On May 15, 2024, the China Securities Regulatory Commission (“CSRC”) released the Administrative Rules for Program Trading in the Securities Market (Trial) (the “Administrative Rules”). The CSRC points out in the Drafting Notes that program trading, especially high-frequency trading, has significant technological, informational, and speed advantages over small and medium-sized investors. It may lead to issues such as strategy convergence and trading resonance and increase market volatility. In recent years, the CSRC has attached great importance to the supervision of program trading and has carried out a lot of work, including strengthening regulatory inquiries in respect of quantitative private fund filings, establishing and improving data statistics and monitoring mechanisms, and formulating program trading reporting rules for the stock market. The CSRC stated that their years of study and research resulted in the creation of the Administrative Rules and that these rules were crafted from the experience of previous regulatory practice. The Administrative Rules incorporate the fundamental provisions in the Circular on Matters Concerning the Stock Program Trading Reporting (the “Circular”) and related rules issued in September 2023 by each of the three stock exchanges, such as the definition of program trading investors, reporting obligations, program trading activity that requires close monitoring, and the responsibilities of securities company.
The Administrative Rules are the first departmental rules regulating program trading within the framework of the Securities Law and are aimed at strengthening the supervision of program trading in the securities market, promoting the development of program trading in a compliant manner, and safeguarding the securities trading order and market fairness. Article 3 of the Administrative Rules provides that “program trading and related activities shall comply with relevant laws, regulations, these Administrative Rules, and the business rules of securities exchanges and industry associations. They shall adhere to the principle of fairness and shall not affect the security of the securities exchanges’ systems or disrupt normal trading order.”
The Administrative Rules will take effect on October 8, 2024.
We have highlighted the key provisions of the Administrative Rules and share our observations below:
Provisions of the Administrative Rules
Observations
Definition of Program Trading Investor
Article 2. Program trading, as referred to in these Administrative Rules, refers to the act of conducting securities trading on a securities exchange through automatic generation or the delivery of trade orders by computer programming.
For the purpose of these Administrative Rules, program trading investors refer to the following investors engaged in program trading:
(1) Clients of securities companies such as private fund managers, and qualified foreign institutional investors;
(2) Securities companies engaged in proprietary trading, market making, asset management, and other businesses;
(3) Public fund managers, insurance institutions, and other institutions using the trading units of securities exchanges for trading;
Other investors determined by securities exchanges.
Regarding the term “clients of securities companies” in the first category and when read in conjunction with the Circular, program trading investors shall include securities company’s clients of any type who engage in program trading, mainly including local private fund managers (“PFM”), and qualified foreign institutional investors (“QFI”). It can be read from the definition that QFIs’ participation in program trading is considered a kind of normal businesses, and consequently, these activities will be subject to the same oversight as local PFMs.
Regarding the fourth category, it remains to be clarified whether overseas program trading investors participating in Northbound trading under Stock Connect fall within this scope. Besides, further observation is required as to whether investors engaged in program trading via swap or similar arrangements but can be looked through and identified by the relevant securities exchange, will be deemed a de facto program trading investor.
Scope of Information Required to Be Reported
Article 7. Program trading investors shall report the following information in a truthful, accurate, complete, and timely manner:
(1) the basic information of the account, including the investor’s name, the securities account code, the securities brokers designated for trading or custodial services, and the product management institution;
(2) the fund information of the account, including the scale and source of the funds in the account, and the scale and source of the leveraged funds and the leverage ratio;
(3) the trading information, including the type and main content of the trading strategy, the trade execution method, the maximum order placement/cancellation frequency, and the maximum number of order placements/cancellations within a single day;
(4) information regarding trading software, including but not limited to the name, version number, and the developer of the software;
(5) other information stipulated by the relevant securities exchanges, including the contact person and the contact information of the securities broker and investor.
Program trading investors shall report any material change in the reported information in a timely manner.
The scope of information required to be reported is the same as the Circular. This provision provides a higher-level legal basis for the reporting obligations and the scope of reported information in respect of stock program trading.
