12 December, 2017
Introduction
Earlier in the year, there has been speculation that some form of investor ID system will be implemented for Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect (together, “China Connect1”) to harmonise the regulatory surveillance of markets in Mainland China and Hong Kong. In Hong Kong, the Stock Exchange of Hong Kong (“SEHK”) has visibility of trade orders at the broker level only, while in Mainland China a real-name registration system is in place that assigns a single account number to each investor for both trading and clearing purposes. However, given the lack of information at the time, some investors naturally had concerns about the level of information that may be disclosed, and the extent of operational adjustment required.
On 30 November 2017, the Securities and Futures Commission of Hong Kong (“SFC”) finally announced an agreement with the China Securities Regulatory Commission (“CSRC”) to implement a new Investor ID regime for China Connect. On the same day, Hong Kong Exchanges and Clearing Limited (“HKEX”) followed with an information paper on the operational details of the regime. The purpose of this new Investor ID regime is to allow better regulatory surveillance, by allowing regulators to collect ID data of China Connect investors for northbound trades (i.e. trades by foreign investors on the Shanghai and Shenzhen stock exchanges) and to track their trade orders on a real-time basis to help detect potential market misconduct. Similar requirements will be imposed on China Connect investors for southbound trades (i.e. trades by Mainland China investors on SEHK) at a later date.
(1) What client information is disclosed under the investor ID regime?
Under the proposed investor ID regime, brokers are required to obtain client identity information (Client Identification Data, or “CID”) and to map that information to a 10-digit unique investor ID (Broker-to-Client Assigned Number, or “BCAN”). SEHK will then forward such information to the Mainland Chinese exchanges.
However, such information will not be available for public viewing.
The CID includes the following types of information:
|
Client Type |
CID |
|---|---|
|
Individuals |
– client’s full name on the identity document – ID issuing country – ID type (e.g. Hong Kong ID card or passport) – ID number |
|
Institutional or Corporate Clients |
– entity name on certificate of incorporation or Legal Entity Identifier (“LEI”) – place of incorporation – LEI or certificate of incorporation number |
Currently, SEHK may already request such client information from the relevant broker using a manual broker enquiry process, and may share such information with the Mainland Chinese exchanges and regulators, but this is not done on a real-time basis.
(2) Who is the client for the purpose of the investor ID disclosure?
The BCAN of the following entity should be used in tagging China Connect trade orders:
|
Trade Type |
BCAN for trade |
|---|---|
|
Proprietary Trade |
A broker will have to assign itself a BCAN for its own proprietary trading. |
|
Agency Trade (non- Funds) |
A broker should tag the BCAN of the client in the agency chain that is not an affiliate of the broker for the relevant trade. |
|
Agency Trade (Funds) |
For orders from asset management companies and discretionary funds, the BCAN of the legal entity for which the broker opened the northbound trading account should be used (i.e. the BCAN can be assigned to the fund manager or to the individual fund, depending on the account opening arrangement). |
As seen above, the client for investor ID purposes may be different from the ultimate beneficial holder of the relevant China Connect shares. The client is the person holding the trading account, but the ultimate beneficial holder could be a different person. SEHK may still ask brokers for beneficial ownership information on top of BCANs and CIDs.
The option to assign BCANs to the asset manager rather than to each individual fund is welcomed. If the trading account is opened under the name of the asset manager, then all funds managed by the same asset manager can use the same BCAN of the asset manager. Whereas, if northbound trading accounts are set up at the individual fund level, then each fund will need to trade with its own separate BCAN. Asset managers will need to weigh the pros and cons of each arrangement. The first approach would be easier operationally, but the potential downside is that if the Mainland Chinese exchanges decide to suspend trading with the asset manager’s BCAN (see section (3) below), then the China Connect trades of all funds managed by that asset manager may be affected. For the second approach, it is not clear if the ability of asset managers to make post-trade allocations between funds could be affected, since the BCAN of a particular fund will need to be tagged to the trade on or prior to the trade date.
(3) How will my China Connect trading be affected?
Brokers must submit one file containing all BCAN-CID mapping data of its clients to SEHK, and submit the updated file each time there is a change to the information relating to any one or more of its clients. Each China Connect trade order must be tagged with a BCAN number on the trade date. A broker will not be able to place an order for a client on trade date (T) unless the BCAN-CID information for such client has been received by SEHK at or before the prescribed time (proposed to be 3pm) on T-1, and such information has passed the relevant validation check by SEHK. Any trade orders with an invalid BCAN will also be rejected.
The Mainland Chinese exchanges will also consolidate and validate the BCANs and CIDs received, and inform SEHK (who will in turn inform the relevant brokers and clearing participants) if any issues arise. If abnormal trading activity is identified in respect of a BCAN, the Mainland Chinese exchanges may suspend trading with such BCAN in China Connect in severe cases, in accordance with applicable Mainland Chinese laws, regulations and exchange rules.
(4) How will my China Connect clearing, settlement and custody arrangements be affected?
