On November 2, the Shanghai Stock Exchange (SSE) officially promulgated the supporting market rules for the depository receipt (DR) business under the stock connect scheme between the SSE and the London Stock Exchange (LSE) (the “DR Business under Shanghai-London Stock Connect”). An SSE official in charge of the program has answered the questions about the formulation of the rules.
1. Can you brief us on the formulation of the supporting business rules for the DR Business under Shanghai-London Stock Connect?
The launch of the DR Business under Shanghai-London Stock Connect is an important measure to further expand the two-way opening up of the capital markets, which will help to improve the international competitiveness of China’s capital market and its ability to serve the real economy, and will also provide more options for domestic investors to achieve worldwide resource allocation. According to the unified deployment of the China Securities Regulatory Commission (CSRC), the SSE has researched and formulated the supporting market rules at the exchange level to ensure that the DR Business under Shanghai-London Stock Connect is implemented in accordance with the laws and regulations.
The supporting market rules intensively issued by the SSE include eight sets of market rules such as the the Interim Measures for the Listing and Trading of Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange (the “Interim Measures”). The market rules were formulated on the basis of the upper laws and regulations such as the Securities Law, the Opinions on Launching the Pilot Program of Domestic Offering of Stocks or Depositary Receipts by Innovative Enterprises (the “Opinions”) issued by the CSRC and forwarded by the State Council, and theAdministrative Measures of Offering and Trading of Depositary Receipts (Trial) (the “Administrative Measures of Depositary Receipts”), the Provisions on the Supervision and Administration of Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange (for trial implementation) ( “Supervision and Administration Provisions”) and other higher level lawsissued by the CSRC.
The Interim Measures is the basic market rules to regulate theDR Business under Shanghai-London Stock Connect, providing the unified provisions on the listing, trading, ongoing regulation and cross-border conversion of Chinese depository receipts (CDRs), the listing and the cross-border conversion of the underlying shares of global depository receipts (GDRs) and other issues related to Shanghai-London Stock Connect. On such a basis, the three sets of business guidelines have been developed, namely, the Guidelines for the Pre-Listing Review of Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange, the Guidelines for the Cross-border Conversion of depositary receipts under the stock connect scheme between Shanghai Stock Exchange and London Stock Exchange and the Guidelines for the Market Making for Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange.
Another 4 sets of supporting business guidelines and notices were also issued this time, namely, the Essential Clauses of the Risk Disclosure Statement for Trading of Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange, the Guidelines on the Content and Format of Listing Announcement for Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange,the Notice on Fees and Charges for the Listing and Trading of Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange and the Notice on Matters regarding Information Disclosure Window for Chinese Depositary Receipt Transactions under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange.
Before the issuance, the SSE had publicly solicited opinions on the four market rules including the Interim Measures in the market, and received about 200 feedback opinions and suggestions. In general, the market participants basically recognized the business model and rules structure of the DR Business under Shanghai-London Stock Connect, and the opinions and suggestions mainly focused on the details in the implementation of the business, the enforcement of the rules and the specific operations. After carefully studying the feedback, the SSE has absorbed the reasonable opinions and suggestions into the Interim Measures and other market rules. Going forward, the SSE will further clarify relevant operational matters by developing supporting guidelines and operational guidance and organizing training activities.
2. In the DR Business under Shanghai-London Stock Connect, overseas issuers may publicly offer and list CDRs that represent existing shares in the domestic market. What is special about the model ofoffering and listing? What is the specific system design?
In the early stage of the DR Business under Shanghai-London Stock Connect, without the financing arrangements, issuers of the underlying overseas securities corresponding to CDRs (“overseas issuers”) can publicly offer and list the CDRs only with the existing shares as the underlying securities. The public offering and listing model is different from the initial public offering (IPO) model of domestic stocks that we are familiar with, as there are no processes such as intensive public offering and subscription of new shares, instead the application for listing and trading can be submitted after establishing necessary liquidity through cross-border conversion on the basis of certain mechanisms.
