Approaching Shanghai-London Stock ConnectAuthor: 于炳光 2018-11-129467
Shanghai-London Stock Connect is the abbreviation for the connectivity mechanism between the Shanghai Stock Exchange (SSE) and the London Stock Exchange (LSE). It refers to the arrangement where eligible companies listed on the two venues can issue depositary receipts (DRs), list and trade them on the other side's market according to local market’s laws and regulations. Meanwhile, through a cross-border conversion mechanism between depositary receipts and underlying securities, the connectivity of the two markets to be realized.
I. A journey from feasibility study to launch
Based on the results of Chinese President Xi Jinping's visit to the UK in October 2015 and the Seventh China-UK Economic and Financial Dialogue, both the Chinese and British sides welcomed the feasibility studies conducted by the SSE and the LSE on the connectivity between the two markets in Shanghai and London. Since then the Chinese and British sides have studied and issued applicable rules and regulations for the launch of Shanghai-London Stock Connect.
On March 22 this year, the General Office of the State Council forwarded the Opinions of the China Securities Regulatory Commission (CSRC) on Launching Pilot Projects for the Domestic Issuance of Shares or Depositary Receipts by Innovative Enterprises, which built up a platform of rules for issuing depositary receipts domestically by Chinese companies, especially for those high-tech innovative enterprises listed overseas.
On June 6, the CSRC promulgated the Administrative Measures for the Issuance and Trading of Depositary Receipts (for Trial Implementation) and related supporting documents, clarifying the requirements for the issuance, trading and information disclosure of Chinese Depositary Receipts. The promulgation of the aforesaid measures constructively broke through the legal system which forbids foreign companies from listing in mainland China, and this represents a further opening up of China's capital market.
On July 10, the LSE announced Consultation on Amendments to the Admission and Disclosure Standards, soliciting advice on the addition of the Shanghai-London Stock Connect Segment and other associated revisions. On September 17, the LSE issued the amended Admission and Disclosure Standards, adding the Shanghai-London Stock Connect Segment to the Main Market and corresponding issuance and disclosure requirements. The Standards came into effect on October 1, 2018.
On August 31, the CSRC announced the Notice on Public Consultation for the Provisions on the Supervision and Administration of Depository Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange (for trial implementation) and on October 12, issued Provisions on the Supervision and Administration of Depository Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange (for trial implementation) (referred to as the Supervision and Administration Provisions), providing a legal and institutional basis for the connectivity of the two markets and issuance of depositary receipts.
On October 12, the SSE published its consultation on the relevant systems of Shanghai-London Stock Connect. These drafts set forth specific provisions on the listing process, cross-border conversion and the market making system for depositary receipts. On November 2, the SSE promulgated the Interim Measures for the Listing and Trading of Depositary Receipts under the Stock Connect Scheme between Shanghai Stock Exchange and London Stock Exchange and other relevant regulations.
In addition to complying with the above-mentioned rules, an SSE-listed company issuing GDRs are still subject to the related requirements of Securities Law and Special Regulations of the State Council Concerning Floating and Listing of Shares Overseas by Companies Limited by Shares, and the relevant rules of the GDR issuance promulgated by the UK securities regulatory authorities, such as Listing Rules and Prospectus Rules promulgated by the Financial Conduct Authority (FCA). Since the UK has not yet left the EU, the issuance of GDRs continues to comply with EU Directives and Regulations, such as the Transparency and Prospectus Directives.
According to the prevailing rules, Shanghai-London Stock Connect includes a two-direction business, eastbound and westbound. The eastbound direction consists of LSE-listed companies listing Chinese Depositary Receipts (CDRs) on the SSE. In the westbound direction, the A-share companies listed on the SSE list Global Depositary Receipts (GDRs) on the LSE. At the initial stage, the underlying securities of the DRs are limited to stocks only. The eastbound direction will not allow LSE-listed companies to conduct direct financing in China's domestic market by issuing new shares in the form of CDRs at current juncture. The A-share companies listed on the SSE can conduct direct financing in the UK market by issuing GDRs. To steadily promote the issuance of the DRs, limitations will be initially placed on the total volume of depository receipts that can be issued and that of the daily trading volume. Qualified securities trading institutions on both sides may directly open securities and fund accounts in the market of the other side and engage in cross-border depositary receipt conversion business provided they abide by the applicable rules and regulations.
