Uncertainties overshadow 'through train' as launch nears

Fund managers and brokers air concerns over trading rules, tax provisions of Shanghai-HK Stock Connect, reports Emma Dai.

With the Shanghai-Hong Kong Stock Connect program set to start next month, fund firms and stockbrokers in Hong Kong are seeking clarity over trading rules, some of which have raised concerns among the investment community.

One rule that has many scratching their heads is "pre-trade checking for sell orders", said Sally Wong, chief executive officer of the Hong Kong Investment Funds Association.

To use the program, known as the "through train", overseas investors must transfer the shares in mainland companies they plan to sell to brokers by 7:30 pm on the evening before the actual trading day, or from 7:15 am to 7:45 am on the trading day itself.

"That not only generates the possibility of information leaks, it also exposes fund managers to counterparty risks," Wong said. The morning window "is very narrow. Lots of shares would still have to stay overnight with brokers, especially when orders come from other time zones."

Andy Maynard, global head of trading and execution at CLSA Ltd, a Hong Kong-based brokerage, said this means that overseas investors must make investment decisions a day before they are able to execute them.

"In a worst-case scenario, Los Angeles-based investors must decide literally two days ahead. This is a massive issue for offshore clients. Should the stock market collapse during the day, fund managers would not be able to sell until the next business day," he added.

Apart from pre-trade checking, lack of clarity in the mainland's disclosure regulation is also posing challenges for overseas fund managers.

"For fund houses, compliance is very important. But while regulations in Hong Kong are very specific, disclosure rules on the mainland are rather more in principle than practice," said Wong. Even seemingly straightforward terms are not specifically defined.

The mainland's Securities Law states that the shareholder of at least 5 percent of an individual company's outstanding shares shall comply with disclosure rules, such as "reporting a considerable change in shareholding".

But there is no clear rule on what constitutes 5 percent, Wong said. "For an international group with a lot of affiliates worldwide, it's not clear whether shareholdings of all of them should be counted together, or whether different funds issued by a fund company can be counted independently.

"What's more, we don't know what kind of shareholdings should be counted - A shares only or B shares, H shares, American depositary receipts, global depository receipts and derivatives issued by the same company," she said.

A shares are those listed on the Shanghai and Shenzhen exchanges, denominated in yuan. B shares are also listed in the mainland but are denominated in foreign currencies. H shares are those of mainland companies listed in Hong Kong. ADRs are the shares of foreign companies that are listed on United States exchanges, while GDRs are issued by banks to represent a foreign company's publicly traded securities.

Confusion over the definition of "5 percent" also makes investors eager for an explanation of the mainland's short-swing profit rule, which aims at discouraging short-term speculation.

Under the mainland's Securities Law, if a shareholder who holds at least 5 percent of a listed company's shares sells those shares within six months of the original purchase, or repurchases the shares within six months after selling them, the profits belong to the issuing company.

"For example, if fund A, holding 5 percent of a company for two years, sells the stock, and fund B, managed by the same fund house, buys 5 percent of the stock of the same company within six months, would that violate the short-swing profit rule? We don't know where to get the answer," Wong said. "It's crucial to get the basics clear, because it's related to the security of investors' assets.

"If the rules are not clear, some pension funds and trustees will not be able to invest, because they are bound by contracts they've signed with investors," she said.

Taxes are another uncertainty for fund managers.

So far, no announcement has been made about whether overseas A-share investors who board the through train are liable for the 10 percent capital gains tax applicable to their mainland peers. Nor has there been any arrangement on how taxes, if due, should be collected.

"The capital gains tax is a massive concern," said Maynard. "In the 13-year history of the qualified foreign institutional investors program, nobody has ever received a tax bill.

"But unlike the QFII program, with the through train, global clients can trade A shares through different brokers. It will be very difficult for finance teams to work out where, when and who is going to be taxed," he said.

"I'm working on the basis that no announcement will be made," he added.

If there are tax implications for the stock connect program, the authorities will also have to go back to QFII investors and collect unpaid tax, he said. "I don't think the mainland tax authorities have the ability to go through 13 years of records to ask for the 10 percent capital gains tax."

The China Securities Regulatory Commission, the mainland's equity market regulator, said it is working with various departments to resolve the problem.

"The tax issue has been one of our focuses since we started preparing for the Shanghai-Hong Kong Stock Connect. The fiscal and taxation authorities have been very supportive to us," said spokesman for the CSRC, Deng Ge, on last Friday.

He said the issue involves various laws and has broad implications.

"We have to strike a balance between fairness and the authority of the current tax policies and be creative and flexible toward the new scheme. The decision to revise the relevant regulations needs to be made cautiously, based on comprehensive consideration.

"We are working closely with relevant departments to solve the problem as soon as possible."