New rules on programme trading in Chinese equities market

On the first day of September, under the guidance of the China Securities Regulatory Commission ("CSRC"), all Chinese stock exchanges issued the rules regulating programme trading in the PRC securities market (the "New Rules"), which makes it possible for global asset managers to legally apply quant strategy in trading equities in China. The New Rules will come into effect on 9 October 2023.

Programme trading is not new to PRC investors and regulators. As early as 2010, the futures exchange has started to require the reporting of programme trading in the financial futures sector. In 2015, when there were wild swings in the PRC stock market, the CSRC released a consultation paper which attempted to regulate programme trading of securities as well as of futures. Since then, the regulation framework of programme trading in futures, stock options and convertible bonds has been gradually established, whilst the specific regulation in the space of equities trading is still slow except for a general provision under the PRC Securities Law which provides that "programme trading shall be conducted in conformity with the securities regulators requirements and be reported to the exchanges, and such trading shall not affect the exchange's system security and normal trading orders.".  Exchanges would only regulate programme trading when it constitutes abnormal trading behaviours.

Due to the lack of specific recognition of the legitimate status of programme trading in equities, before the issuance of the New Rules, global asset managers were not actually able to apply quant strategy in their equities trading through the QFI regime. As for domestic fund managers, the regulator's attitude is ambiguous in practice as long as there is no illegal element (such as market manipulation) involved.

During the stock market turbulence in the past few months, fund managers which adopt quant strategy have significantly outperformed the market and thus invited a lot of attentions from the public. The New Rules were issued against such backdrop.

We set out below a summary of the key requirements under the New Rules and outstanding issues that global asset managers may be interested in.

1. Pre-trading reporting obligation

According to the New Rules, before the investors conduct programme trading, they shall report to the relevant exchange through their brokers.

The New Rules broadly define "programme trading" as the act of automatically generating or placing orders to trade equities on Chinese stock exchanges, including quantitative trading, algorithmic trading and other acts satisfying characteristics of programme trading. In the instructions on the filling of the reporting form that Shanghai Stock Exchange has issued, investors will be obligated to report if their trading activities bear any one of the following characters:

(1) High Degree of Automation in Order Placement: the key elements of trading orders, such as securities code, trading direction, quantity, price and order placement time, are automatically generated by computers.

(2) Fast placement/cancelation frequency: engaging in more than 10 declarations (including placements and cancellations) within a second, with more than 10 occurrences in a single day.

(3) High Number of Traded Stocks with a High Turnover Rate: trading no less than 50 stocks on average per day on the Shanghai Stock Exchange for the past 30 trading days, and have an annualized turnover rate of over 30 times in the past 30 trading days.

(4) using self-developed or other customized software.

(5) Other circumstances identified by the exchange that require reporting.

2. What need to be reported

The exchanges have released a reporting form which covers the following items:

(A) Basic account information, including the investor name, securities account code, designated trading members, and product manager;

(B) Account funding information, including the size and source of funds in the account, the size and source of leveraged funds, leverage ratio, etc; 

(C) Transaction information, including the type and description of the trading strategy (for quant trading only),  execution method of trading orders,  maximum declaration rate,  maximum number of declarations in a single day, etc;

(D) Trading software information, including software name and version number, and the developer of the software;

(E) Other information, including members, investor contacts and contact information;

(F) Other information specified by the exchange.

Investors who hedge their trading positions in the futures market shall also report the name and code of the relevant futures account.

3. Additional oversights on high frequency trading (HFT)

In the case where an investor indicates in the report that its maximum number of order placements or cancelations is expected to be or exceed 300 per second or 20,000 per day ("HFT"), it will be subject to stricter scrutiny, such as additional reporting requirements, including the location of trading system server, system testing report, contingency plan for system failures, and other information that the exchange may require from time to time.

Before the issuance of the New Rules, Chinese exchanges have already issued rules on monitoring of abnormal trading behaviours, eg spoofing, cross-trades, ramping up and suppressing stock prices etc. According to the New Rules, the exchanges will have the authority to adjust the monitoring standard when HFT is involved.

