Considering emerging markets? The time is right.

Major index providers are adding new frontier market stocks to their popular emerging market indices—meaning funds that use those products as benchmarks will need to buy in. Learn about the opportunities this creates in the article below.

Tags: International, Bonds, Investing, Stocks, Custody
Published: October 18, 2018

Investment managers and institutional investors around the globe are showing increased interest in frontier and emerging markets. Due to regulatory and operational developments across many of these frontier markets, index providers are upgrading their statuses.

For instance, the restrictive Chinese government has begun over the past few years to relax and simplify foreign investor registration requirements for investing in the market. Historically, only capital-heavy investors could trade with markets in mainland China, and those that wished to do so faced cumbersome local registration requirements. Now, through Hong Kong, they’re accessible to almost anyone who wants to participate—which presents broad potential.

Stock Connect

Since 2014, the mainland Chinese market has been partnering with the infrastructure and regulators of Hong Kong to build a program linking the Hong Kong, Shanghai, and Shenzhen stock exchanges. The platform also links the central securities depositories where stocks are held electronically and where trades are settled. This means foreign parties can invest in the China A shares market more easily than by accessing the market through a sub-custodian in mainland China.

To participate in the “Northbound” (i.e., Hong Kong accessing mainland China market) Stock Connect, investors must first open accounts with a local custodian and a broker in Hong Kong. They then use these accounts to purchase, settle and sell mainland Chinese stocks through the connect platform.

This connection presents many advantages for small to mid-cap investors, namely:

  • There are no minimum investment requirements or foreign exchange quotas to be met as there are in mainland China.
  • The currency used to settle trades is a freely traded offshore Chinese yuan, allowing investors to freely purchase and sell the foreign currency without registering with the mainland authorities.
  • Stock Connect provides accessibility to almost all stocks, including Chinese A shares investors need to purchase to meet indexing requirements.

A broker and a custodian

Participating in Chinese markets via Stock Connect requires foreign investors to use a Hong Kong-based broker and a Hong Kong custodian.

  • Broker: Investors are responsible for finding a broker in Hong Kong to facilitate trades with the China A shares market. Many international brokers have local brokerage access that clients can utilize.
  • Custodian: Investors also need a local custodian. As an example of this, U.S. Bank recently partnered with HSBC Hong Kong, one of the leading custodians in the Asia-Pacific region to provide access to Stock Connect. Once stocks have been purchased or sold, the custodian facilitates the settlement of such transactions as well as any foreign exchange activity related to the purchase and sale of shares. The custodian also processes all corporate actions (e.g., proxy voting, income events) on long-held positions.

Bond Connect

Beyond its stock market, China boasts the third-largest bond market in the world (as defined by market capitalization). In tandem with its Stock Connect program, the country offers a bond connect counterpart which provides foreign investors with a less cumbersome access point to the China Interbank Bond Market (CIBM). Using the same trading and settlement platform, Bond Connect links the exchange and central securities depositories of the Chinese and Hong Kong bond markets. While the settlement process differs slightly, many of the other functions are similar, and U.S. Bank anticipates offering clients CIBM solutions by the end of 2018.

Markets to watch: Saudi Arabia

China isn’t the only country easing restrictions on foreign investment. Saudi Arabia is another sizeable market that’s beginning to allow outside entry. As recently as a few years ago, the Saudi equities market was completely inaccessible to any non-Gulf Cooperating Council (GCC) country. Now, the government has put a process in place allowing institutional investors from around the world to open accounts. While China currently elicits most of the emerging-market attention, investors will likely start taking greater interest in Saudi Arabian opportunities—especially with an index upgrade on the horizon.

As markets continue to open and evolve, indexes will adapt and investors will follow their lead. New opportunities will keep emerging, and with the right partners, you’ll be well-positioned to make the most of them. Learn more about our global custody solutions.