China is injecting new energy and vitality into its capital market with groundbreaking reforms. Richard Li reports on recent key measures

China’s capital markets have witnessed a number of major reform measures since the beginning of this year. The objectives of these measures are to promote further opening of domestic markets, strengthen connections between domestic and foreign markets, and to attract high-quality, innovative enterprises to list on the A-share markets. These new reforms are crucial steps towards greater openness and transparency.

Zhang Liguo, the chief partner at Grandway Law Offices in Beijing, says recent capital market trends reflect three macro approaches in China’s economic development. First, the macro layout of the capital markets must serve state strategy and also the real economy. For example, the launch of the pilot depository receipt project represents an effort to connect capital markets with innovation and entrepreneurship.

Second, capital markets will be opened further and gradually move towards globalization. “The opening of the capital markets is a bi-directional opening, encouraging both ‘please come in’ and ‘going out’,” says Zhang Liguo.

“In the past few years, China has carried out reforms in terms of ‘please come in’ with qualified foreign institutional investors [QFII], renminbi-qualified foreign institutional investors [RQFII], etc., and such ‘bi-directional mechanisms’ as Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect, achieving relatively good results. Now the focus of reform has fallen on ‘going out’ through such systems as qualified domestic institutional investors [QDII], qualified domestic limited partnerships [QDLP], etc.”

Finally, it is essential to ensure the stability and financial safety of the capital markets. “The opening of the capital markets – regardless of whether it is QFII/RQFII or QDII/QDLP, or bond connect, or Shanghai-London Stock Connect – must proceed in an orderly fashion, guard against cross-border capital flow risks, ensure the safety of foreign exchange reserves and ensure financial safety and stability,” says Zhang Liguo.

Zhu Ning, the managing partner at Chance Bridge Partners in Beijing, says that further opening of the financial markets is a key component of China’s commitments to the World Trade Organization. All the various new measures introduced in recent years have continually made the cross-border flow of funds more convenient. “The gradual opening of the financial markets not only unshackles the investment demand of domestic investors, but also satisfies the financing needs of domestic enterprises,” she says.

However, Zhu also points out that the key to opening of the financial markets is risk control. How to allow domestic investment entities to enjoy the benefits brought about by opening, while minimizing the adverse impact of the volatility of international financial markets on the domestic market, is a huge challenge.

朱宁-ZHU-NING-卓纬律师事务所-管理合伙人,北京-Managing-Partner-Chance-Bridge-Partners-Beijing

With respect to the government’s approach to designing the financial market systems, “looking at it from the perspective of recent years, China, in opening its financial markets, has consistently upheld the principles of ‘step by step’ and ‘gradual progress’, and these principles will remain unchanged for the long term”, says Zhu.

“Whether it is in the promotion of Shanghai-Hong Kong Stock Connect and Shanghai-London Stock Connect, and establishment of QDII, or studying the opening of the depository receipt mechanism, the government will fact-find, examine and implement on a trial basis over a long period of time, which obliquely reflects the government’s basic principle of gradual reform. In designing the systems, the government will first consider its own regulatory and control capabilities, not allowing opening to outstrip policy control.”

WHY IS CDR ATTRACTIVE?

On 22 March, the State Council approved and published the Several Opinions on the Launch of a Pilot Project for the Domestic Offering of Stocks and Depository Receipts by Innovative Enterprises, formulated by the China Securities Regulatory Commission (CSRC). With this, a new type of securities product known as depository receipts has appeared on mainland China’s domestic capital markets, now commonly referred to as CDR (an imitation of ADR, or American depositary receipts).

Pursuant to the above-mentioned opinions, the CSRC drafted the Administrative Measures for the Offering and Trading of Depository Receipts, and published them on 4 May, seeking comment from the public. The administrative measures further provide for such matters relating to depository receipts as the application of the law, the offering of the product, information disclosure, depository and custody systems, investor protection, etc.

Pursuant to the opinions, the entities participating in the offering of depository receipts include the issuer of the underlying securities (i.e., the pilot enterprise), the depositary, the custodian and the depository receipt holder. The underlying securities issued abroad by the pilot enterprise are held by the depositary, and the latter issues the depository receipts in China. The depository receipt holder exercises his rights through the depositary and enjoys the interests in the foreign underlying securities represented by the depository receipts.

The depositary may appoint a financial institution abroad to serve as custodian. The custodian is responsible for holding the property underlying the depository receipts (including the foreign underlying securities and their derivative interests), and handling other matters relating to custody.

It should be noted that the opinions are only a programmatic guiding document, and the administrative measures are still only at the consultation stage. Accordingly, there will certainly be more specific implementing rules and complementary regulations concerning the CDR mechanism issued in future. This article is only a preliminary look at this new mechanism.

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