China is injecting new energy and vitality into its capital market with various 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 (CDR) 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.


Yang Yingfei, counsel at Fenxun Partners, which operates a joint office with Baker McKenzie, says the much anticipated trial rules for the issuance and trading of CDRs, which the China Securities Regulatory Commission (CSRC) released recently, was well received, as evidenced by strong interest from China’s tech giants. “Yet, while the rules provided much needed clarity on the qualifications criteria that issuers need to meet in order to issue CDRs – including market capitalization and valuation, disclosure obligations and share structure – the rules governing trading of CDRs and investor requirements remain unclear,” says Yang.

“Right now, the rules stipulate that the trading of CDRs should be carried out in accordance with the rules of CSRC and the stock exchanges, while QFII and RQFII are eligible to invest in CDRs. Further clarifications on the trading rules, and whether CDRs are fully open to all investors, would no doubt benefit the future growth of CDRs.”

In Asia-Pacific, China’s market reforms may facilitate greater cross-border listings, an example being the HKSE’s reforms to allow dual share structures “which should help it attract companies that would otherwise list in the US, and the introduction of depository receipts to allow Chinese citizens to invest in international companies,” says David Holland, head of capital markets in Asia-Pacific at Baker McKenzie.

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 WTO. All the various new measures introduced in recent years have continuously 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.

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, or 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.”

H-share reform

On 20 April, China Securities Depository and Clearing Corporation Limited (CSDC) and the Shenzhen Stock Exchange jointly issued and implemented the Implementing Rules for Matters Relating to the Pilot Project for the Full Tradability of H-Shares (for Trial Implementation), which marks the launch of the pilot system for the full tradability of H-shares. Based on the arrangement for the full tradability of H-shares, when the registration of shares that are held by shareholders of Hong Kong-listed companies, and that are registered on the mainland and cannot be listed and traded abroad (i.e. domestic shares), is transferred to the foreign market, the corresponding holder may trade such shares on the foreign market through the CSDC.

“For enterprises that have listed by way of H-shares, the full tradability of H-shares gives domestic shareholders the opportunity to cash in their asset value through the financial markets,” says Michael Wang, a senior partner at Dentons in Shanghai. “For enterprises seeking to list abroad, the full H-share tradability arrangement strengthens their motivation to raise funds offshore through the H-share channel. This is because, in contrast to the red-chip model, the H-share model cuts out the steps of sending capital abroad and erecting a structure offshore, while also retaining the possibility of relisting on the mainland in future.”


In April 2018, the National Equities Exchange and Quotations (the New Third Board) and the Stock Exchange of Hong Kong Limited (HKEx) executed a memorandum of understanding where each party welcomes qualified companies listed on the other party’s market to apply to list on its market. With respect to companies listed on the New Third Board that wish to apply to offer stock and list on HKEx, the New Third Board will not subject them to a prior approval procedure or special conditions. This co-operation has been dubbed “New Third Board + H-share” by those in the industry. “The insufficient liquidity of New Third Board enterprises has become extremely serious, and a path for directly changing boards from the New Third Board to a domestic securities exchange has yet to be opened,” says George Wang, a partner at Duan & Duan in Shanghai. “Through the ‘New Third Board + H-share’ model, a New Third Board enterprise can directly seek a listing in Hong Kong without delisting from the New Third Board, saving them the costs and time of such delisting. This will greatly promote the liquidity of New Third Board enterprises.”

Sam Liu, the managing partner of DeHeng Law Offices in Shenzhen, also states that “New Third Board + H-share” has great strategic significance for the New Third Board market. “Firstly, ‘New Third Board + H-share’ expands the financing channels for the New Third Board; secondly, it prevents a massive loss of high-quality New Third Board listed companies; and, lastly, it can promote the internationalization of the New Third Board, strengthening the New Third Board’s status as an independent market.”


However, Liu also points out that the “New Third Board + H-share” two-region listing policy also poses major challenges for the New Third Board market, for example, regulatory co-ordination between the two regions, how the regulators are to enhance their regulatory capabilities, etc., which will require clarification through the future issuance of a series of specific policies and regulations.

“As this is a new thing, market opinions are sharply divided. From the perspective of the present, it would seem that ‘New Third Board + H-share’ is more for the purpose of helping NEEQ retain numerous high-quality companies with ideas, reducing their impulse to delist from the New Third Board,” he says. “However, with the deepening of co-operation and the liberalization of policy, it is possible that there will be more information to quicken the pulse of man. That is worth waiting for.”

It should be noted that, with a view to attracting innovative enterprises to list in Hong Kong, HKEx has recently carried out some reforms to its listing mechanism. The provisions of the new listing rules entered into effect on 30 April. Liu says that this is a major reform of Hong Kong’s capital market, offering new-economy enterprises major favourable policies. With the reform of Hong Kong’s listing mechanism, biotechnology companies that could not pass main board financial eligibility testing will be permitted to list, as will companies with differential voting right structures.

Why is CDR attractive?

On 22 March, China’s 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.

“For key innovative enterprises listed abroad, CDR will effectively assist them in circumventing such obstacles as variable interest entity [VIE] structures, the same shares with different rights, rigid requirements in respect of profitability, etc., to smoothly return home as A-shares, that is to say, issuers can directly evade the legal obstacles that they could face in directly offering stock in China,” says Michael Wang at Dentons. “Furthermore, with an offering of CDR, the existing entity listed abroad can be retained and the stability of the equity maintained.”