Program Trading Is Allowed Only After Confirmation of Reported Information
Article 8. Securities companies’ clients who engage in program trading shall report the relevant information to the security company that accepts their entrustment in accordance with the rules of the securities exchange and the terms of the entrustment agreement. The securities company shall verify the information reported by the client in a timely manner in accordance with the rules of the securities exchange. If the reported information is correct upon verification, the securities company shall promptly confirm it to the client and report it to the securities exchange as required. Clients may conduct program trading only after receipt of confirmation from the securities company.
Clients of a securities company may conduct program trading only after receiving the securities company’s confirmation of the reported information. Notably, clients themselves, not the securities company, shall still assume and fully discharge their reporting obligations, although the securities company is required to verify and confirm the program trading reports submitted by clients.
Inspection Power of Securities Exchanges
Article 10. Securities exchanges shall confirm the reported information, conduct regular data screening, and check the consistency of program trading investors’ trading activity with the information they have reported, such as trading strategies and frequency, in a timely manner.
Securities exchanges may conduct on-site and off-site inspections of the institutions and individuals involved in program trading and focus inspection of institutions or individuals whose trading activity is frequently inconsistent with the reported information.
The Administrative Rules stipulate that securities exchanges should conduct regular data screening and check the consistency of program trading investors’ trading activity with the information they have reported. The relevant securities exchanges may conduct on-site and off-site inspections of the institutions and individuals involved in program trading, and focus inspection of institutions or individuals whose trading activity is frequently inconsistent with the reported information. The Circular contains the same provisions as above. In comparison with the Circular, the targets of securities exchanges’ inspections are clarified, which includes the individuals and institutions involved in program trading.
Standards of Securities Exchange’s Close Monitoring and Abnormal Program Trading Activity Monitoring
Article 11. Securities exchanges shall conduct real-time monitoring of program trading activities, and focus on the monitoring of the following abnormal trading behavior that may affect the security of securities exchange’s systems or trading orders:
(1) The number or frequency of order placements or cancellations reaches a certain threshold within a short period of time, or the number of order placements or cancellations within a single day reaches a certain threshold;
(2) Large-amount, consecutive or frequent order placements and executions within a short period of time, resulting in obvious abnormalities in the trading price or the trading volume of multiple securities;
(3) Large-amount, consecutive or frequent order placements and executions within a short period of time, resulting in obvious abnormalities in the overall operation of the securities market;
(4) Other circumstances that the securities exchange deems necessary to focus on monitoring.
The standards for monitoring abnormal program trading activities shall be formulated by the securities exchange.
With respect to standards of securities exchange’s close monitoring, the Circular provides one of the quantitative criteria as such: the maximum order placement frequency reaches 300 orders per second or higher, or the maximum number of order placements within a single day reaches 20,000 or more.
New Template of the Entrustment Agreement
Article 12. Where a securities company accepts the program trading entrustment of a client, it shall sign an entrustment agreement with the client and clarify in the entrustment agreement the rights and obligations of both parties and the securities company’s management responsibilities and risk control requirements for the client.
The SAC shall formulate and update a template program trading entrustment agreement for the reference of securities companies in a timely manner.
The Administrative Rules require a securities company to sign an entrustment agreement with a program trading client and clarify in the entrustment agreement the securities company’s management responsibilities and risk control requirements for the client. In addition, the Securities Association of China (“SAC”) shall formulate a template program trading entrustment agreement for the reference of securities companies. We understand that clients who engaged in program trading and have previously signed an entrustment agreement with the securities company may be required to sign an updated entrustment agreement once the template agreement is released by SAC.
Compliance and Risk Control Obligations of Relevant Institutions and Individuals
Article 14. Securities companies, public fund managers, private fund managers, QFIs and other institutions shall formulate special business management, compliance and risk control rules for program trading, improve the program trading order examination and monitoring systems, and prevent and control business risks.
Persons in charge of compliance and risk control in securities companies, public fund managers, private fund managers, QFIs and other institutions shall review, supervise and inspect the compliance of their own and their clients’ program trading activity, and be responsible for risk management work.
The Administrative Rules explicitly require PFMs and QFIs to formulate special business management, compliance and risk control rules for program trading, improve the program trading order examination and monitoring systems, and prevent and control business risks. The personnel in charge of compliance and risk control in PFMs or QFIs shall review, supervise and inspect the compliance of their own and their clients’ program trading activity, and be responsible for risk management work. This means that PFMs and QFIs shall formulate and improve internal rules as soon as the Administrative Rules are formally promulgated, while the personnel in charge of compliance and risk control shall assume the compliance and risk control responsibilities in respect of program trading.
