Launch of ETF Connect and other Recent Developments on Stock Connect

Launch of ETF Connect

On 28 June 2022, the China Securities Regulatory Commission (“CSRC”) and the Hong Kong Securities and Futures Commission (“SFC”) jointly announced the launch of the trading of eligible exchange-traded funds (“ETFs”) in Stock Connect (“ETF Connect”) commencing on 4 July 2022.  Under ETF Connect, Mainland and Hong Kong investors will be able to trade eligible ETFs listed on each other’s exchanges through local securities houses.  The expansion of the types of traded products in Stock Connect will be very much welcomed by domestic and overseas investors as it will provide more investment opportunities and convenience for investors who should all by now be quite familiar with Stock Connect as an investment channel.  

With respect to Northbound trading, ETFs listed on the Shanghai Stock Exchange (“SSE”) and the Shenzhen Stock Exchange (“SZSE”) will only be included as eligible securities if they satisfy certain criteria (including criteria relating to the ETF’s size as measured by its average assets under management (AUM), the weighting of shares in the benchmark index and the benchmark index methodology).  Eligibility is subject to regular review (at six monthly intervals) and eligible ETFs may be designated as sell-only securities and restricted from buying if they cease to meet certain criteria at a regular review.  The Hong Kong Exchanges and Clearing Limited (“HKEX”) has published an initial list of eligible ETFs for Northbound trading which will be updated from time to time and has also published amendments to the Rules of the Exchange for the purpose of facilitating the inclusion of eligible ETFs listed on the SSE and the SZSE as eligible securities for Northbound trading under Stock Connect.  

Certain regulatory requirements applicable to the trading of A-shares may not apply to the trading of ETFs.  For example, disclosures of interest in shares and short swing profit rule applicable to A-share trading would not apply to trading in ETFs. In addition, overseas investors’ indirect holdings in the A-shares constituting an ETF will not be counted towards the foreign ownership limits applicable to A-shares1.  Market participants should familiarise themselves with these regulatory requirements when trading eligible ETFs under ETF Connect.  Banks and securities houses wishing to expand their cash equities trading services under Stock Connect to include eligible ETFs should review their client terms (including risk disclosures) to ensure they are appropriate for the additional product type.  Those offering derivatives over Stock Connect securities should consider if their trading and legal documentation sufficiently provides for derivatives over ETFs.

Prohibition of domestic investors from Northbound trading 

Further to a consultation in December last year by the CSRC on a proposed rule change with the effect of prohibiting Mainland investors from Northbound trading under Stock Connect, the CSRC has published its finalised rules on 24 June 2022 to take effect on 25 July 2022.  

The CSRC has adopted its proposal and the Several Provisions on the Programme of the Mainland and Hong Kong Stock Market Trading Interconnection Mechanism issued by the CSRC have now been amended such that Mainland investors will be excluded from Northbound trading under Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect2 once the amended rules take effect.  According to the CSRC’s background drafting notes, the term “Mainland investors” is defined to mean “Chinese citizens who hold domestic identity cards as well as institutions registered in Mainland China, with or without legal persons status, but exclude any Chinese citizens who have obtained overseas permanent residence.”  As for the reason for the rule change, the CSRC explained in the background drafting notes that the intention for Northbound trading under Stock Connect is to attract foreign capital to trade in the A-share market; allowing Mainland investors to trade under Northbound trading is inconsistent with this intention.  There is also more scope for cross-border market violations if Mainland investors are permitted to have both onshore accounts to trade A-shares and offshore accounts to trade under Northbound Stock Connect.  

Securities houses in Hong Kong may not open new trading accounts for Mainland investors for Northbound Stock Connect trading once the amended rules take effect on 25 July 2022.  Securities houses in Hong Kong should also promptly cancel the Northbound trading accounts of Mainland investors if there is no longer any A-share holding in such accounts.  A one-year transitional period is provided under the amended rules.  During the transitional period (and precisely, before 23 July 2023), existing Mainland investors may continue to buy and sell A-shares under Northbound Stock Connect.  After the transitional period (after 24 July 2023), existing Mainland investors may continue to sell their A-shares but they are no longer allowed to buy A-shares under Northbound Stock Connect.

Securities houses in Hong Kong offering Northbound trading services under Stock Connect should ensure their customer due diligence process is sufficient to satisfy the requirements of the new rule.  The new rule also requires them to enhance the monitoring of existing accounts.  It would also be advisable to ensure proper documentation and records are kept to demonstrate compliance.  

The trading prohibition on Mainland investors only applies to Northbound Stock Connect and not the QFI scheme.  On the face of it, the prohibition also only applies to cash trading and not derivatives.  However, as a compliance policy and risk management matter, market participants may wish to consider carefully the scope of application of the rule change. 

Linklaters Zhao Sheng is pleased to have advised HKEX on the development of ETF Connect. With dedicated teams in our Shanghai and Hong Kong offices, Linklaters Zhao Sheng also advises banks, financial institutions and end-investors on a wide spectrum of work relating to China Connect schemes (including Stock Connect and Bond Connect).  


1  With respect to the trading of A-shares (under Northbound Stock Connect and other channels such as QFI), the shareholding of a single foreign investor in a listed company is not allowed to exceed 10% of the company’s total issued shares, and the aggregate shareholdings of all foreign investors in the A-shares of a listed company is not allowed to exceed 30% of its total issued shares.  A-shares constituting an ETF and held by overseas investors under ETF Connect will not be counted towards these limits.

2  Article 13 of the Several Provisions on the Programme of the Mainland and Hong Kong Stock Market Trading Interconnection Mechanism.

3  In another context, it is noted that some market participants are applying the restriction on the type of investors (i.e. institutional professional investors) who can trade in shares that are listed on the ChiNext Board of the SZSE and the STAR Board of the SSE under Northbound trading to equity derivatives as well, despite the fact that such restriction does not strictly apply.