Operational complexities mean Stock Connect set for a slow start

For all the hyperbole surrounding the launch on Monday of Stock Connect there is a distinct sense that China is keen to manage expectations about just how big of a bang this is likely to be – even though it is undeniably the biggest development in the opening of China’s capital market for years.

The reason lies in the operational complexity of the link, specifically the extremely short settlement cycle of “T plus zero”, in the jargon.

This means that anyone wanting to sell a security today must already have moved that security from their custodial account to their brokerage account yesterday in order to be able to trade.

The only other global market that operates comparably is the Tadawul, Saudi Arabia’s exchange. It uses T plus zero because it is forbidden under the laws of sharia finance to have money sitting on deposit earning interest – as money would be in a two-day or lengthier settlement cycle.

A second issue investors have to grapple with is even scarier: the end-of-day window in which to settle buy and sell orders – that is, for the security to be delivered and cash received in return – is an extremely tight 30-90 minutes.

That compares with 24 hours on most T+2 (or two-day) settlement zones, an eternity when set against what Chinese regulators appear to have decided is right for Stock Connect.

Small wonder that Charles Li, chief executive of Hong Kong Exchanges & Clearing, hoses people’s expectations down in his regular blog this weekend.

Making a reference to the “through train” connection between Hong Kong and Shanghai, he says that “whether the initial trains are sold out with large crowds left on the platform or the train departs with some empty seats may not be as important”.

“What matters to us is that this is a long-term scheme and its success will be measured in years, not days or weeks,” he says. “The immediate achievement is the infrastructure itself, which connects such vastly different and disparate markets and systems.”

It is not clear why Chinese regulators decided on such a short settlement cycle. But the effect surely is that by ensuring only those institutions with gold-plated operational capabilities can cope with the ultra-short settlement cycle, China has ensured a race to the top in quality of participants even before the opening bell.

Tony Freeman, executive director of industry relations at Omgeo, a post-trade firm that has produced a code of practice for participants using Stock Connect, says that the big, integrated banks with custodial systems are at an advantage. Those banks are generally considered by industry participants to be BNP Paribas, Citigroup, Deutsche Bank, HSBC, JPMorgan and UBS.

“There’s no way a broker in Hong Kong is going to allow a client in Baltimore access unless they can be very sure they can fulfil their operational responsibilities,” he says.

The settlement cycle is “do-able” at T plus zero, Mr Freeman thinks. But he questions whether it is do-able “across the whole market in the volumes that people expect”.

That suggests things are likely to be off to a modest start.