Handling of Emergencies
Article 15. In the event of force majeure events, accidents, major technical failures, significant human errors, or other sudden events that may cause significant abnormal fluctuations or disrupt normal securities trading, investors engaged in program trading shall immediately take measures such as suspending trading or canceling orders. Clients of securities companies shall promptly report to the securities companies they have entrusted, while other program trading investors shall promptly report to the securities exchanges.
If a securities company discovers that a client falls under the circumstances mentioned in the preceding paragraph, it shall immediately take measures in accordance with the terms of the entrustment agreement, such as suspending the acceptance of the client’s orders or canceling orders, and promptly report to the CSRC’s branch office and the securities exchanges.
Securities exchanges shall specify the specific procedures and requirements for taking measures in the aforementioned circumstances, such as the technical suspension of trading, temporary market closure, trade cancellation, and notification to securities registration and settlement institutions to defer delivery.
The Administrative Rules set forth requirements for the handling of emergencies. In response to emergencies, program trading investors shall immediately take measures, such as suspending trading, and shall perform the reporting obligations as required.
Requirements on Information Technology Systems
Article 16. The IT systems used for program trading shall comply with the rules of securities exchanges and possess effective functions such as capital and securities verification, permission control, threshold management, abnormality monitoring, error handling, and emergency response to ensure secure and stable operations.
Program trading investors using IT systems shall conduct sufficient testing in accordance with the requirements of the preceding paragraph and report testing records as required by the securities exchanges.
The Administrative Rules only require that the IT systems used for program trading shall comply with the rules of securities exchanges and possess the relevant functions. They also require that sufficient testing be carried out on such IT systems, but it is unclear whether these IT systems must be owned by a securities company, nor does it restrict the use of IT systems that have system connectivity functions.
Prohibiting the Provision of Special Privileges of Trading Units to Program Trading Investors
Article 17. Securities companies shall conduct unified management of trading units in accordance with the regulations and provide services to various types of investors based on the principles of fairness and reasonableness. Providing special privileges to program trading investors is prohibited.
The Administrative Rules prohibit securities companies providing special privileges of trading units to program trading investors. This reflects and reinforces the principle of fairness.
Circumstances Where Trading Server Colocation Services Are Prohibited
Article 18. A securities exchange providing trading server colocation services shall adhere to the principles of security, fairness, and reasonableness, allocate resources fairly, and strengthen the management of entities using the trading server colocation services.
Securities companies shall use trading server colocation resources in a reasonable manner and in accordance with the rules of securities exchanges to ensure trading fairness between different clients. Securities companies shall not provide trading server colocation services to clients who frequently engage in abnormal trading, whose program trading systems frequently experience significant technical failures, or who frequently violate the rules of securities exchanges.
Securities companies shall not provide trading server colocation services to clients who frequently engage in abnormal trading, whose program trading systems frequently experience significant technical failures, or who frequently violate the rules of securities exchanges. It remains to be seen how this will be implemented in practice.
System Access and Connectivity
Article 19. Securities companies that provide trading IT system connectivity services and other services by technical means to clients in respect to program trading shall include such services in its compliance and risk control regime and establish comprehensive management mechanisms throughout the entire process, including due diligence investigations, verification and testing, pre-examination, trade monitoring, abnormality handling, emergency response, and service exit arrangements.
Program trading investors connected to securities companies’ systems shall not use the system connectivity service to engage in illegal securities business, solicit investors or process third-party’s trading instructions in violation of regulations, nor transfer or lend their own investment or trading systems or provide system access to third parties in violation of regulations.
Securities companies implementing trading IT system connectivity and program trading investors connected to securities companies’ systems shall comply with the relevant rules.
Program trading investors connected to securities companies’ systems shall not:
(1) use the system connectivity service to engage in illegal securities business;
(2) solicit investors or process third-party trading instructions in violation of regulations; or
(3) transfer or lend their own investment or trading systems or provide system access to third parties in violation of regulations.
