to brokers and investors. The Hong Kong stock exchange that systems testing has been successful ahead of the launch.

“From an operational point of view there are definitely going to be teething problems, which are part of any new initiative,” said one senior trader in Hong Kong, who declined to be named as the exchanges and regulators want everything to be seen to run perfectly. “The October deadline is putting stress on the buy-side, sell-side and the stock exchanges,” he added.

Many key questions remain unanswered, such as whether the broker should withhold 10% capital gains tax. China has a capital-gains tax at 10% and dividend tax ranges from 5% to 20%, depending on the length of holding period. One person familiar with the matter said there will be a grace period of a few months while the issue is sorted out. 

Mainland investors trading in Hong Kong won't have to pay capital gains tax as the SAR does not impose any type of capital gains tax. 

There are also questions about the functionality of the custody system. 

Answers are winding their way through the Chinese government’s approval process but time is running out ahead of launch for brokers and fund managers to prepare properly.

“It is all supposed to kick off in October, which is going to be a tough deadline,” said Mark Tinker, head of AXA Framlington Asia.

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