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3 April, 2017
First sanction imposed for market manipulation through China Connect
On 10 March 2017, the China Securities Regulatory Commission (“CSRC”) published a decision sanctioning two individuals for the manipulative trading of securities (Chinese page). This is the first ever such sanction for activities committed through the China Connect mechanism: in this case the two individuals sent trading instructions through Hong Kong brokers and orders were routed onto Shanghai Stock Exchange (“SSE”) as China Connect northbound trades.
Shanghai – Hong Kong stock connect was launched in November 2014 and further expanded to cover mutual stock market access between Shenzhen and Hong Kong in December 2016 (“China Connect”) 1.
One of the key principles of China Connect is that “home market rules” apply to stock trading in either market. For northbound investment, this means that offshore investors must comply with the PRC Securities Law (“Securities Law”) and other Mainland China regulations, and are subject to the supervisory jurisdiction of CSRC. What has not yet been clear to investors is whether and to what extent CSRC would actively enforce laws and regulations of the Mainland China in respect of northbound trading activities.
According to the decision, two individuals named Tang Hanbo and Wang Tao controlled four different securities accounts (three Hong Kong accounts and one Mainland onshore account) and used such accounts to carry out manipulative trading of the shares of Zhejiang China Commodities City Group (SHA:600415). The decision describes the different stages of their position building, price maintenance, overweighting, and sell-off in great length, and identifies their activities such as churning, intra-day trading, fictitious quotation, and quote revocation. The decision is to the effect that Tang and
Wang committed manipulation activities under article 77 of the Securities Law, including continuous trading manipulation, wash trade manipulation, and manipulation through other methods.
CSRC imposed a penalty f confiscating the illegal gain of about RMB42 million and further imposing a monetary fine of RMB209 million. This represents the “maximum penalty” permitted under the Securities Law – being five times of the amount of the illegal gain.
Heightened supervision and discipline against manipulation and abnormal trading
Prohibition against manipulative securities trading is codified in the Securities Law, and in 2007, CSRC issued its guidance on the determination of manipulative activities. In addition, other securities trading activities not having all the characteristics of market manipulation, and thus not punishable under the Securities Law, can nevertheless be “abnormal trading activities” under the rules of SSE and the Shenzhen Stock Exchange (“SZSE”). SSE and SZSE can each take disciplinary measures against investors and suspend trading of their securities accounts. Tang and Wang were punished by CSRC for stock manipulation, and the CSRC decision also identified their activities as “abnormal trading activities” (i.e. intra-day trading of the shares on 29 trading days).
In July and August 2016, SSE published 14 case studies in respect of 7 types of abnormal trading activities including fictitious quotation and abnormal quotation, which can occur during pre-market trading, continuous centralized bidding, and end-market trading. These cover trading in stocks, bonds, as well as open-ended ETF units. SSE explained that the case studies were intended to help clarify the criteria for disciplinary action to the public.
Since the stock market crash in mid-2015, both SSE and SZSE have updated their rules in respect of “abnormal trading activities”. SSE took 3,000 and 6,000 disciplinary actions, respectively, in 2015 and 2016, against such activities. The decision demonstrates that SSE and CSRC can closely track the size and timing of the onshore account orders and China Connect northbound orders. CSRC was able to examine data in respect of the manipulative orders in the context of the market orders at the prevailing time for the same shares. This revealed clearly why the price and size of the quotation under those trading orders were abnormal and what pricing and trading impact such orders had on the market.
It should be pointed out that although the CSRC sanction against Tang and Wang is the first sanction against manipulative trading under China Connect, the offenses committed and the trading activities concerned are no different from those committed by domestic market investors, or foreign investors who, for more than a decade, have accessed SSE and SZSE in the capacity of QFII and RQFII. It is equally important for QFIIs and RQFIIs to understand and be familiar with the trading rules and regulatory guidance of CSRC, SSE and SZSE.
Benefits of regulatory & enforcement co-operation between Mainland and Hong Kong
All these point to the fact that both the regulator and the stock exchanges in the Mainland China have taken more robust supervision and enforcement measures against malicious and illegal securities trading activities. The Mainland authorities’ are not deterred by the complexity and challenges in cross-border enforcement cooperation under China Connect.
The decision to sanction Tang and Wang revealed that the Securities and Futures Commission of Hong Kong (“SFC”) co-operated with CSRC in respect of the collection of evidence such co-operation was made possible by the regulatory and enforcement memorandum of understanding entered into between CSRC and SFC for China Connect mutual access, and also because both CSRC and SFC are members of IOSCO.
On the closing day of the 5th Session of the 12th National People’s Congress earlier this week, the Chinese Premier gave a press conference and announced that, to give international investors wider access to the Chinese financial market, a “Bond Connect” is to be launched in 2017 and will start between Mainland China and Hong Kong. Bond Connect may operate under a different market infrastructure and may be different from China Connect, however what is clear is that co-operation between Mainland China and Hong Kong in the areas of regulation and enforcement will continue. This will no doubt influence the China central people’s government decision to have Hong Kong play an important role in furthering market reform and the opening of the China capital markets in the years to come.
1 Previous Linklaters bulletins on this subject include:
(2016) Another milestone in mutual market access: The Shenzhen-Hong Kong Stock Connect
(2015) Stock Connect: The Beneficial Ownership Conundrum
(2015) Shanghai-Hong Kong Stock Connect: New short selling rules
(2014) Shanghai-Hong Kong Stock Connect: Further clarifications of Stock Connect Rules
(2014) Shanghai-Hong Kong Stock Connect: Are You Ready for the “Through Train” to Shanghai?
For further information, please contact:
Andrew Malcolm, Partner, Linklaters
andrew.malcolm@linklaters.com