Specifically, after the overseas issuer has obtained the approval of the public offering by the CSRC, the qualified domestic securities company (the “Chinese Cross-border Conversion Institution”) can purchase or otherwise lawfully acquire the underlying shares in the overseas market and deliver such shares to the depositary, who then issues the corresponding CDR to Chinese Cross-border conversion institution according to relevant rules and the terms of the business agreement.. The cross-border conversion business process before the listing is also called the “initial creation”. After the initially created CDRs reach the minimum listed shares and market value thresholds prescribed in the Interim Measures for, the issuer can submit the application for listing.
Due to the large differences in business models, overseas issuers who publicly offer and list the CDRs that representexistingshares in the domestic market cannot apply to the current domestic legal system on IPO. Therefore, in the offering approval and listing review system, the following specific arrangements have been made: first of all, in accordance with the provisions of the “Securities Law”, the business is included in the public offering of securities for regulation, and the public offering is approved by the CSRC according tolaw; secondly, the pre-listing review mechanism is introduced as the SSE shall examine whether the overseas issuer meets the requirements for listing (including the requirements for offering); thirdly, in light of the actual situation where the overseas issuers do not raise funds, the relevant application documents and review procedures have been simplified to some extent, as the examination by the offering review committee is not required in the process of reviews by the CSRC; fourthly, to provide convenience for the parties concerned, the pre-listing application and the application for public offering can be accepted at the same time, and specifically the documents of application for public offering will be submitted to the CSRC through the SSE.
3. In the DR Business under Shanghai-London Stock Connect, which overseas issuers can publicly offer and list the CDRs? What institutional arrangements have been made for information disclosure and ongoing regulation?
As the name suggests, the overseas issuers of CDRs under Shanghai-London Stock Connect are limited to the overseas issuers listed on the LSE. With regard to the specific conditions, the overseas issuers shall first meet the basic offering requirements of the Administrative Measures of Depositary Receipts and the Supervision and Administration Provisions for public offering of DRs; secondly, the specific requirements of the Interim Measures for listing the CDRs shall be met. In general, the requirements for listing are in three aspects: first of all, in terms of the aggregate market capitalization, it is required to have an average market capitalization of no less than RMB 20 billion, per the closing price of the underlying shares, over the 120 trading days prior to the offering application date; secondly, with regard to the period of local listing, it’s required to have been listed on the LSE for at least 3 years and have obtained the premium listing for at least 1 year; thirdly, regarding the listing size in China, the amount of CDRs applying to list shall be no less than 50 million units of CDRs representing no less than RMB 500 million of corresponding underlying shares at market value.
In terms of information disclosure and ongoing regulation, generally speaking, the same standards for the red-chip companies listed overseas in the pilot program for innovative enterprises will be applied to the overseas issuers of CDRs under Shanghai-London Stock Connect. The overseas issuer shall abide by the Chinese laws and the requirements of the SSE market rules for information disclosure; the announcements disclosed in the LSE market shall be simultaneously revealed in the SSE market; the application documents for listing and the documents for continuous information disclosure shall be written in Chinese, etc. In addition, the information disclosure requirements of the main board market on the LSE are roughly the same as those of the SSE market; the overseas issuers of CDRs under Shanghai-London Stock Connect are limited to the listed companies on the main board of the LSE which have obtained premium listing, which usually have good compliance practices in information disclosure; the investor suitability management system is implemented for CDRs under Shanghai-London Stock Connect, and only qualified investors with higher risk perception and tolerance can participate in the program. Considering the above-mentioned factors, the Interim Measures allows overseas issuers to, on the premise of not lowering the substantive standards for information disclosure, adjust the applicable rules of the SSE in accordance with the relevant provisions on the company's place of registration and overseas listing location as well as the standards generally accepted in the LSE market in practice. When the relevant applicable arrangements are adjusted, the overseas issuer shall explain the reasons and offera alternative plan and engage a law firm to issue a legal opinion on the matter.. If the SSE believes that the applicable arrangements should not warranted by law, then the adjustments will not be made.