The LSE and the SSE have by now almost completed the formulation of applicable rules and regulations for eligible companies to list DRs on each other's market. With the launching of the Shanghai-London Stock Connect mechanism, the listed companies in the two countries are already at concert pitch. On September 25, Huatai Securities announced that it will issue GDRs and apply for listing on the LSE. It plans to raise no less than US$500 million for its domestic and overseas business development and investment. Upon the launch of Shanghai-London Stock Connect, Huatai Securities will become the first A-share company to be listed on three venues: Mainland China, Hong Kong and London (A+H+GDR). Apart from Huatai Securities, China’s Bluestar Adisseo is also considering issuing GDRs to raise about US$500 million. According to statistics, there are still about 224 SSE-listed companies eligible for issuing GDRs. Parallelly, LSE-listed companies are also actively preparing, and it is reported that HSBC might become the first foreign company to issue CDRs on the SSE. An optimistic forecast is that the first issuance of DRs under Shanghai-London Stock Connect will take place in early December this year.
II. Comparison between Shanghai-London Stock Connect and Shanghai-Shenzhen-Hong Kong Stock Connect, QFII andRQFII
Shanghai-London Stock Connect is a mechanism under which listed companies in Shanghai and London, satisfying certain conditions, can list and trade their depositary receipts in the market on the other side. Trading and settlement of the depositary receipts is similar to that for stocks. In addition, with reference to international practices, the depositary receipts and the underlying stocks can be converted into each other in Shanghai-London Stock Connect. With the mutual conversion mechanism between the underlying stocks and the depositary receipts, the trading in the two markets will be connected, as such achieve cross border fungibility.
Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect is a connectivity model, in which the trading orders placed by domestic investors are routed by the securities trading service companies established by the exchanges to the overseas exchanges for execution. The securities registration and settlement institutions on both sides provide the local investors with nominal holder service, hold the overseas securities as a representative and participate in clearing and settlement.
Simply put, in Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, the investors on both sides directly buy and sell stocks in the market on the other side, with the "investors" crossing the border but the products still remaining in their home market. However, in Shanghai-London Stock Connect, the depositary receipts are converted from the stocks in the opposite market and then listed and traded in the local market, with the "products" crossing the border but the investors still remaining in the local market.
QFII (Qualified Foreign Institutional Investors) refers to the qualification accreditation system for foreign professional investment institutions to invest in China. According to current regulations, the foreign investors who meet certain conditions is qualified to invest in China’s capital market and contribute a certain amount of foreign exchange funds to its account after the approval of the CSRC and the SAFE, and invest in China's securities market through a special account under strict supervision. RQFII (RMB Qualified Foreign Institutional Investors) refers to RMB qualified foreign institutional investors, which is also known as ‘little QFII’ as the approved investment quota is much less than that of QFII. RQFII is a system for overseas institutions to invest in China with RMB. Both QFII and RQFII are the primary ways for foreign investors to participate in China's securities market prior to the launch of Shanghai-London Stock Connect.
The difference between QFII/RQFII and Shanghai-London Stock Connect is that the former is a qualification accreditation system for foreign institutional investors to invest in China, while the latter allows eligible listed companies to issue depositary receipts in the other side’s market, a system under which cross-border stock transactions are realized.
III. Depositary receipts issuance, Cross-border conversion and Investor protection
The current regulations such as the Supervision and Administration Provisions and the relevant rules on the Shanghai-London Stock Connect trading system issued by the SSE have made corresponding arrangements for the requirements of the issuers, the functions of relevant institutions and investor protection.
l Issuing CDRs on eastbound business
Ø Approved by the CSRC and the SSE, a LSE-listed company meeting the following conditions is entitled to issue CDRs: a) having 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; b) listed on the LSE for at least 3 years and have obtained the premium listing for at least 1 year; and c) seeking the listing of no less than 50 million units of CDRs with a market value of no less than RMB500 million. At the same time, an overseas issuer shall establish a securities affairs office in mainland China and engage domestic representatives for information disclosure, who will be responsible for the information disclosure and regulatory communications in connection with the listing of the CDR.
Ø The overseas issuer shall disclose the annual report and the semi-annual report and disclose major transactions and related party transactions that reach a certain amount, as well as other matters such as major lawsuits and major external guarantees that may affect the trading price of the underlying shares of overseas issuers.
Ø When applying for the initial listing of CDRs on the SSE, the overseas issuer shall appoint a qualified domestic sponsor and qualified domestic securities service providers such as law firms and accounting firms to provide relevant services.
l Issuing GDRs on westbound business
Ø a) an issuer must have published a prospectus that has been approved by the UKLA (part of FCA); b) the issuer’s application to admit depositary receipts to the Official List must have been approved by UKLA; c) the issuer’s stocks must be listed on the Main Board Market of the Shanghai Stock Exchange; and d) at admission the market capitalization of the applicant must be equal to or above RMB 20 billion.
Ø Where the SSE-listed companies offer GDRs representing newly-issued shares, the number of outstanding GDRs shall not exceed the amount cap approved by the CSRC and the offering price of GDRs after pro-rata conversion shall, in principle, not be lower than 90% of the average price of the underlying shares in 20 transaction days prior to the benchmark date of pricing. The GDRs which are initially and publicly offered by domestic listed companies shall not be converted into domestic underlying shares within 120 days as of the listing date. The GDRs subscribed to and held by the listed company’s controlling shareholder, actual controller and entities under its control shall not be transferred within 36 months as of the listing date.
Ø Although overseas institutions can purchase shares of A-share listed companies, equities of a single listed company held by one overseas investor shall not exceed 10% of the total shares of the company. The aggregate A-shares holdings by all overseas investors in a listed company shall not exceed 30% of the total outstanding shares of the company. Overseas investors' strategic investments in listed companies abiding by the law shall not be bound by the aforesaid limits.
Ø The disclosure obligation of annual report and share-pricing sensitive information. An issuer must inform the LSE immediately if there is any change in the status of its listing on the Main Board Market of the SSE (including suspension or cancellation of the listing, or any disciplinary action in relation to its listing).
Ø An issuer shall perform the continuing obligations in Section 4 of Admission and Disclosure Standards issued by the LSE. An issuer must also have regard to the disclosure requirements of the insider information, transactions related to the performance of management duties and their related parties, and restrictions on trading behavior during specific periods stipulated in the EU Market Abuse Regulation.
l Cross-border conversion
Ø Qualified China Securities Depositary and Clearing Corporation Limited and its subsidiaries, Commercial banks approved by the banking regulator of the State Council, and Securities companies may act as a depositary. The depository shall issue corresponding depository receipts to the domestic securities companies or investors in accordance with applicable rules and depository agreement. After the listing of DRs, qualified domestic securities companies engaging in cross-border conversion business may instruct the depository to convert the overseas underlying shares into CDRs or to convert the CDRs into corresponding overseas underlying shares.
l Investor protection
Ø Eligible investors are institutional investors and individual investors satisfying the condition that the daily average value of assets in her/his securities account and funds account over the 20 trading days prior to applying for trading CDRs is no less than RMB 3 million.
Ø The issuers' legal responsibilities are stipulated. The overseas issuers of the underlying securities are required to participate in the CDR issuance, fulfill the obligations of the issuer and the listed company in accordance with the law and bear the corresponding legal responsibilities.
Ø The security of the underlying assets of the depositary receipts is ensured. The depositaries are required to open individual accounts for the underlying assets of the depositary receipts, which effectively separates the underlying assets of the depositary receipts from their own assets. The depositaries also cannot classify the underlying assets of the depositary receipts as their own assets and cannot encroach on or embezzle the underlying assets of the depositary receipts.
Ø The domestic investors' right to know is protected. The overseas issuers of the underlying securities are required to establish securities affairs institutions within the territory of China, employ domestic representatives for information disclosure who are familiar with China's rules and requirements for information disclosure and shall be responsible for information disclosure and regulatory liaison during the listing of the CDRs under the Shanghai-London Stock Connect mechanism, set up the channels for effective communication with investors, regulators and the SSE, and protect the legitimate rights and interests of domestic investors in accordance with the rules.
Ø A dispute mediation mechanism is established. The depositary agreement is required to expressly stipulate that the disputes arising from the depositary receipts shall be governed by Chinese laws and shall be under the jurisdiction of the domestic courts. When the rights of CDR investors under the Shanghai-London Stock Connect mechanism are infringed, the domestic investors may file securities lawsuits at the domestic courts against the issuers of the underlying securities in accordance with the provisions of relevant laws and regulations as well as the depositary agreement; or, according to the arbitration agreement, they may apply to an arbitration institution with jurisdiction for arbitration.
IV. Opportunities and Challenges are Co-existing
Following the Brexit referendum, people from all walks of life have been holding a wait-and-see attitude on whether the UK and London will continue to maintain its status as an international financial center. However, the facts show that since the referendum on June 23, 2016, the UK's time zone advantages, legal advantages, talents advantages, language advantages, institutional advantages, cultural advantages, economic advantages and service advantages have not been changed substantially. London is still an international financial center and has always maintained its position as the world's number one foreign exchange trading center. According to a report released by SWIFT (Society for Worldwide Interbank Financial Telecommunications), 39% of offshore renminbi (RMB) foreign exchange transactions were completed in London in the first quarter of this year, Hong Kong ranked second (27%), the US, France and Singapore followed behind.
London is also the world's largest offshore RMB foreign exchange trading center. The first London RMB Business Quarterly Report jointly released by the City of London and the People's Bank of China in Europe on September 26 shows that the average daily trading volume of RMB in the second quarter of this year reached GBP69 billion, an increase of 13.54% from the previous quarter and a 32.85% rise year-on-year. London is also the second largest offshore RMB clearing center in the world after Hong Kong. The liquidation in the first quarter accounted for 5.94% of the global RMB liquidation. As per relevant rules, GDRs can be issued and traded in RMB, which will accelerate the process of RMB internationalization.
On September 25, China Construction Bank (CCB) successfully issued US$1 billion sustainable development bonds on the London Stock Exchange. This is the first time that CCB has issued sustainable development bonds, and it is also the first time that a Chinese-funded institution has issued US dollar sustainable development bonds. According to data released by the LSE, CCB's sustainable development bonds have received an enthusiastic response and attracted many international institutional investors. Among them, 85% of the allocation were from Asia, and 15% were from Europe, the Middle East and other countries and regions.As the Sino-British relationship continues to heat up and we approach the launch of Shanghai-London Stock Connect, the LSE will become an important partner for Chinese companies who wish to conduct cross-border financing.
Issuing GDRs bolsters A-share listed companies’ efforts in cross-border mergers and acquisitions and reduces financing costs because London-listed shares are accepted in more jurisdictions as acquisition currency than any other exchange. The LSE is also home to an unrivalled GDR ecosystem, and according to statistics, there are a total of 245 GDRs currently issued by more than 140 companies from more than 30 different countries and regions including China, Russia, Japan, South Korea, India, etc. on the Main Market, Alternative Investment Market (AIM), Professional Securities Market, the ‘Admission to Trading Only’ MTF (Multilateral Trading Facility) of the LSE, covering technology, finance, utilities, health care, construction/materials, insurance, basic resources, industrial products/services, telecommunication, oil, gas and other industry sectors. Joining the world’s most internationalized stock market, the LSE’s complete Issuer Services offering will help the A-share listed company to shape new relationships with high-quality institutional investors and sell-side research institutions and enable them to gain broader and much more internationalized brand recognition. At the same time, The CSRC also supports A-share listed companies in raising funds from overseas capital markets, carrying out cross-border financing and M&A to achieve Going Out. A-share blue chip companies have now shown long-term investment value with valuations at historical lows. Shanghai-London Stock Connect will provide new channels for foreign investors to invest in the A-share market.
Meanwhile, China is the second largest and the fastest-growing market globally. The Stock Connect offers LSE-listed companies a unique opportunity to access a high trading volume (average total mainland Chinese daily trading volume is eight times that of the LSE) and high valuation market, collaborate with the world's fastest-growing asset management institutions and attract high-quality Chinese investors (according to the latest statistics, the number of high-net-worth individuals in China now ranks second in the world), which are already one step ahead of the listed companies of the same industry in other countries. Furthermore, the Stock Connect will help LSE-listed companies to expand their customer base and improve their brand recognition in the Chinese market.
The connection and efficient integration between the market with the greatest potential and the most internationalized market will lead to a vibrant UK-China financial ecosystem in each country and enable issuers, banks, brokers, asset managers and professional services firms to participate fully in the Connect. However, we should also realize that there are still many differences between China and the UK in terms of trading hours and time zone, professional technology, supervision and trading mechanism, laws and regulations, foreign exchange control, investor composition and culture. To ensure a smooth launch of the Shanghai-London Stock Connect, this requires all the relevant parties to work hard collectively and complete the supporting mechanisms, educate investors and improve the quality of intermediary services.