China Access Market Practices - PowerPoint Presentation

China Access Market PracticesRMPG discussion October 2018 Lisa O’Connor, Jason Brasile, Harry Huang

2Business Background (Lisa O’Connor) Offshore RMB Market Practice Guidelines (Lisa O’Connor )Bond Connect Market Practice with CMU (Lisa O’Connor)China Stock Connect and Bond Connect Flows (Harry Huang)Bond Connect Operational Challenges for Custodians (Jason Brasile)Discussion (All) Table of Content

3Business Background

Source: SSE, SZSE as of Mar 2018 China Stock Market is the 2nd largest worldwide Global Exchange Market Capitalization April 2018, in USD trillion Top 8 Currency in Global PaymentsThe successful RMB inclusion in the SDR basket (in effect from Oct16) has shaken up the way the world thinks about a ‘reserve asset’. Source: RMB tracker by SWIFT as of July 2018 Market No. of Listed CompaniesMarket Cap(in USD billion)Average Daily Trading Value(in USD billion)Shanghai Main Board1420517932Shenzhen Main Board465120811Shenzhen- SME Board910163617Shenzhen-ChiNext Board72286214 Summary of China Equity Market Mar 2018 China is the world’s 3rd largest bond market China Interbank Bond Market (June 2018, USD10.34 trillion)- 96.3% of Total Bond Market 4 Source: Bloomberg as April 2018 Note: Credit Bond includes Enterprise Bond, Commercial Bank Bond, Government Sponsored Bond, MTN, and PPN“Others” include CP, SCP, ABS, Tier 2 Capital Tool, and etc. Source : CCDC and SCH as of June 2018 Too Big to Ignore China Market Snapshot Source: Citibank

China Connect | Overview and Potential Future Expansion Recent or Upcoming Changes Jul 3, 2017, Bond Connect to China Interbank Bond Market (CIBM) was launched Nov 20 , 2017, HKEx introduced the Realtime Delivery-versus-Payment (RDP) settlement for Stock ConnectMarch 23, 2018, Bloomberg has announced the inclusion of China government and policy bonds to Bloomberg Barclays Global Aggregated Index over a 20 month period starting April 2019. This is subject to implementation of several planned operational enhancements including DVP, block trade, tax clarification. May 18, 2018, PBOC issued Circular no. [2018] 96 to allow financial institutions in Hong Kong conduct CNY (onshore rate) spot FX and hedging services for Stock Connect investors May 31, 2018, A-shares have also been included to the MSCI indexes for the first timeAugust 2018, Bond Connect operational enhancements e.g. DVP settlement, trade allocation, and 3 years tax waiver Sept 26 2018, Introduction of Investor ID for Stock ConnectMSCI A-Share Inclusion Implemented on 1 June 2018 2nd tranche on Sep 1st 2018 Exchange Traded FundSH/SZ Connect (2019*)BondCIBM Connect (2017)Listed Bond Connect (2019*)With the launch of Bond Connect, international investors could easily access over 80% of onshore securities investmentsChina Bond Inclusion23 Mar 2018 announced the inclusion of China bond into the Bloomberg Barclays Global Aggregate Index starting April 2019 over 20 month period China A Equity SH Connect (2014)SZ Connect (2016)IPO (2019*) Recognized as the most efficient and scalable China access platform for international investors Mutual Recognition of FundsMRF (2015)According to Bloomberg In order to be considered for inclusion in the Global Aggregate Index, a local currency debt market must be classified as investment grade and its currency must be freely tradable, convertible, hedgeable, and free of capital controls.  Ongoing enhancements from the PBoC have resulted in RMB-denominated securities meeting these absolute index rules.There are Citibank's estimates as official target dates will or have been announces by HK and China regulators.Source: Citibank

CIBM | Number of Foreign Institutional Investor Accounts 6 Increased to 425 Investors as of Aug18 Bond Connect already represents over 40% of total institutional investor or funds accessing CIBM Source: Citibank

