New Rules Impacting QFIs: Programme Trading, Securities Borrowing and Lending, and Streamlined FOREX Rules
The third plenary session of the CPC Central Committee, a pivotal event that sets the direction for major economic and political reforms of the country and occurs only twice a decade, took place recently. The session reaffirmed China's commitment to embrace “high-quality opening up,” leading to a series of streamlined measures for foreign investors, including Qualified Foreign Investors (QFIs).
Meanwhile, China’s financial regulators are imposing more curbs on short selling (i.e., securities borrowing and lending) and tightening scrutiny over programme trading, among other measures, in response to the need to boost the stock market.
It is anticipated that these types of regulations will continue to co-exist in the foreseeable future. While they may appear to pursue conflicting goals, they could ultimately converge to form a unity of opposites.
Programme Trading
Please refer to our previous regulatory update on programme trading via this link.
On 7 June 2024, Beijing, Shanghai, and Shenzhen Stock Exchanges collectively issued the “Programme Trading Management Implementation Rules (Consultation Draft)” (hereinafter referred to as “Implementation Rules”) to solicit public opinion after China Securities Regulatory Commission (CSRC) released the “Regulations on the Management of Programme Trading in the Securities Market” (hereinafter referred to as “Programme Trading Rules”) about a month ago. Implementation Rules stand out as a more comprehensive version of Programme Trading Rules, offering further clarification on regulatory and compliance details for investors involved in programme trading. Notably, the Implementation Rules adopted by the Beijing Stock Exchange differs slightly from those issued by the other two Exchanges, particularly centring on co-location arrangement and programme trading of Northbound Investors under Stock Connect.
Even though the consultation period has ended, and the Implementation Rules are not yet officially issued, in practice, relevant securities exchanges are already testing the waters by adhering to the key principles enshrined in the Implementation Rules and implementing certain quantifiable parametres which are only made known to brokers.
Some of the highlights in the Implementation Rules include:
1. Scope of application: It is clarified that programme trading includes automatically selecting specific securities and trading timing according to a set strategy, or automatically executing trading instructions according to a set algorithm, as well as other behaviours that conform to the characteristics of programme trading. The addition appears to have followed the same approach as that of the filing requirements issued by securities exchanges in September 2023. In other words, even if portfolio managers exercise discretionary investment decisions, the use of programme trading software to execute these decisions will likely mean they need to comply with the Implementation Rules as well as the Programme Trading Rules.
2. Reporting obligations: Among the existing reporting and filing requirements, QFIs and their brokers can agree to allow the brokers to automatically generate or execute trading instructions. In this case, the brokers can fulfil the programme trading reporting obligations on the QFIs’ behalf. It is worth noting that certain major changes taking place after the initial reporting may lead to a subsequent filing (such as changes in the size of funds, leverage, contact details of the broker, declaration rates or volume, trading strategies, trading software, cessation of programme trading, etc.)
3. Extra abnormal activities introduced: The Implementation Rules further specify that the following behaviours are considered market abnormalities and will be monitored under heightened scrutiny. Exchanges have internally passed on their guidance to the brokers, which aims to quantify those trading abnormalities, but have not yet published the same.
Notably these newer market abnormalities are either stricter than those in the existing rules (like Items A – C) or entirely new (like Item D) with an aim to deal with the propensity to intensify market volatility caused by programme trading.
A. Unusual instantaneous declaration rates, which refer to a large number of declarations or cancellations in one second;
B. Frequent instantaneous cancellations, which refer to frequent instances of quick cancellations after declarations in one second throughout the day;
C. Frequent price manipulations (i.e., price pumping and dumping), which refer to multiple instances of minor price manipulations on single or multiple stocks in one minute throughout the day;
D. Large transactions in a short time, which refer to particularly large buying (selling) amounts in one minute; and
E. Other abnormal trading behaviours that the Exchange believes need to be closely monitored.
4. High frequency trading: HFT is defined as programme trading with the following characteristics, with extra reporting obligations attached:
1. The maximum number of declarations and cancellations per second for a single account reaches more than 300; or
2. The maximum number of declarations and cancellations per day for a single account reaches more than 20,000; or
3. Other situations determined by the Exchange.
5. Stock Connect included: Northbound Investors conducting programme trading on the Shanghai and Shenzhen Stock Exchanges must report basic account information, source of funds, trading strategies, and other details to their Hong Kong brokers. This information is then relayed to the Shanghai and Shenzhen Stock Exchanges via the regulatory cooperation arrangements under the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, facilitated by the Hong Kong Stock Exchange. Specific reporting requirements will be detailed separately by the Shanghai and Shenzhen Stock Exchanges, which is estimated to take place by the end of this year or earlier next year.
Please note that the Implementation Rules do not apply to trading in Chinese futures market, where programme trading and even HFT is allowed, with or without co-location arrangements established. According to our market intelligence futures exchanges in China are also in the process of revisiting and upgrading their current market abnormality rules which may take a couple of years to finish.
Securities Borrowing and Lending
From September last year, CSRC has taken a series of measures to curb securities borrowing and lending (“SBL”), aiming at establishing and re-boosting the stock market. Those measures include the following:
1. Suspending any lending of shares to China Securities Finance Corporation Limited (CSFC, a government-sponsored intermediary which is to facilitate the lending of stocks by the holders of listed shares to the brokers) from mutual funds, pension funds, substantial shareholders, as well as any other holders of listed shares and eventually suspending any such lending to brokers, which has significantly restricted and reduced the brokers’ ability to build up their inventory for the purpose of offering SBL;
2. Substantially increasing the margin ratio for SBL;
3. Brokers are prohibited from lending the stocks (via SBL) to clients who have purchased the stocks on the same day with the aim to achieve the “T+0” effect; and
4. Reiterating that investors (and their affiliates) who hold restricted shares shall not short sell shares of the listed company during the lock-up period - in other words, they are not allowed to borrow from the brokers to conduct short sales if they hold restricted shares.
Whilst such restrictions have a serious and material adverse impact on domestic brokers’ ability to offer SBL, they appear to have little legal impact on overseas brokers (including overseas affiliates of Chinese brokers) as their swap business overseas is not yet regulated by PRC law or subject to the purview of the CSRC, until the time in which the new rule on derivatives is issued which is currently subject to indefinite timeline. (Please refer to our previous regulatory update on PRC offshore derivatives transactions via this link.) Furthermore, those overseas brokers do not heavily rely upon lending via CSFC to build up their inventories, as they may also have QFIs and Stock Connect as alternatives. Whilst CSRC’s guidance and announcement have no direct legal impact on overseas swaps, we understand that this would have a substantial commercial impact, which may lead to an increased cost or a more limited range of offerings.
Streamlined FOREX procedures
On 26 July 2024, the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) jointly amended the Provisions on the Administration of Capital for Domestic Securities and Futures Investment by Foreign Institutional Investors (“New QFI FOREX Rules”), which streamlines a number of procedures concerning capital deployment for QFIs:
1. QFIs are now permitted to open one single cash account (i.e., RMB special deposit account) for trading both securities and derivatives, without the need to open separate accounts respectively for different types of trading as in the past. In other words if a QFI fund trades both equities and futures, there would be no need to open separate RMB special deposit accounts.
2. Under the previous regulations, QFIs had the option to elect between investing in CNY or a foreign currency for their investments in China. If they decided to invest in a foreign currency, they were restricted to remitting the principal and returns in that same foreign currency. Now, under the New QFI FOREX Rules, QFIs now have the flexibility to remit principal and returns in either such foreign currency or in CNY. However, if a QFI elects to invest in CNY in the first place, the remittance of principal and returns is still limited to CNY only.
3. Trading on the China Interbank Bond Market (CIBM) has been made more accessible for QFIs. Specifically, a QFI fund may now freely transfer capital between its QFI accounts and its CIBM accounts opened under its name and based on its investment needs. Furthermore, non-bank QFIs may conduct spot FOREX settlement and derivatives transactions not only through their QFI custodian bank but also with other eligible financial institutions, or alternatively apply to become a member of China Forex Trade System (CFETS) itself and engage in CIBM investment via an eligible prime broker.
4. As a general principle, a QFI shall carry out FOREX derivatives transactions according to its genuine business needs and for the purpose of hedging (not speculation). In other words, a QFI’s China investment denominated in CNY shall bear a reasonable correlation with its exposures to FOREX derivatives. The New QFI FOREX Rules has taken out the requirement that a QFI should adjust its exposures to FOREX derivatives within the first five working days of each month. That said, as we understand in practice, a QFI would still be asked by its custodian bank to make such measurement and adjustment on a monthly basis to ensure the “reasonable correlation” test stands.
Should you have any questions or require further assistance regarding any of the above, please do not hesitate to contact us.
Kind regards,
Melody
联系人:
杨帆
联席负责人，上海/北京
电话：+86 21 8013 5022
