China Access Market Practices RMPG discussion Lisa OConnor

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

Table of Content Business 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) 2

Business Background 3

China Market Snapshot Too Big to Ignore China Stock Market is the 2 nd largest worldwide Top 8 Currency in Global Payments The successful RMB inclusion in the SDR basket (in effect from Oct 16) has shaken up the way the world thinks about a ‘reserve asset’. 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 42. 63% 36. 74% 35. 00 30. 00 25. 00 20. 00 15. 00 10. 00 5. 00 0. 00 29. 40 Global Exchange Market Capitalization April 2018, in USD trillion US Source: Bloomberg as April 2018 4. 14% 4. 08% USD EUR GBP JPY 6. 37 5. 52 China Japan Hong Kong 3. 79 UK 2. 07% 1. 78% 1. 40% 1. 24% 0. 94% 0. 62% CAD CHF AUD CNY HKD SEK Source: RMB tracker by SWIFT as of July 2018 China is the world’s 3 rd largest bond market China Interbank Bond Market (June 2018, USD 10. 34 trillion) - 96. 3% of Total Bond Market Others 6% Credit Bond 19% NCD 13% Central Govt Bond 18% Local Govt Bond 23% Policy Bank Bond 20% 4 7. 35 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. Summary of China Equity Market Mar 2018 Market Cap (in USD billion) Average Daily Trading Value (in USD billion) Shanghai Main Board 1420 5179 32 Shenzhen Main Board 465 1208 11 Shenzhen- SME Board 910 1636 17 Shenzhen-Chi. Next Board 722 862 14 Source: SSE, SZSE as of Mar 2018 Source: CCDC and SCH as of June 2018 No. of Listed Companies Source: Citibank

China Connect | Overview and Potential Future Expansion With the launch of Bond Connect, international investors could easily access over 80% of onshore securities investments China A Equity Mutual Recognition of Funds Bond Exchange Traded Fund SH Connect (2014) SZ Connect (2016) IPO (2019*) MRF (2015) CIBM Connect (2017) Listed Bond Connect (2019*) SH/SZ Connect (2019*) Recognized as the most efficient and scalable China access platform for international investors 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 Connect March 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 time August 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 Connect • • 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 PBo. C 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. MSCI A-Share Inclusion • Implemented on 1 June 2018 • 2 nd tranche on Sep 1 st 2018 China Bond Inclusion • 23 Mar 2018 announced the inclusion of China bond into the Bloomberg Barclays Global Aggregate Index starting April 2019 over 20 month period Source: Citibank

CIBM | Number of Foreign Institutional Investor Accounts Bond Connect already represents over 40% of total institutional investor or funds accessing CIBM Increased to 425 Investors as of Aug 18 6 Source: Citibank

Bond Connect | Further Development of Bond Connect Upcoming key developments highlighted in Bond Connect Anniversary Summit 1. Full realisation of the delivery versus payment settlement system (announced on 23 Aug 18) DVP settlement is implemented on 24 Aug 2018 2. Launch of block trade allocation service (announced on 31 Aug 18) Pre-trade allocations function allows trader to allocate block trade in % or amounts up to 30 funds 3. Clarify tax policy for overseas investors (announced on 30 Aug 18)* 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 4. Addition of 10 more Bond Connect dealers to a total of 34 (announced and effective on 3 Jul 18) 5. Discounts of up to 50 per cent in Bond Connect transaction fees (announced and effective on 3 Jul 19) 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 authorities Source: Citibank

Bond Connect | Northbound 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 in Hong Kong. Trading Settlement Bond Connect Market Maker China Foreign Exchange Trade System (CFETS) CCDC/SHCH CIBM Direct (2016) Account Structure · · CFETS Trading ID needs to be created Segregated & direct account at CCDC/SHCH 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 Requirement · Appoint 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 custodian Trading · · · Hours: 09: 00– 12: 00 & 13: 30– 16: 30 All CIBM Market Makers and participants Price inquiry via BSA, or directly contact counterparty, however must formally conduct the trade via the BSA · · · Hours: 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 RFQ Block trade allocations function allows trader to send one RFQ for up to 30 CFETS IDs Mainland China Central Moneymarket Unit (CMU) Eligible Securities · · · CMU Participant HK or Overseas Investors 8 · · · Hong Kong Tradeweb / Bloomberg (TBD) Bond Connect (2017) Cash bond, · Bond lending, bond forward, IRS and FRA (for hedging · purpose only) Repos only allowed for ROIIs, RMB Participating/Clearing Banks (Need NAFMII) CFETS Trading ID needs to be created Supports multi-layer custodian arrangement with subaccount at the CMU level Cash bond Repos & CNY derivatives at later stage Settlement Cycle · · 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 Or Global Custodian Source: Citibank