Bond Connect | Further Development of Bond Connect Upcoming key developments highlighted in Bond Connect Anniversary Summit Full realisation of the delivery versus payment settlement system (announced on 23Aug18) DVP settlement is implemented on 24 Aug 2018 Launch of block trade allocation service (announced on 31Aug18) Pre-trade allocations function allows trader to allocate block trade in % or amounts up to 30 funds Clarify tax policy for overseas investors (announced on 30Aug18)* State Council announced that enterprise income tax and value added tax are exempt for three years. Pending for State Administration of Taxation (SAT) to officially announce the implementation details Addition of 10 more Bond Connect dealers to a total of 34 (announced and effective on 3Jul18)5. Discounts of up to 50 per cent in Bond Connect transaction fees (announced and effective on 3Jul19)6. Permit international investors to access repo and derivatives markets - TBD 7. Cooperation with other international e-trading platforms (e.g. Bloomberg) - TBD * Further details on the implementation are expected to be announced by China authoritiesSource: Citibank

Bond Connect | Northbound CIBM Direct (2016) Bond Connect (2017) Account Structure CFETS Trading ID needs to be created Segregated & direct account at CCDC/SHCH CFETS Trading ID needs to be created Supports multi-layer custodian arrangement with subaccount at the CMU level Eligible Investors The overseas financial institutions lawfully registered and incorporated, including commercial banks, insurance companies, securities companies, fund management companies and other asset management institutions, investment products issued by the aforementioned institutions to clients in accordance with the laws and regulations, and other medium and long term institutional investors approved by the PBOC, such as pension funds, charity funds and endowment funds Access RequirementAppoint Bond Settlement Agent (BSA) in China and execute BSA agreement and submit required KYC documents Access an approved electronic platform(s) e.g. Tradeweb and a CMU custodianTradingHours: 09:00–12:00 & 13:30–16:30All CIBM Market Makers and participants Price inquiry via BSA, or directly contact counterparty, however must formally conduct the trade via the BSAHours: 09:00–12:00 & 13:30–16:30 Approved Bond Connect Market Makers (34)Price inquiry with the BCMM directly , however must formally execute the trade via Tradeweb using RFQBlock trade allocations function allows trader to send one RFQ for up to 30 CFETS IDs Eligible Securities Cash bond, Bond lending, bond forward, IRS and FRA (for hedging purpose only)Repos only allowed for ROIIs, RMB Participating/Clearing Banks (Need NAFMII) Cash bond Repos & CNY derivatives at later stage Settlement CycleT+0 or T+1 or T+2 (for foreign investors only)Gross settlement, DVP T+0 or T+1 or T+2 (for foreign investors only) Gross settlement, DVP Settlement Cutoff SD 17:00 SD 12:00 FX Hedging Able to access CNY or CNH CNY FX & hedging available via BSA Ratio of FCY to RMB when paying into and repatriate from China, should not deviate more than 10% Able to access CNY or CNH CNY FX & hedging purpose of Bond Connect trades available via CMU member, which engages a HK Settlement Bank Cash balance Maintained with BSA or custodian in Mainland China Maintained custodian in Hong Kong including CNY balance Trading China Foreign Exchange Trade System (CFETS) HK or Overseas Investors Tradeweb / Bloomberg (TBD) Hong Kong Mainland China Settlement CCDC/SHCH Central Moneymarket Unit (CMU) CMU Participant Key benefits for investors are trading through an international platform, no account opening in China, no Bond Settlement Agent and custodian bank, cash and FX bank are offshore i n Hong Kong. Bond Connect Market Maker Global Custodian 8 Or Source: Citibank

Bond Connect | How to get ready? Fund Manager Checklist to Prepare to Use Bond Connect Establish access to Tradeweb (initially) or Bloomberg (expected to be available soon) For regulated funds: Check with depot bank and relevant regulator on disclosure or approval requirement for Bond Connect Confirm with your custodian that they are a CMU Participant and CFETS Settlement Bank1 for Bond Connect Instruct your custodian to setup CMU sub-account number for Bond Connect and assist with the CFETS Trading ID registration (takes about 13 business day upon receipt of completed registration form)Decide and establish RMB FX (CNH/CNY or both) funding, FX and hedging arrangement Review any additional documentation e.g. Bond Connect Terms and Conditions and fee arrangement Review operation specifics including cutoff times May 16 th 2017June 2017 July 3rd 2017 Aug 7th 2017 Going Forward Pilot launch Joint announcement by PBOC and HKMA Rules published Citi Launched Integrated Bond Connect Solution Enable block trade Tax Clarification on CIBMUsing CIPS 2 to potentially deliver DVP settlement for CCDC securities and improve cutoff time Send MT599 to custodian Custodian opens CMU Subaccount(1 business day) Submit CFETS Registration Form and PBOC to provide approval (~3-6 weeks) CFETS ID Link to CMU subaccount (2-3 business day) Completed Custody Setup 4 - 6 Weeks Higher risk of fail trade and limited capability for CNY if the FX bank is not same as the CMU Participant/local custodian bank. As of January 15, 2018, there are 20 eligible CFETS Settlement in Hong Kong. Source: Citibank

Major Impact from Bond Index Inclusion Starting from April 2019, Bloomberg Barclays Global Aggregate Index will include Chinese RMB-denominated government and policy bank bonds, phased in over a 20-month period. The index would include 386 Chinese bonds and represent 5.49% of a US$53.73 trillion index 1 . Effective in February 2018, China onshore bonds are included to: 2EM Government Bond Index (EMGBI) Asian Government Bond Index (AGBI) Asia Pacific Government Bond Index (APGIB)Emerging Markets Government Bond Index-Capped (AGBI-Capped) – newly createdAsian Government Bond Index-Capped (AGBI-Capped) – new createdChina onshore bonds placed under review for inclusion in JPM’s fixed income indicesPossible inclusion in JPM Government Bond Index (GBI) series and other investment grade indicesMarket estimated US$ 262 billion of offshore deployment to China onshore bonds catalyzed by index inclusion 1Source: Bloomberg press announcement, issued on 23 Mar 20182Source: The Yield Book announcement “China Inclusion to the Government Bond Indexes”, issued on 31 Jan 2018 Major Bond IndexEstimate passive AUM (US$bn)Estimated weightEstimate inflow (US$bn) JP Morgan Government Bond Index-Emerging Markets250 10%25Bloomberg-Barclays Global Aggregate2,5005.49%137World Government Bond Index2,0005%100Source: Citi Research “Surprise Index Inclusion Announcement is a Positive Step”, issued 25 Mar 2018Source: Citibank

Stock Connect | Northbound Flow Continues to Grow Average Daily Turnover ~US$ 3.1 Billion* Shanghai -Hong Kong Stock Connect (Nov 2014) RMB 234.4 Bn | US$ 37.0 Bn Shenzhen-Hong Kong Stock Connect (Dec 2016)RMB 180.6 Bn | US$ 28.5 BnQualified Foreign Institutional Investors QFII (late 2002) RMB 630.1 Bn | US$ 99.5 BnRMB Qualified Foreign Institutional Investors RQFII (late 2011) RMB 618.1 Bn | US$ 97.6 Bn Source: SAFE, HKEX 1 as of 27 Apr 2018 Aggregate net buy of Shanghai A-shares as of Jun 28, 2018: ~USD44Bn Source: YahooChina Connect average daily trading volume has increased to US$3.1bn* in 2018Stock Connect Aggregated Net Buy ~33% of QFII/RQFII schemes Northbound Trading daily turnover continues to growA-shares market trend since launch of Stock ConnectSource: ReutersAggregate net buy of Shenzhen A-shares as of Jun 28, 2018: ~USD34Bn Stock Connect Northbound Aggregate Net Buy reaches about ~USD 78BN* (In US$ Billion) Source: Reuters as of 28 Jun 2018 *as of Jun 2018 YTDShanghai Shenzhen CSI 300 Index