It is worth noting that the above prohibitive provisions only target those clients who connect to securities company’s systems, not all program trading clients. We guess such prohibitive provisions are intended to restrict securities company’s program trading client who connects to the securities company’s systems from providing facilities to another high-frequency trading firm in violation of regulations so that the high-frequency trading firm can get access to the securities company’s systems indirectly (the so-called “channel” business), in which case, the securities company’s program trading client may be regarded as “use the system connectivity service to engage in illegal securities business” while the high-frequency trading firm behind it may also be held liable for circumventing the regulation in violation of this Article 19.
Article 19 further provides that securities companies implementing trading IT system connectivity and program trading investors connected to securities companies’ systems shall comply with the relevant rules. This indicates that the CSRC or securities exchanges may separately formulate system access and connectivity rules.
Market Data Fee
Article 20. Program trading investors using value-added market data services provided by securities exchanges shall pay fees as required. For program trading activity where the number and frequency of order placements or cancellations reaches a certain threshold, securities exchanges may increase the fee standards, with specific standards to be formulated by the securities exchanges.
According to the CSRC Announcement [2016] No.14: Core Technical Indicators of the Capital Market Transaction Settlement Systems, Level-2 data feed service is a non-complimentary real-time market data service provided by the exchange, which primarily provides real-time transaction data of products listed and traded on the exchange. For the first time, the Administrative Rules explicitly provide that the securities exchange may provide value-added market data subject to extra fee charges.
Notably, though an activity may not constitute high-frequency trading as defined under the Administrative Rules, securities exchanges may increase the data service fee standards for program trading activity when the number or frequency of order placements or cancellations reaches a certain threshold.
Definition and Determination Standards for High-frequency Trading
Article 21. For the purpose of these Administrative Rules, high-frequency trading refers to program trading that possesses the following characteristics:
(1) A high number or frequency of order placements or cancellations within a short period of time.
(2) A high number of order placements or cancellations within a single day.
(3) Other characteristics determined by the securities exchanges.
Securities exchanges shall specify and improve the determination standards for high-frequency trading in due course.
Notably, the Administrative Rules are the first regulation in which the CSRC provides a definition of high-frequency trading. Under the Administrative Rules, the CSRC not only gives a general definition of high-frequency trading, but also authorizes securities exchanges to specify and improve the determination standards for high-frequency trading in due course.
Additional Reporting Obligations of High-frequency Trading Investors
Article 22. Prior to engaging in high-frequency trading, investors shall report additional information, including the location of the high-frequency trading system servers, system testing reports, contingency plans in the event of system failures, and other information, in addition to the reporting information required under Article 7 of these Administrative Rules.
The Circular provides that if a program trading investor’s reported maximum order placement/cancellation frequency is 300 orders per second or higher, or the reported maximum number of daily order placements/cancellations is 20,000 or more, the program trading investor shall report additional information as follows: (1) the server location of the program trading system; (2) testing reports of the program trading system; (3) contingency plans for a program trading system failure; and (4) other information stipulated by the relevant exchange. We expect that securities exchanges may adopt the above as the determination standards for high-frequency trading at the current stage and may adjust such standards from time to time.
Different Fee Standards for High-frequency Trading
Article 23. Securities exchanges may implement different fee standards for high-frequency trading to reflect its characteristics. They may appropriately increase transaction fees and charge fees for order cancellations and other purposes. The specific standards and methods shall be stipulated by the securities exchanges.
Securities exchanges may implement different fee standards for high-frequency trading.
Applying Stricter Management Standards to Abnormal Trading Activity by High-frequency Trading Investors
Article 24. Securities exchanges shall focus supervision of high-frequency trading activities. In the event of abnormal trading behavior by high-frequency trading investors, securities exchanges shall apply stricter management standards in accordance with the regulations.
It is unclear what stricter management standards will be triggered by abnormal trading activity by high-frequency trading investors. However, we understand that this provision sets out the principle of enhanced regulation on high-frequency trading.
Self-disciplinary Measures
Article 25. Securities exchanges, the SAC, and the AMAC may conduct interviews, give reminders, or conduct on-site inspections of institutions and individuals involved in program trading based on self-disciplinary needs.
If institutions and individuals involved in program trading violate the regulatory requirements, securities exchanges, the SAC, and the AMAC shall take self-disciplinary measures in accordance with the regulations.