Unlike the Mainland Chinese market, where the “Yimatong” account is used for both trading and settlement purposes, the BCANs and CIDs are for the regulators’ market surveillance only. They will not be used for clearing or settlement, so it appears that settlement of China Connect shares between different accounts of the same beneficial owner (which does not involve a trade order) will not require BCAN tagging. The BCAN is also different from the Special Segregated Account used for pre-trade checking under China Connect.
Since the BCANs relate to trade orders and not to securities accounts, investors can still have multiple trading accounts with the same or different brokers, and multiple securities accounts with the same or different custodians. Market participants will welcome this approach which takes into account international market practice, preserves the investors’ choice of different brokers and custodians, and retains their flexibility to set up segregated accounts for different purposes, such as the pledging of shares.
(5) How will my obligations under Mainland Chinese laws and regulations be affected?
In principle, the investor ID regime should not affect the investors’ existing obligations under the Mainland Chinese laws and regulations applicable to China Connect shares, which include compliance with the disclosure of interest regime, foreign ownership limits, and relevant market misconduct rules such as the prohibition on intra-day trading (that is, placing buy orders and sell orders on the same stock within the same day) and the “no short swing profit” rule. However, the investor ID regime does provide an additional tool for the Mainland Chinese exchanges and regulators to monitor the markets, and if a surveillance of trade data based on the BCANs raises any concerns, the relevant investor may need to explain the situation to the regulators. As mentioned above, if abnormal trading activity is identified, the investor’s trading in China Connect may also be suspended.
For example, if an asset manager is assigned a single BCAN for all its funds under management, and engages in the buying and selling of the same listed shares for different funds on the same day, questions of intra-day trading (which is considered an abnormal trading activity) may arise. Similarly, an asset manager who buys and sells shares in the same company for different funds using the same BCAN within a short period and makes an apparent profit from the trades, where the shareholding involved is more than 5%, could raise questions relating to the “no short swing profit” rule.
(6) Will my derivatives trades referencing China Connect shares be affected?
The trading of derivatives and structured products over China Connect shares will not be subject to the investor ID regime. However, any buy or sell orders for China Connect shares to hedge such derivatives or structured products will need to be reported by the hedging party using its own BCAN under the investor ID regime, in the same way as other China Connect trades. If any concerns about potential abnormal trading activity are raised in connection with such hedging trades, the hedging party may need to explain the situation to the regulators and disclose further information relating to such hedging activity. If the regulator deems that any abnormal trading activity has occurred and suspends any trading with the hedging party’s BCAN, this would constitute a Hedging Disruption under the 2002 ISDA Equity Derivatives Definitions.
(7) Will my China Connect terms require amendment?
Brokers may wish to consider the following changes in relation to its China Connect client terms:
- risk factors to highlight that following implementation of the investor ID regime, trades could be rejected if CID information is not provided or updated in time, and that all trades relating to the same BCAN could be rejected if there is abnormal trading activity relating to such BCAN;
- allocation of risk of trade failure due to lack of or incorrect BCAN-CID mapping data or BCAN trade-tagging;
- ensuring that the terms allow the use, storage, transfer and disclosure of client information to the extent required to implement the Investor ID model;
- ensuring that all applicable data protection and privacy laws are complied with in relation to any CID under the investor ID regime, including any requirement to obtain client consent;
- requiring clients to represent the accuracy of the CID information provided, to promptly notify any change in CID information, and to agree not to trade until such information is updated; and
- obtaining the client’s prescribed consent to use its personal data for the investor ID regime in accordance with the Hong Kong Personal Data Protection Ordinance (“PDPO”), and making the provision of such prescribed consent a condition to the client ’s use of the broker’s northbound trading services.
Under the PDPO, brokers will need to review existing client consent for the use of personal data to see if it is broad enough to cover the use under the new investor ID regime. If not, the relevant broker would need to obtain investors’ prescribed consent before using their personal data for the investor ID regime. Simple notification of the new use will not be sufficient and actual consent will need to be obtained. Other relevant local data protection and privacy laws should also be checked where the relevant investor is located outside of Hong Kong or where the data collection takes place outside Hong Kong.
(8) When will the investor ID regime be implemented?
The launch of the investor ID regime is subject to relevant regulatory approvals. However, the expected implementation plan is as follows:
- Q4 2017 – Q2 2018: Market communications, system changes and market rehearsals
- Q3 2018: Launch (subject to market readiness and finalisation of relevant SEHK rules)
Conclusions
The investor ID regime has been long in the making, and the information paper issued by HKEX provides more certainty to the market on how the regime is expected to be implemented. Market sentiments following the announcement have been generally positive, as the proposal is seen to strike a fair balance between giving regulators the information required and minimizing the compliance burden on market participants in light of Hong Kong and international market conditions. However, considerable documentation and operational changes will need to be completed by the expected launch in Q3 2018. Given the amount of time required to implement such changes (particularly to obtain consent for PDPO and privacy law purposes), market participants are advised to start early to allow enough time for the process.
1 For an overview of China Connect, see our Linklaters Guide to China-Hong Kong Stock Connect: https://www.linklaters.com/en/insights/publications/2017/
november/linklaters-guide-to-china-hong-kong-stock-connect.
For further information, please contact:
Chin-Chong Liew, Partner, Linklaters
chin-chong.liew@linklaters.com