Since the beginning of this century, a large number of high-quality new economy enterprises have sprung up in China, and this is particularly noticeable in the internet and information technology sectors. “Unfortunately, however, hampered by the composition of their initial investors and policy restrictions in the domestic capital markets, a significant number of high-quality innovative enterprises erected red-chip structures with the objective of listing abroad,” says Zhang Shiwei, a partner at Zhong Lun Law Firm in Beijing.


He explains, that, before the rollout of the CDR mechanism, if these types of red-chip structures wished to return home and list A-shares, they first needed to privatize and delist, or first revise their existing structure (i.e. dismantle the red-chip structure) in accordance with A-share listing requirements, and then get into the queue to list as A-shares.

“However, with the rollout and implementation of CDR, red-chip structure enterprises can realize a domestic listing at low cost and with high efficiency through such means as depository receipts,” says Zhang Shiwei. “For new economy enterprises that listed abroad early, this has great significance in terms of returning to list as A-shares, expanding financing channels, enhancing financing capabilities, expanding development space, etc.”

George Wang, at Duan & Duan, says that, “previously, enterprises with VIE structures and those with ‘same share, different right’ structures were unable to list on domestic markets. Accordingly, in addition to using large amounts of funds to carry out a takeover offer, such enterprises listed abroad wishing to return to China and list A-shares had to dismantle their VIE structures in the course of privatization, a process subject throughout to stringent oversight by foreign regulators, requiring quite a bit of time and presenting certain legal risks.”

George Wang says that with the introduction of the CDR mechanism enterprises with VIE structures and those with ‘same share, different right’ structures can indirectly list in China, enjoying the policy benefits and market environment of China’s capital markets. “Accordingly, the objective of establishing this system is to have innovative enterprises return to and list in China,” he says. “Additionally, the arrangement of this system expresses the regulators’ wish to have certain as yet unlisted, high-quality enterprises remain in China.”

Liu, of DeHeng Law Offices, says the China concept stock’s model of privatization and returning to China to list is no longer suited to the objective circumstances of enterprises listed abroad because the enormous valuations of such foreign-listed enterprises as Alibaba, Baidu, etc., make privatization practically impossible.

“For these enterprises, the CDR return home model will have a relatively minor impact on their financial position and business position, and in addition to relieving the massive funding pressure that privatization could entail, it will help in making the return home by China concept stocks practicable and more efficient, both legally and in terms of listing efficiency,” says Liu. “At the legal level, CDR allow red-chip-structured enterprises to smoothly break through legal obstacles to return home and list; and at the listing efficiency level, the CDR model, as compared to privatization and return to China, is both less costly and more time-efficient.”

More open channels

Against the background of China’s commitments to further open its financial markets, the regulators will roll out QDII reform and are additionally proposing to increase the total limit on QDLP and QDIE in Shanghai and Shenzhen. Going forward, China will additionally steadily promote the bi-directional opening of the financial markets, including improving bond connect, studying Shanghai-London Stock Connect and further supporting Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect trading.

The CSRC has indicated that it will endeavour to launch “Shanghai-London Stock Connect” in 2018. Michael Wang, from Dentons, says that “Shanghai-London Stock Connect” will follow in the footsteps of the “Shanghai-Hong Kong Stock Connect” and “Shenzhen-Hong Kong Stock Connect” mechanisms. “However, in comparison, the interconnection with London will present more and greater challenges technically and compliance-wise. That is because China’s and the UK’s investors find themselves in different time zones, resulting in a time lag in trading hours,” he says.

“The interconnection of ‘Shanghai-London Stock Connect’ will certainly open brand new channels, attracting participation not only by mainland but also by international investors from everywhere around the world. This will greatly enhance the global influence of the A-share markets and significantly raise the profile of A-shares on the global stage.”


Cindy Hu, a partner at East & Concord Partners in Beijing, believes that there exists a complementary effect between the capital market opening mechanisms of CDR on the one hand, and “Shanghai-London Stock Connect”, QDII, etc., on the other hand. “CDR fills in the lacunae of the other systems, providing new options for investment and financing; also, they present opportunities for enterprises and intermediary firms without squeezing out existing business,” she says.

“Although the CDR system is focused on the return home of unicorn enterprises, its systemic significance should not just be limited to this. If one says that Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect are a ‘point-to-point’ trial, then CDR are a key ‘point-to-plane’ measure. The ‘Shanghai-London Stock Connect’ project will initially realize the interconnection of the markets through cross-listing of depository receipts … [CDR] are retaining system space for the future activation of ‘Shanghai-London Stock Connect’.

“From the perspective of system design, CDR can substitute for the system functions of Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect. However, from the perspective of reality, the access threshold for CDR remains higher than the requirements of Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect. Accordingly, the attractiveness of the CDR system for enterprises listed in Hong Kong is limited, so the CDR system will not replace Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect.”

With respect to the comparison of CDR to QDII, Hu says that CDR has the natural advantage of fewer risks than QDII, although this does not diminish the necessity of the existence of QDII. “The objectives of the two systems are different, particularly the fact that it is entirely possible to use the premium model through landing by way of, and offering, CDR,” she says. “In order to make depository receipts represent the stocks of the corresponding company to the greatest extent possible, a company will generally set a ratio for converting between the depository receipts and its common stock. All of these cause the existence of a discrepancy between the domestic market and foreign market.”