The targets of self-disciplinary management are broad enough to cover the institutions and individuals involved in program trading.
The self-disciplinary measures include: (1) interviews, reminders, or on-site inspections prior to or following the determination of any violations; and (2) certain self-disciplinary measures following the determination of any violations.
CSRC’s Powers of Inspections and Investigations
Article 26. The CSRC and its branch offices may conduct inspections or investigations of institutions and individuals involved in program trading in accordance with the law. They may also appoint agencies to assist in works such as evaluation and testing, and the institutions and individuals should cooperate accordingly.
The CSRC may conduct inspections or investigations of institutions and individuals involved in program trading, with wide-reaching target coverage.
In addition, the CSRC may appoint agencies to assist in work such as evaluation and testing.
Regulatory Measures
Article 28. If public fund managers, private fund managers, QFIs, and other institutions and individuals involved in program trading violate the requirements of Articles 7, 8, 9, 14, 15, 16, 19, 20, or 22 of these Administrative Rules, the CSRC and its branch offices may take regulatory measures in accordance with the provisions of the Securities Law, Securities Investment Fund Law, Regulations on the Supervision and Administration of Private Investment Funds, Measures for the Administration of Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors Investing in Domestic Securities and Futures, and other relevant regulations.
This provision sets out the legal basis and the types of regulatory measures that the CSRC may take against PFMs, QFIs and other program trading investors who violate the Administrative Rules. For example, if a QFI, in violation of Article 7, 8 or 22 of the Administrative Rules, fails to report or reports false information, or in violation of Article 14 of the Administrative Measures, fails to formulate special business management, compliance and risk control rules, the CSRC may take regulatory measures in accordance with Article 25 (7) and (4) of the Measures for the Administration of Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors Investing in Domestic Securities and Futures, such as orders for rectifications, regulatory talks, or warning letters. In addition, if a PFM violates the corresponding requirements of the Administrative Rules, the CSRC may take measures such as orders for rectifications, regulatory talks, or warning letters in accordance with the Regulations on the Supervision and Administration of Private Investment Funds.
Different Legal Basis for Imposing Administrative Penalties
Article 29. If institutions and individuals involved in program trading affect a securities exchange’s system security or normal trading order, the CSRC and its branch offices shall impose penalties in accordance with Article 190 of the Securities Law. If they engage in illegal activities such as insider trading, trading based on undisclosed information, or market manipulation, penalties shall be imposed in accordance with Article 191, Article 192, and other relevant provisions of the Securities Law. In the case of violations of laws, regulations, or these Administrative Rules with serious consequences, measures of securities market entry bans shall be imposed on the responsible personnel in accordance with Article 221 of the Securities Law.
Article 190 of the Securities Law provides that “anyone who, in violation of the provisions of Article 45 of this Law, engages in program trading that affects the securities exchange’s system security or normal trading order shall be ordered to make corrections and be fined at least 500,000 yuan but not more than 5 million yuan. The person directly in charge and other directly responsible personnel shall be given a warning and be fined at least 100,000 yuan but not more than 1 million yuan.”
In addition to the above, if the circumstances are serious and considered as market manipulation, penalties applicable to market manipulation will be applied.
Program Trading Regulations for Stock Connect
Article 30. Investors who engage in program trading in the securities market in Chinese mainland through the Stock Connect regime between Chinese mainland and Hong Kong shall, in accordance with the principle of equivalent treatment of domestic and foreign investors, be subject to reporting management and trading monitoring regulations. Cross-border regulatory cooperation will be implemented regarding their abnormal trading behavior. These Administrative Rules shall be taken as a reference for other management matters. Specific measures shall be stipulated by the securities exchanges.
This indicates that the program trading regulations for Stock Connect are going to come out very soon. Such regulations are expected to be basically the same as the requirements applicable to local program trading investors.
The trading monitoring provisions under the Administrative Rules will directly apply to Northbound program trading under Stock Connect. In addition, the Administrative Rules will be taken as a reference for other management matters. The law enforcement will still depend on regulatory cooperation between regulators in Chinese mainland and Hong Kong.
Detailed rules for the management of Northbound program trading under Stock Connect will be issued by the securities exchanges separately.
