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30 July, 2018
In China’s immature capital markets, regulatory enforcement has typically oscillated between two extremes, which we can refer to as “weak regulation” and “strong regulation”, and this continues to be the case. Times of “weak regulation” have generally occurred due to an absence of regulatory measures and resources, while “strong regulation” has tended to be implemented in the form of “campaign-style law enforcement”. To understand the general direction in which regulatory enforcement has been moving requires insight into recent considerations of top-level policy formulation and of the general status of market development in China.
Following the abnormal fluctuations of the stock market of 2015, it has now been three years since the China Security Regulatory Commission (the “CSRC”) took the lead with its regulatory actions to “enforce the law thoroughly, stringently and lawfully”. Despite some criticism of its “strong regulation”, the CSRC appears to have been able to withstand external pressure and has proceeded determinedly with its approach. Regardless of how the current round of “campaign-style” law enforcement is ultimately evaluated, regulators have at least provided a degree of transparency appropriate in the current internet era, and has responded to public opinion with the timely disclosure of their regulatory activities.
Successful investment, whether on the part of domestic or foreign investors, requires a thorough understanding of the ongoing changes in the regulatory environment. This article seeks to provide an analysis on the features and possible future trends of the “Chinese-style” regulatory enforcement by reference to the CSRC’s Bulletin on Inspection and Law Enforcement in the First Half of the Year (the “Bulletin”), published by the CSRC on its official website on 20 July 2018.1
I. The “Imperial Sword” of Regulatory Enforcement
The most recent round of regulatory enforcement has a clear policy orientation that is explicitly articulated in the Bulletin. In their stated objective relating to financial policy, the Party Central Committee and State Council have indicated the need to “enforce the law thoroughly, stringently and lawfully”. As one of the executive departments, it is the CSRC’s responsibility to ensure the strength and effectiveness of enforcement. On the basis of regulatory enforcement information published by the CSRC, 2017 witnessed record highs in the number and total value of administrative penalties and in the number of people banned from the market. In that year, the CSRC undertook 312 investigative decisions and issued 237 administrative penalties and 25 market ban orders on 44 people.2 This level of activity has continued on through the first half of 2018, with 307 investigations initiated and 108 cases newly put on file. The average case handling time in the first half of this year has been 133 days, a year-on-year reduction of 22%.3
It is worth noting that the Bulletin reaffirms that “enforcing the law thoroughly, stringently and lawfully” must be closely tied to “fighting the tough battle to prevent and resolve financial risks.” It is our observation that by using these specific terms, the regulator is declaring its position that, “enforcing the law thoroughly, stringently and lawfully” is the means while “fighting the tough battle to prevent and resolve financial risks” is the purpose, with the implication that the former must serve the latter. Regulators will be expected to follow this logic and should try to avert triggering or aggravating any threats to the financial system when imposing tough regulatory actions.
II. “Selective” Law Enforcement — Constantly “Focusing”
People familiar with China's financial markets are likely to understand that, with only limited regulatory resources, regulators need to be “selective” in how they go about carrying out enforcement actions. There are circumstances in which the decision about whether and how to take regulatory action could depend on a variety of factors, including: whether it involves a “key area” as defined by regulators; what type of signals the regulators wish to convey to the market; and whether their regulatory actions will produce immediate results. This goes some way to explain why the Bulletin intentionally outlines various key areas for law enforcement and proposes two guiding principles for actions, namely to “focus on key areas violations” and to “cautiously monitor any risks that could eventuate from illegal behaviors.”
According to the Bulletin, during the first half of 2018, there have been three areas of focus for law enforcement actions. The first has been the use of so called “financial innovation" tools to disrupt market order or to accumulate market risks, such as using funds raised illegally through wealth management products on P2P platforms to manipulate the market, or the use of OTC options to carry out insider trading. The second is activity that causes a disruption to the order of the bond market and damages the interests of bondholders. The third is the use of privately raised funds to implement cross-border market manipulation under cross-border Connect Programs. Some of the activities highlighted in the Bulletin follow on from recent bursts of illegal online fundraising, and have the intention of regulating new areas that might be targeted by violations, such as market manipulation related to Connect Programs. From this, we can conclude that the CSRC is keeping a watchful eye on the development of the market, in order to make its determinations about future key areas for regulatory enforcement. Hence, decisions about areas for enforcement in the second half of this year may shift depending on how the market evolves.
III. Providing order to Chaotic Markets through Campaign-style Law Enforcement
In China, there are three approaches typically used in campaign-style law enforcement: investigating and punishing multiple similar illegal activities at the same time; investigating and severely punishing any major infringement; and conducting deep and thorough investigations into “special cases.”
The Bulletin lists three potential sources of chaos in the market that the regulators are aiming to eliminate through the targeted use of their resources: serious breaches in the orderly dissemination of information to capital markets; repeatedly committing offences; and late disclosure of regular reports. The CSRC also names several major and special cases, in doing so reflecting the regulator’s determination to take a tough line in those cases.
Conclusion
This round of “strong regulation” activity takes an approach that is distinctively Chinese, and the market should pay close attention to its further development. By continuing to review regulatory policies and to monitor the enforcement of relevant laws, we hope that foreign investors will ultimately be able to better understand the inherent logic of China's capital market supervision and enforcement actions, putting them in a position where they are able to adapt to the specific characteristics of the Chinese market.
1. Source: http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwdd/201807/t20180720
2. Source: http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwdd/201805/t20180511
3. Source: http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwdd/201807/t20180720
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