4. What are the considerations for adopting cross-border conversion of DRs under Shanghai-London Stock Connect? How will the conversion be implemented in practice?
As an innovative arrangement, the DR trading system under Shanghai-London Stock Connect allows the cross-border conversion. The Opinions and the Administrative Measures of Depositary Receipts have provided provisions on the cross-border conversion of DRs in principle. Allowing the cross-border conversion of DRs under Shanghai-London Stock Connect is mainly due to three considerations: first of all, the liquidity has to be established through the cross-border conversion for the CDRs listed with the existing stocks as the underlying securities; secondly, cross-border conversion is conducive to the reasonable pricing of the DRs under Shanghai-London Stock Connect; thirdly, cross-border conversion is the common practice in the DR business on the overseas markets and is in line with the orientation of the DR Business under Shanghai-London Stock Connect toward an international program.
Cross-border conversion refers tothe conversion between the domestic CDRs and the overseas underlying shares in accordance with the conversion ratio. Taking CDRs as an example, cross-border conversion of CDRs includes the initial creation stage before listing and the ongoing conversion stage after listing. From the perspective of business process, the cross-border conversion involves two aspects, creation and redemption. The creation process corresponds to the conversion of the overseas underlying stocks into the domestic DRs, which means that a Chinese cross-border conversion institution purchases or otherwise lawfully acquires the underlying shares in the overseas market and delivers such shares to the depositary, who then issues the corresponding CDR according to relevant rules and the terms of the depositary agreement.; the redemption process corresponds to the conversion of the domestic DRs into the overseas underlying stocks, which means that the depositary cancels the CDR according to relevant rules and the terms of the depositary agreement, and then delivers the corresponding underlying shares to the Chinese cross-border conversion institution..
The cross-border conversion is a two-way balance mechanism in trading, where the relevant market participants make their own judgments in implementation and bear the risks on their own according to the factors such as changes in supply and demand. The number of the shares of the DRs in the duration will change constantly based on the cross-border conversion within the upper limit of the quantity of the public offering approved for the issuer.
5. What are the differences between the trading mechanisms for the CDRs under Shanghai-London Stock Connectand the A-shares?
The trading of CDRs under Shanghai-London Stock Connect adopts a hybrid trading mechanism combining auction trading and market making trading. In terms of auction trading, the trading mechanism is generally consistent with that of the A shares with some differentiated arrangements, which are mainly in the following aspects: first of all, the same price limit as A shares is implemented, but the price limit for the first trading day after 7 or more calendar days of daylong market closure at SSE shall be 20 percent; secondly, for the CDRs publicly offered and listed representing existingshares, the price limit will not be exempted on the first day of listing, the reference opening price of the CDRs for the first day of listing shall be the RMB-denominated price converted from the nearest closing price of the underlying shares on the LSE market and the rules of the SSE on the supervision of trading of newly issued shares during the early days of their listing shall not apply to a CDR following the first day of its listing.; thirdly, if the overseas issuer distributes cash dividends, the SSE will not make ex-dividend adjustment to the CDR; fourthly, the CDRs have the real-time market data and other information published on each trading day, but the abnormal stock fluctuation indicators and open trading information in the SSE’s “Trading Rules” are not applicable. In addition, at present the CDRs are not included in the scope of underlying securities for the businesses of margin trading and short selling transactions, stock-pledged repurchase and agreed repurchase securities trading and other businesses.
6. Since the investor suitability management system will be implemented for the trading of DRs under Shanghai-London Stock Connect, what are the considerations in setting the specific conditions? In addition, what other measures for investor protection will be taken?