Impact of MSCI Inclusion Shanghai 30-May 31-May 1-Jun 11-Jun Total Turnover 11.9 22.1 10.6 11.8 Total Buy 5.8 12.6 6.07.4Total Sell6.19.64.64.4Quota usage0% 7% 3% 6%      Shenzhen30-May31-May 1-Jun11-Jun Total Turnover 10.112.5 9.2 9.7 Total Buy5.97.65.0 5.5Total Sell4.24.9 4.3 4.1 Quota usage 4% 6% 2% 3%           Total 30-May 31-May 1-Jun 11-Jun Total Turnover 22.0 34.6 19.8 21.5 Total Buy 11.7 20.2 11.0 12.9 Total Sell 10.3 14.5 8.9 8.5 Net Buy 1.4 5.7 2.1 4.2 RMB (billion) 12 Number of institutional investors or funds setup for Stock Connect have doubled since the beginning of 2018. The successful inclusion of A-shares into MSCI indexes on June 1st and Sep 1 st is likely to facilitate additional inflow

Stock Connect vs. RQFII / QFII China Connect (Northbound) Nov 2014, Dec 2016 RQFII (Since 2011) QFII (Since 2002) Eligible Investors Over 5000 institutions with net holding of US$93bn (Apr 2018) Available to all overseas investors 196 institutions with total approved quota US$97.6 bn (Apr 2018)Only available to approved RQFII market (19) and limited to institutional investors with asset management license and subject to qualification requirements. Japan added in May 2018.287 institutions with total approved quota of US$99.5bn (Apr 2018)Only available to qualified institutions in markets with MOU with China (~55) limited to institutional investors subject qualification requirements Quota Daily Net Buy Quota: RMB52 billion each for Shanghai and ShenzhenGo through a filing process, additional quota requires approval from SAFEGo through a filing process, additional quota requires approval from SAFE. Minimum Basic Quota of each QFII is US$20 millionEligible InvestmentsConstituent stocks of SSE 180 and 380, SZSE Component Index and SZSE Small/Mid Cap Innovation Index with market capitalization >RMB6 billion1 All dual-listed shares 1ChiNext are limited to Professional Institutional Investors at initial stage All SSE and SZSE stocks Corporate, government, enterprise, convertible and interbank bond marketSecurities investment funds including closed-end, open-ended and ETFs Others such as warrants, index futures, IPOsCCY Offshore RMB and onshore RMB Offshore RMB US$ or other major foreign currencies Liquidity Daily liquidity No restriction on sell trades No prefunding requirement for CNH or other currencies RQFII custodian must confirm available cash before trade occurs QFII custodian must confirm available cash before trade occurs Setup Time 2-3 weeks upon receipt of documentations At least three months to a year At least three months to a year Docs Stock Connect Terms and Conditions SPSA if applicable Application statement, copy of registration, financial business permit, certificate of proof of qualification, certificate of proof no violation in past three years, statement on fund sources and domestic securities plan, audited financial statement, power of attorney signed with PRC custodian and other documents required by CSRC Appointment of PRC RQFII/QFII custodian as associated documentation Accounts No need to open additional account 2 Segregated account required for each QFII/RQFII underlying funds along with associated KYC/AML docs Fees Closer to HK market Onshore China market Exceptions : Shares not traded in RMB, Shares under “risk alert”, IPOs Source: Hong Kong Exchanges and Clearing Limited ( HKEx ), State Administration of Foreign Exchange, Citi Securities Services, Bloomberg.

14Offshore RMB Market Practice Guidelines for Payments, Treasury, Securities, etc..

15Offshore CNY – Background Industry stakeholders have approached SWIFT on challenges surrounding offshore Chinese Yuan operations, in particular concerns regarding straight-through-processing (STP). During a meeting held on 2011 April attended by representatives from a variety of segments of the financial industry, agreed that defining and documenting best practice on how to use SWIFT MT and ISO 15022 messages for offshore CNY transactions was required. The use of structured code is optional but serves as a baseline in counterparty communication. The industry decided to focus on the immediate concerns, therefore, the first version of the guidelines focuses on SWIFT MT and ISO15022. In 2012 February, the agreed guidelines were published on www.swift.com . The most recent document can be found here: https ://www.swift.com/sites/default/files/resources/swift_standards_guidelines_offshorecny.pdf

16The Industry Challenge at the Time The operational challenges started because firms are using the code CNH (that is being passed from the front office) for dealing of Offshore CNY Once the code CNH is passed to the middle or back office, CNH is likely to be translated to CNY for settlement, because CNH is NOT a valid ISO 4217 currency code and therefore not able to be processed in systems. ISO 4217 Registration Authority is SIX Interbank Clearing Limited. The majority of these transactions were being processed outside of STP channel.As volume of transactions increases, this practice is hindering STP and could be prohibitive to business growth.There was a need for a “tactical solution” since banks proprietary, vendor operated and SWIFT systems are all based on ISO currency codes.

17Offshore CNY Guidelines for SWIFT MT & ISO 15022 Securities MT 513 Client Advice Of Execution MT 514 Trade Allocation Instruction MT 515 Client Confirmation of Purchase or Sale MT 518 Market-Side Securities Trade Confirmation MT 535 Statement of Holdings MT 536 Statement of Transactions MT 537 Statement of Pending Transactions MT 540 Receive Free MT 541 Receive Against Payment MT 542 Deliver Free MT 543 Deliver Against Payment MT 544 Receive Free Confirmation MT 545 Receive Against Payment Confirmation MT 546 Deliver Free Confirmation MT 547 Deliver Against Payment Confirmation MT 564 Corporate Action Notification MT 565 Corporate Action Instruction MT 566 Corporate Action Confirmation Note: See full guidelines for the Payments, Treasury, SSI, etc. messages

18Securities @ 2012 The securities post-trade, settlement instruction, settlement instruction confirmation message formats all support the mandatory or optional use of the place of settlement (PSET) that will identify the transaction as offshore CNY. In securities settlement instructions (MT540, MT 541, MT 542, MT 543) and confirmations (MT 544, MT 545, MT 546, MT 547) the message layout is identical. PSET in the Mandatory Repetitive Subsequence E1 Settlement Parties block. Listed securities use the country code (e.g. CN, HK, GB, etc.) of where they are incorporated not where they are traded. Therefore the country prefix in the ISIN code together with CNY as the statement currency cannot be used to differentiate the securities in the statement messages . As a result, the MT 535, MT 536, and MT 537 messages were added. MT 535 guidelines are applicable for the sub-custodians handling stock positions of both on-shore and off-shore CNY securities for their clients. The same logic will apply for corporate actions messages (MT 564, MT 565, and MT 566).

19Bond Connect Market Practice with CMU *as communicated by HKMA

20Bond connect, in SMPG operational post-trade market practice terms, is a CSD-CSD settlement. It means that settlement takes place through a link established between an investor CSD (CMU) and an issuer CSD (CCDC or SHCH). It results that for flows between foreign investors ( eg , Asset Managers) and their (global and/or local) custodians, there will be a need to identify both CSDs to ensure proper routing of settlement, ie, via the bond connect rather than through domestic set-up. This will be done in ISO 15022 through the use of :94F::SAFE and :95P::PSET. PSET is always where the counterparty is located. PSAFE where the instructing party is located. Both fields have no legal or regulatory meanings, only operational usage. The following slides will illustrate how these fields need to be used. Note that in ISO 20022, it is easier. Delivering and receiving depositories are to be used (not place of safekeeping). Description Bond Connect

Receiving Delivering Depository and Place of Safekeeping Bond Connect Settlement: BUYING Example (CCDC) BUYRGB22 provides the below settlement info to CUSTHKHH, which will be input in the instruction from CUSTHKHH to HKMAHKHC Delivering agent is DEAGCN22 Seller is SELLCN33 Place of settlement (Delivering agent’s CSD) Today the CMU guidance is to use NDCCCNB1. This will be change to NDCCCNBJ for the live BIC cutover of CCDC in the future. Place of safekeeping (Receiving agent’s CSD) is HKMAHKHC CFETS trade reference number Buyer BUYRGB22SellerSELLCN33CustodianCUSTHKHHClearing Agent DEAGCN22 MT 541 MT 541HKMA CMU HKMAHKHCCCDC / SHCH NDCCCNB1*MT 541/sese.023 or proprietaryProprietary MsgProprietary Msg

ISO 15022 Illustrations From the buyer to custodian (global or sub ) MT 541Sender: BUYRGB22Receiver: CUSTHKHH:94F::SAFE//NCSD/HKMAHKHC and :95P::PSET// NDCCCNB1 allows the custodian to identify the settlement as a bond connect settlement. CBTnnnnnnnnnnnnnn is the CFETS Trade Reference NumberNOTE: NDCCCNB1 is used as an example but will be replaced by NDCCCNBJ

ISO 15022 Illustrations From the receiving sub-custodian to HKMA for the settlement at CCDC MT 541 Sender: CUSTHKHHReceiver: HKMAHKHC94F::SAFE//NCSD/HKMAHKHC and :95P::PSET// NDCCCNB1 allows the custodian to identify the settlement as a bond connect settlement. CBTnnnnnnnnnnnnnn is the CFETS Trade Reference Number NOTE: NDCCCNB1 is used as an example but will be replaced by NDCCCNBJ

24China Stock Connect and Bond Connect Flows

Bond Connect – PBOC’s regulation on RMB FX of Bond connect settlement 25 http:// www.pbc.gov.cn/goutongjiaoliu/113456/113469/3330621/index.html People's Bank of China Order [ 2017 ] No. 1 Article 10. Foreign investors may use their own RMB or foreign exchange to invest. For invest using foreign exchange, foreign exchange funds can be exchanged through agent in the RMB clearing bank and overseas renminbi businesses participating bank in Hong Kong that are approved to enter the China domestic inter-bank foreign exchange market (hereinafter referred to as the Hong Kong Settlement Bank) . The resulting position of the Hong Kong Settlement Bank can be placed in the China domestic inter-bank foreign exchange market. In the case of foreign exchange investment, after the bonds have expired or been sold, the settlement proceeds should be exchanged for foreign exchange remittance and processed through the Hong Kong Settlement Bank. 第十条  境外投资者可使用自有人民币或外汇投资。使用外汇投资的，可通过债券持有人在香港人民币业务清算行及香港地区经批准可进入境内银行间外汇市场进行交易的境外人民币业务参加行（以下统称香港结算行）办理外汇资金兑换。香港结算行由此所产生的头寸可到境内银行间外汇市场平盘。使用外汇投资的，其投资的债券到期或卖出后不再投资的，原则上应兑换回外汇汇出，并通过香港结算行办理。

Bond Connect – 2 CNY FX with only one RMB cash account 26 *Source: Citibank Trading China Foreign Exchange Trade System (CFETS) HK or Overseas Investors Tradeweb / Bloomberg (TBD) Hong Kong Mainland China Settlement CCDC/SHCH Central Moneymarket Unit (CMU) CMU Participant Bond Connect Market Maker RMB cash account with Citibank Current Issues:HK Investors need to settle the China bond connect trade with offshore RMB (normally called CNH), previously they have.China regulator PBOC* also allows Investors to get offshore RMB with onshore FX rate (normally called CNY) from HK settlement bank (RMB clearing bank) with their money in foreign currency, but when investor would like to sell bonds and convert from RMB to foreign currency they have to get onshore RMB FX rate from HK settlement bank as well.So CMU participant who also is HK settlement bank has to prepare 2 accounts for 1 HK investor to segregate the two sources of RMB in compliance with regulation, for those big international commercial banks used to only support 1 currency 1 cash account for one client, now has operational limitation; for those able to support, feel nuisance on duplicate accounts.* Refer to next slide for PBOC regulation. 2 sources of RMB:HK Investor could get offshore RMB themselves from other source to settle the bond trade. (offshore RMB FX rate, CNH)HK Investor could also get RMB from HK settlement bank for onshore RMB FX rate, CNY.

27Bond Connect Operational Challenges for Custodians

Bond Connect Operational Challenges 28 Source : State Street

29 …. FOR DISCUSSION ….

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