Bond Connect | How to get ready? May 16 th 2017 June 2017 Joint announcement by PBOC and HKMA Rules published July 3 rd 2017 Aug 7 th 2017 Pilot launch Citi Launched Integrated Bond Connect Solution Going Forward • Enable block trade • Tax Clarification on CIBM • Using CIPS 2 to potentially deliver DVP settlement for CCDC securities and improve cutoff time Fund Manager Checklist to Prepare to Use Bond Connect 1. Establish access to Tradeweb (initially) or Bloomberg (expected to be available soon) 2. For regulated funds: Check with depot bank and relevant regulator on disclosure or approval requirement for Bond Connect 3. Confirm with your custodian that they are a CMU Participant and CFETS Settlement Bank 1 for Bond Connect 4. 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) 5. Decide and establish RMB FX (CNH/CNY or both) funding, FX and hedging arrangement 6. Review any additional documentation e. g. Bond Connect Terms and Conditions and fee arrangement 7. Review operation specifics including cutoff times 4 - 6 Weeks Send MT 599 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 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 Major Bond Index Estimate passive AUM (US$bn) Estimated weight Estimate inflow (US$bn) 250 10% 25 Bloomberg-Barclays Global Aggregate 2, 500 5. 49% 137 World Government Bond Index 2, 000 5% 100 JP Morgan Government Bond Index. Emerging Markets Market estimated US$ 262 billion of offshore deployment to China onshore bonds catalyzed by index inclusion Source: Citi Research “Surprise Index Inclusion Announcement is a Positive Step”, issued 25 Mar 2018 Bloomberg -Barclays • 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. • Yield Book – FTSE Russell JP Morgan Effective in February 2018, China onshore bonds are included to: 2 EM Government Bond Index (EMGBI) Asian Government Bond Index (AGBI) Asia Pacific Government Bond Index (APGIB) Emerging Markets Government Bond Index-Capped (AGBI-Capped) – newly created Asian Government Bond Index-Capped (AGBI-Capped) – new created 1) 2) 3) 4) 5) • China onshore bonds placed under review for inclusion in JPM’s fixed income indices • Possible inclusion in JPM Government Bond Index (GBI) series and other investment grade indices 1 Source: Bloomberg press announcement, issued on 23 Mar 2018 2 Source: The Yield Book announcement “China Inclusion to the Government Bond Indexes”, issued on 31 Jan 2018 Source: Citibank

Stock Connect | Northbound Flow Continues to Grow China Connect average daily trading volume has increased to US$3. 1 bn* in 2018 Stock Connect Northbound Aggregate Net Buy reaches about ~USD 78 BN* (In US$ Billion) Stock Connect Aggregated Net Buy ~33% of QFII/RQFII schemes Aggregate net buy of Shanghai A-shares as of Jun 28, 2018: ~USD 44 Bn Shanghai-Hong Kong Stock Connect (Nov 2014) RMB 234. 4 Bn | US$ 37. 0 Bn Aggregate net buy of Shenzhen A-shares as of Jun 28, 2018: ~USD 34 Bn Shenzhen-Hong Kong Stock Connect (Dec 2016) RMB 180. 6 Bn | US$ 28. 5 Bn Qualified Foreign Institutional Investors QFII (late 2002) RMB 630. 1 Bn | US$ 99. 5 Bn RMB Qualified Foreign Institutional Investors RQFII (late 2011) RMB 618. 1 Bn | US$ 97. 6 Bn Source: Reuters as of 28 Jun 2018 Source: SAFE, HKEX 1 as of 27 Apr 2018 Northbound Trading daily turnover continues to grow A-shares market trend since launch of Stock Connect Shanghai Shenzhen CSI 300 Index Average Daily Turnover ~US$ 3. 1 Billion* Source: Reuters *as of Jun 2018 YTD Source: Yahoo

Impact of MSCI Inclusion 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 1 st and Sep 1 st is likely to facilitate additional inflow RMB (billion) Shanghai 30 -May 31 -May 1 -Jun 11. 9 5. 8 6. 1 22. 1 12. 6 9. 6 10. 6 6. 0 4. 6 11. 8 7. 4 4. 4 0% 30 -May 7% 31 -May 3% 1 -Jun 6% 11 -Jun 10. 1 5. 9 4. 2 12. 5 7. 6 4. 9 9. 2 5. 0 4. 3 9. 7 5. 5 4. 1 4% 30 -May 6% 31 -May 2% 1 -Jun 3% 11 -Jun Total Turnover Total Buy Total Sell 22. 0 11. 7 10. 3 34. 6 20. 2 14. 5 19. 8 11. 0 8. 9 21. 5 12. 9 8. 5 Net Buy 1. 4 5. 7 2. 1 4. 2 Total Turnover Total Buy Total Sell Quota usage Shenzhen Total Turnover Total Buy Total Sell Quota usage Total 12

