New Regulations on Program Trading in the Chinese Securities Market

CSRC's New Regulations on Program Trading in the Chinese Securities Market (Consultation Paper)

On 12 April 2024, China Securities Regulatory Commission (CSRC) released the "Regulations on the Management of Program Trading in the Securities Market (Consultation Paper)" (hereinafter referred to as “Program Trading Rules”) for public consultation.

This regulatory development aims to address the increasing complexity and impact of program trading in the Chinese securities market, echoing the fairly recent enforcement cases targeting Chinese domestic fund managers (please watch our webinar on this topic here) and following securities exchanges’ filing requirements on programmatic traders issued in September 2023 here.

Legislative Intent

According to the CSRC, the legislative intent behind these Program Trading Rules is to address several key objectives as follows:

1. Market Stability and Integrity: With the proliferation of program trading, there is a growing concern about its potential impact on market stability and integrity. Whilst the CSRC indicates that it decides to embrace rather than suppress the development of program trading, these Program Trading Rules seek to establish clearer guidelines and standards to prevent market manipulation, excessive volatility, and systemic risks associated with program trading activities.

2. Investor Protection: The Program Trading Rules aim to enhance investor protection by promoting transparency, fairness and accountability in program trading.

3. Risk Management: Recognising the inherent risks of program trading, including algorithmic errors and technology failures, the Program Trading Rules mandate market participants to implement robust risk management systems and controls.

Key Provisions and Analysis

1. Definition and Scope

The Program Trading Rules provide a comprehensive definition of program trading, i.e., automated generation or execution of trading orders via computer programs with respect to “securities trading via securities exchanges” is all deemed as program trading. The Program Trading Rules apply to private fund managers, retail fund managers, securities firms, insurance companies and other investors required by the securities exchanges (which we believe may possibly include certain prop trading firms). Overseas investors trading Chinese securities markets via QFI and Connect Programs are all technically in-scope entities. They don't apply to CIBM or futures markets.

2. Registration and Disclosure Requirements

Market participants engaged in program trading are required to register with the securities exchanges and make disclosures on the following:

(1) basic information of the accounts;
(2) source of funds and source of leverage as well as leverage ratio;
(3) type of trading strategy, means of order execution, maximum declaration rate, maximum number of declarations on any single trading day;
(4) name, version and developer of the trading software; and
(5) other information stipulated by securities exchanges, such as information of the brokers, name of contact person, and contact details of such contact person.

Disclosed information is subject to validation by the securities exchanges and any subsequent changes of the disclosed information requires filing. Such disclosure requirements are very similar to what have been required by the securities exchanges since September last year (again, if helpful, please see our client alert on securities exchanges rules via here). What is worth noting is that the CSRC no longer requires the disclosure of source code of the investors’ algorithms (which they once attempted back in 2015 when issuing a similar draft rule on program trading), which is a pleasing development.

3. Risk Control Measures

To mitigate risks associated with program trading, the Program Trading Rules mandate market participants to establish comprehensive risk management systems and mechanisms. Securities exchanges would specially monitor the following behaviours:

(1) orders placed but cancelled within a relative short time period or intra-day reaching certain level;
(2) large, continuous or dense orders placed and filled, causing obvious abnormality to the pricing or trading volume of multiple securities;
(3) large, continuous or dense orders placed and filled, causing obvious abnormality to the securities market; and
(4) other circumstances as deemed necessary by the securities exchanges.

Existing market abnormality rules have quantifiable definitions with respect to most of the market abnormality such as wash trades, frequent order cancellations, large order cancellation, circumventing position limits or limits on holding periods. In the recent enforcement cases, the securities exchanges notably invoked a non-quantifiable definition of market abnormality which is program trading causing market disruption. Following those enforcement cases, domestic quant fund managers were also warned that “orders filled in large volume and within a short time period by the certain fund manager, taking up a significant portion of all the orders filled within the same time period and causing a substantial volatility of the major stock indexes” may be subject to special monitoring.

It looks like the above-mentioned Limbs (2) and (3) also unveil a consistent school of thoughts from the regulators, though we believe that regulators and exchanges would exercise such power very cautiously not arbitrarily. More background of why we believe so can be found in our webinar.

Furthermore, the Program Trading Rules prohibit brokers from providing any co-location arrangement to investors who A) have committed frequent abnormal trading behaviours B) have major technical failure of their program trading systems, C) violate the exchange rules, and D) trade securities via swaps (with Item D) inferred). They also allow securities exchanges to charge higher fees if the number and frequency of orders placed and cancelled reach certain level.

4. HFT (High Frequency Trading):

For the first time regulators have attempted to define high frequency trading which refer to program trading with the following characteristics:

(1) The number and frequency of order placement and order cancelation within a short period of time is relatively high;
(2) The number of orders placed and cancelled intraday is relatively high;
(3) Other characteristics identified by the securities exchanges.

The CSRC has deferred to securities exchanges to come up with more detailed explanations and parameters on HFT, which timeline is yet unknown.

5. Market Surveillance and Supervision

The CSRC will enhance market surveillance and supervision of program trading activities through advanced monitoring technologies and data analytics. This includes real-time monitoring of trading activities, market data analysis, and surveillance of order flows to detect and investigate irregularities, market abuse, and manipulative behaviours.

Conclusion

In conclusion, the Program Trading Rules were created during a time with higher volatility and regulators' strong will to boost the stock market. It somewhat tells that, although regulators are not yet fully prepared on the technical side, they now pay higher attention on the program trading activities focusing on market stability, investor protection, and risk management. They are also actively seeking new tools to regulate the market to complement the existing ones.

The consultation process will end on 27 April 2024.

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