On 15 July 2015 the Central Bank of Ireland (the "Central Bank") issued updated versions of its UCITS Q&A and AIFMD Q&A (the "Q&As"). The updated Q&As confirm that the Central Bank has, in principle, no objection to investment in the Hong Kong-Shanghai Stock Connect Program ("Stock Connect") by Irish domiciled investment funds.
Background
Stock Connect launched on 17 November 2014 and was established as a joint collaboration of Hong Kong Stock Exchanges and Clearing Limited ("Hong Kong Stock Exchange") and the Shanghai Stock Exchange. Stock Connect established mutual stock market access between Hong Kong and mainland China and has significantly expanded the options for persons wishing to invest in shares listed on the Shanghai Stock Exchange.
Prior to the introduction of Stock Connect, international investors, including Irish domiciled investment funds, could only access the securities markets of mainland China indirectly through the Qualified Foreign Institutional Investor ("QFII") and Renminbi Qualified Foreign Institutional Investor ("RQFII") regimes. These regimes involve an application process in order to obtain a quota and are subject to restrictions in relation to permitted investments and repatriation of returns. Stock Connect effectively removes the requirement to acquire a separate QFII or RQFII quota and is one of the most significant developments to date in the opening up of mainland China's capital markets.
Central Bank Requirements
The Q&As issued by the Central Bank set out the regulatory considerations to be addressed by Irish domiciled investment funds seeking to access Stock Connect. In general, the relevant fund's depositary needs to satisfy itself that the manner in which the shares are to be held allow that depositary to meet its legal obligations under the UCITS / AIFM Regulations1 and any conditions currently imposed by the Central Bank.
In particular, the Central Bank requires that the depositary (or an entity within its custodial network), must ensure that it retains control over the shares at all times.
The Central Bank maintains that the legal obligations of a depositary can currently only be met where the depositary, or its local broker, is a participant in Hong Kong Securities Clearing Company Limited ("HKSCC"), the clearing house of the Hong Kong Stock Exchange. The Central Bank has also confirmed that the broker must be an entity within the depositary's custodial network (ie, a sub-custodian).
The Q&As state that depositaries need to consider both the terms on which they or a sub-custodian can become participants in HKSCC and the arrangements in place from time to time between HKSCC and China Securities Depository & Clearing Corporation Limited, the clearing house of the Shanghai Stock Exchange.
The Central Bank has outlined the various levels of participation within HKSCC ie, "General Clearing Participant", "Direct Clearing Participant" or "Custodian Participant". The Central Bank has further confirmed that it is not in a position to designate the appropriate level of participation. The Central Bank maintains that the appropriate level of participation may vary over time. The depositary or a member of its custodial network must identify one or more appropriate levels of participation which would be in line with its legal obligations as a depositary.
The Central Bank also requires the depositary to review and keep under review the Stock Connect infrastructure to ensure that its legal obligations can be met.
Comment and Next Steps
This is a very positive development for the Irish funds industry: investment managers of Irish domiciled investment funds now have the flexibility to directly access shares listed on the Shanghai Stock Exchange without obtaining a QFII or RQFII quota.
Shay Lydon, a partner in Matheson's Asset Management and Investment Funds Group, has been closely involved in the preparation of industry submissions to the Central Bank in relation to the approval of Stock Connect. In anticipation of the updated Q&As, Matheson has also been in separate discussions with the Central Bank on behalf of our clients with respect to the appropriate level of disclosure regarding Stock Connect to be provided in a fund prospectus and other documentation and has been working closely with a number of depositaries with respect to Stock Connect.
The Central Bank is very clear that the depositary is responsible for ensuring that it can meet its legal obligations to the relevant fund and we recommend early engagement with your depositary to ensure that they can facilitate access to Stock Connect.
Footnote
1: UCITS: European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations (SI No 352 of 2011); and AIFM: European Union (Alternative Investment Fund Managers) Regulations 2013 (SI No 257 of 2013)
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