Stock Connect vs. RQFII / QFII China Connect (Northbound) Nov 2014, Dec 2016 Eligible Investors Quota · Over 5000 institutions with net holding of US$93 bn (Apr 2018) · 196 institutions with total approved quota US$97. 6 bn (Apr 2018) QFII (Since 2002) · 287 institutions with total approved quota of US$99. 5 bn (Apr 2018) · Available to all overseas investors · Only available to approved RQFII market (19) and limited · Only available to qualified institutions in markets with MOU · Daily Net Buy Quota: RMB 52 billion each for to institutional investors with asset management license with China (~55) limited to institutional investors subject and subject to qualification requirements. Japan added in qualification requirements May 2018. · Go through a filing process, additional quota requires approval from SAFE. Minimum Basic Quota of each QFII is US$20 million · All SSE and SZSE stocks Shanghai and Shenzhen Eligible Investments RQFII (Since 2011) · Constituent stocks of SSE 180 and 380, SZSE Component Index and SZSE Small/Mid Cap Innovation Index with market capitalization >RMB 6 billion 1 · All dual-listed shares 1 · Corporate, government, enterprise, convertible and interbank bond market · Securities investment funds including closed-end, open-ended and ETFs · Others such as warrants, index futures, IPOs · Chi. Next are limited to Professional Institutional CCY Liquidity Setup Time Docs · · Investors at initial stage Offshore RMB and onshore RMB Daily liquidity No restriction on sell trades No prefunding requirement for CNH or other currencies · 2 -3 weeks upon receipt of documentations · Stock Connect Terms and Conditions · Offshore RMB · US$ or other major foreign currencies · RQFII custodian must confirm available cash before trade · QFII custodian must confirm available cash before trade occurs · At least three months to a year · Application statement, copy of registration, financial business permit, certificate of proof of qualification, certificate of proof · SPSA if applicable 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 Source: Hong Kong Exchanges and Clearing Limited (HKEx), State Administration of Foreign Exchange, Citi Securities Services, Bloomberg. Exceptions: Shares not traded in RMB, Shares under “risk alert”, IPOs

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

Offshore 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 ISO 15022. 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 15

The 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. 16

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

Securities @ 2012 • The securities post-trade, 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 (MT 540, 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 E 1 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). 18

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

Bond Connect Description Bond 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 : 94 F: : SAFE and : 95 P: : 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). 20

Receiving Delivering Depository and Place of Safekeeping Bond Connect Settlement: BUYING Example (CCDC) BUYRGB 22 provides the below settlement info to CUSTHKHH, which will be input in the instruction from CUSTHKHH to HKMAHKHC • Delivering agent is DEAGCN 22 • Seller is SELLCN 33 • Place of settlement (Delivering agent’s CSD) • Today the CMU guidance is to use NDCCCNB 1. 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 BUYRGB 22 Seller SELLCN 33 Proprietary Msg MT 541 Custodian CUSTHKHH Clearing Agent DEAGCN 22 Proprietary Msg MT 541 HKMA CMU HKMAHKHC CCDC / SHCH MT 541/sese. 023 or proprietary NDCCCNB 1*

ISO 15022 Illustrations From the buyer to custodian (global or sub) MT 541 Sender: BUYRGB 22 Receiver: CUSTHKHH : 94 F: : SAFE//NCSD/HKMAHKHC and : 95 P: : PSET// NDCCCNB 1 allows the custodian to identify the settlement as a bond connect settlement. CBTnnnnnnn is the CFETS Trade Reference Number NOTE: NDCCCNB 1 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: CUSTHKHH Receiver: HKMAHKHC 94 F: : SAFE//NCSD/HKMAHKHC and : 95 P: : PSET// NDCCCNB 1 allows the custodian to identify the settlement as a bond connect settlement. CBTnnnnnnn is the CFETS Trade Reference Number NOTE: NDCCCNB 1 is used as an example but will be replaced by NDCCCNBJ

China Stock Connect and Bond Connect Flows 24

Bond Connect – PBOC’s regulation on RMB FX of Bond connect settlement 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 foreign exchange remittance and processed through the Hong Kong Settlement Bank. 第十条 境外投�者可使用自有人民�或外�投�。使用外�投�的，可通��券持有人在香港人民���清算行及香港地区�批准可�入境内 �行�外�市��行交易的境外人民���参加行（以下�称香港�算行）�理外��金��。香港�算行由此所�生的�寸可到境内�行� 外�市�平�。 使用外�投�的，其投�的�券到期或�出后不再投�的，原�上���回外��出，并通�香港�算行�理。 25

Bond Connect – 2 CNY FX with only one RMB cash account Trading Settlement Bond Connect Market Maker China Foreign Exchange Trade System (CFETS) CCDC/SHCH Mainland China Hong Kong Tradeweb / Bloomberg (TBD) Central Moneymarket Unit (CMU) Current Issues: 1. HK Investors need to settle the China bond connect trade with offshore RMB (normally called CNH), previously they have. 2. 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. 3. 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. CMU Participant HK or Overseas Investors *Source: Citibank RMB cash account with Citibank 2 sources of RMB: 1. HK Investor could get offshore RMB themselves from other source to settle the bond trade. (offshore RMB FX rate, CNH) 2. HK Investor could also get RMB from HK settlement bank for onshore RMB FX rate, CNY. 26

Bond Connect Operational Challenges for Custodians 27

Bond Connect Operational Challenges Source: State Street 28

…. FOR DISCUSSION …. 29

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