Regulators in mainland China and Hong Kong have reached an agreement on the inclusion of ETFs into the Stock Connect programme.

The Stock Connect has served to integrate and strengthen the securities markets in mainland China and Hong Kong.

In a joint statement, Hong Kong’s Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) indicated that they expect ETFs to be integrated into the Stock Connect within two months.

The Stock Connect, which launched in November 2014, allows international investors to trade Chinese A-share securities listed on the Shanghai and Shenzhen exchanges, and mainland investors to trade securities listed on the stock exchange of Hong Kong.

The scheme offers significant benefits including broadening the product line-up for mainland Chinese investors, helping to diversify their portfolios, and enabling investors trading in Hong Kong to obtain more precise exposure to China’s onshore equity market.

The idea of including ETFs within the Stock Connect was floated as far back as 2016. Indeed, an “ETF Connect” was launched in October 2020; however, the mechanism relied on a separate model which involved the listing of a so-called ‘feeder’ ETF, run by a local asset manager, which invests at least 90% of its assets in a target ETF listed in the other market. Trading volumes through this ETF Connect have been underwhelming since launch.

The addition of ETFs into the Stock Connect, however, means that investors will be able to directly trade ETFs listed in the other market using the same trading, clearing, and settlement processes that support the Stock Connect.

According to the SFC and CSRC, only certain ETFs will be eligible for trading on the Stock Connect.

Northbound ETFs (those that have their primary listing in mainland China) must have been trading for at least six months and have market capitalizations above RMB 1.5 billion (approx. $230 million). They must also track indices that have at least a 90% exposure to Chinese A-shares. For broad-based indices, no stock may account for more than 30% of the total index weight, while for non-broad-based indices, no stock may account for more than 15% and the cumulative weight of the top five constituents must be less than 60%.

Northbound Stock Connect trading is currently subject to a “net buy” daily quota of RMB 52bn for each of the Shanghai and Shenzhen stock exchanges. Eligible Northbound ETFs will be included as part of this quota.

Southbound ETFs (those that have their primary listing in Hong Kong) must also be at least six months old and have market capitalizations above HKD 1.7bn (approx. $220 million). Synthetic and inverse & leveraged products are ineligible for inclusion. Eligible ETFs must track indices focused on Hong Kong-listed equities with similar diversification requirements as described above.

If any eligible Northbound or Southbound ETF subsequently falls below certain eligibility thresholds, they will be classified as sell-only and will be restricted from future buying.

Arrangements for voting rights, margin trading, securities borrowing and lending, and covered short selling will be the same as those set out in the existing Stock Connect rules.