That said, it is still unclear how the exchanges may exercise such authority and to what extent. We expect more clarity would be given by the exchanges (either publicly or through a form of verbal guidance before the New Rules take full effect).

4. Will global investors that trade through QFI/Stock Connect/Swap be captured?

4.1 QFI

Yes. The New Rules have specifically stated that, where a qualified foreign investor (QFI) stipulates with its broker that the QFI may engage in programme trading, the QFI may entrust the broker to fulfil its reporting obligation. In other words, QFIs will also be subject to the New Rules without exemption whilst the details on how should QFIs report through the brokers are yet to be seen.

4.2 Stock Connect

For global investors that participate in northbound trading under the Stock Connect regime and conduct programme trading in the PRC securities market, separate rules will be rolled out to regulate on this front. We believe this is because the Stock Connect program was launched collectively by the regulators of both the mainland and Hong Kong. The exchanges of both places will work together to see how reporting may be implemented.   

4.3 Swap

As mentioned in section 2 above, source of funds for programme trading (including leveraged funds) shall be reported. It is further specified in the template reporting form that, leveraged funds include those acquired through margin trading, securities lending, and OTC arrangements such as total return swaps ("TRS"). If a global investor enters into a TRS with a PRC broker who conducts programme trading in the PRC market, the broker may need to report the amount of funding acquired through such TRS and the percentage of such amount against total amount for programme trading, which details need to be further opined on by the exchanges.

A typical TRS comprises two separate and distinct transactions: (1) the offshore swap taking place between the offshore investor and its counterparty (such as a broker) outside of the PRC for the purpose of offering the offshore investor economic interest synthetically derived from Chinese market, and (2) the hedging transaction conducted by the counterparty in the PRC market.

We believe it is step (2), ie the hedging transaction, that may involve programme trading in China and therefore falls under the regulation of the New Rules. That said, it is unclear whether the New Rules will reach further to capture the global investor who merely participates in step (1), ie the offshore swap.

PRC regulator has for a long time considered whether and how to regulate overseas swaps which reference PRC market. In March 2023, CSRC released a consultation paper ("Derivatives Trading Consultation Paper") trying to reach overseas derivative transactions where "the relevant hedging transactions take place in China" and in turn requires aggregation of positions acquired via derivatives and via cash trading. (Please click here to find our write-ups on this consultation paper.)

We expect that the PRC regulator will also consider the Derivatives Trading Consultation Paper and the industry's feedback to such consultation paper when it determines whether and how to cover swaps in terms of programme trading.

5. Any exemptions?

As discussed under section 3 above, HFTs (ie maximum order placements or cancelations expects to be or exceed 300 per second or 20,000 per day) will be subject to stricter scrutiny including the reporting of additional information to the exchanges. However, the New Rules introduce an exemption which states that, such heightened regulation will not apply to the situations where mutual fund companies and their subsidiaries, brokers that conduct asset management businesses, and QFIs use pre-set order splitting algorithms in order execution for the purpose of reducing the market impact of large orders or ensuring the trade fairness of different investment portfolios, even though the aforesaid HFT threshold has been reached.

That said, the New Rules are silent on the implementation standard of such exemption. For example, how would the exchanges assess whether the frequent trading is done merely for order splitting purpose.

In summary, the PRC regulator has officially started to regulate programme trading in Chinese equities market by requiring the investors to conduct pre-trading report. Yet there are some questions unanswered in the New Rules, such as the applicability to swaps, the implementation details for QFIs, the exemptions to heightened regulation, etc. We anticipate that the exchanges would add more clarity to those issues in the next few months to put the New Rules into full implementation.

Please note that this article is produced by jointly Simmons & Simmons and Shanghai YaoWang Law Offices.

Should you have any questions or require further assistance regarding any of the above, please do not hesitate to contact us.

Melody Yang
Co-Head, Partner
Shanghai YaoWang Law Offices
T +86 21 8013 5022
M +86 135 2105 2486
melody.yang@yaowanglaw.com