Both theAdministrative Measures of Depositary Receipts and the Supervision and Administration Provisionsstipulate that the investor suitability management system shall be implemented in the trading of CDRs under Shanghai-London Stock Connect. The Interim Measures further provides specific requirements for the investor suitability, stipulating thatthe daily average value of assets in individual investor’s securities account and funds account over the 20 trading days before applying for trading CDRs is no less than RMB 3 million, no serious adverse entry in her/his integrity record; and she/he is not under any circumstance where she/he would be prohibited or restricted from trading securities by the provisions of domestic laws, market rules of the SSE, or otherwise and pass the comprehensive assessment organized by the members; the institutional investors should comply with the domestic laws and the market rules of the SSE. The recognition of specific qualification conditions shall be implemented with reference to the existing requirements for affirmation of the average daily asset and the comprehensive assessment in the Shanghai-Hong Kong Stock Connect, the stock options and other businesses.
The above-mentioned requirements for the suitability management have been set mainly out of the considerations in the following three aspects: first of all, CDRs under Shanghai-London Stock Connect involving quite a few innovative links are characterized by the complicated businesses, and make higher requirements for the investors’ risk identification and tolerance; secondly, according to the experience in the investor suitability management for the Shanghai-Hong Kong Stock Connect, the stock options and other innovative businesses, as one of the important criteria for investor suitability management, the asset size is also an important reference for assessing investors' risk tolerance; thirdly, the investors who have serious bad credit records or prohibited or restricted from trading securities by the provisions of domestic laws, market rules are excluded, which is conducive to creating a honest market environment and maintaining the normal trading order.
On the basis of the implementation of the investor suitability management, the multi-dimensional investor protection arrangements are implemented in the DR business under Shanghai-London Stock Connect, mainly including: first of all, overseas issuers of underlying securities are required to participate in the offering of the CDRs, fulfill the obligations of an issuer and listing company according to law, and assume corresponding legal responsibilities; secondly, the overseas issuers are required to ensure that the actual rights and interests of domestic investors are roughly equal to those of overseas holders of underlying securities, and shall not discriminate against domestic investors; thirdly, the depositaries are required to take effective measures to ensure the safety of the underlying assets of the DRs; fourthly, the overseas issuers are required to set up their domestic offices for securities affairs, hire the domestic representatives for information disclosure, andprotect the domestic investors’ right to know; fifthly, it is required that the depositary agreements should clearly stipulate that Chinese laws are applicable to the disputes arising from the CDRs, which shall be governed by domestic courts, and so on.
7. What are the domestic regulatory requirements for domestic issuer’sissuing and listing GDR under Shanghai-London Stock Connect on the LSE market?
It is an important part of the DR Business under Shanghai-London Stock Connect for the domestic issuers to issue and list the GDRs on the LSE market. In this regard, the the Supervision and Administration Provisions has made a series of basic provisions on the conditions for the issuance, requirements for the offering price, the period limits for the creation and redemption of cross-border conversion, mergers and reorganization, and the upper limit for the equities held by overseas investors, etc.
The domestic issuers of the GDRs under Shanghai-London Stock Connectare also the listed companies on the SSE, and in principle the SSE conducts information disclosure regulation on domestic issuers in accordance with the provisions of the Listing Rules of the Shanghai Stock Exchange on the companies listed at home and abroad at the same time. In addition, with the cross-border conversion implemented for GDRs under Shanghai-London Stock Connect, the Interim Measures further provides the provisions on the application for listing the domestic underlying stocks, the cross-border conversion of the GDRs and other related matters.
It should be noted that in addition to the rules made in the domestic market, domestic issuers are also required to comply with the relevant listing conditions and regulatory requirements on the LSE market. The SSE will vigorously provide services and support for eligible domestic issuers to publicly issue and list the global GDRs on the LSE market.
The Chinese versions of the supporting market rules published at the same time are available in the section of “SSE Market rules – Shanghai-London Stock Connect Rules” on the official website of the Shanghai Stock Exchange, and the English versions can be found in the section of “Laws & Regulations - Shanghai-London Stock Connect” on the English website of the SSE.
Notice on Issuing the Essential Clauses of the Risk Disclosure Statement for Trading of Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange
Notice on Issuing the Guidelines on the Content and Format of Listing Announcement for Chinese Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange