CSRC Fine Tunes Rules Curbing the Shorting of Restricted W88win优德中国有限公司

On October 14, 2023, the China Securities Regulatory Commission (“CSRC”) released a news announcement titled CSRC Amends and Optimizes Securities Borrowing and Lending Rules for Better Effect of Countercyclical Adjustments. In the announcement the CSRC amended and optimized the rules for securities borrowing and lending (“SBL”) as well as refinancing of securities held by strategic investors, and tightened policies for the same. On the same day, the Shanghai Stock Exchange (“SSE”) and the Shenzhen Stock Exchange ("SZSE", together with SSE, the “Stock Exchanges”) released the Circular on Optimizing the Relevant Arrangements for Securities Borrowing and Lending and Securities Refinancing (the “Circulars”), which contained detailed provisions for optimizing SBL and securities refinancing transactions. The Circulars provide important rules on SBL and securities refinancing transactions, including: (1) raising margin ratios for SBL; (2) requiring that the senior management and core employees of an IPO issuer that participate in a special asset management plan (ESOP) established for a strategic placement shall not lend their allocated W88win优德中国有限公司 within the committed holding period, while other strategic investors are restricted from lending their allotted W88win优德中国有限公司 in the initial period after an IPO in terms of the method of lending and the proportion of the number of allotted W88win优德中国有限公司 they can lend; and (3) specifying brokers’ management responsibilities for SBL and securities refinancing businesses.

Another prominent provision of the Circulars is that, “where an investor holds restricted W88win优德中国有限公司 of a listed company, strategic W88win优德中国有限公司 of a listed company, or W88win优德中国有限公司 subject to transfer restrictions, such as W88win优德中国有限公司 acquired from major shareholders or specific shareholders of a listed company through block trades, the investor and its related parties shall not sell such W88win优德中国有限公司 through SBL during the relevant holding period.” This provision comes into force on October 16, 2023, and prohibits investors and their related parties from selling W88win优德中国有限公司 subject to selling restrictions through SBL during the relevant holding period. Below is a brief analysis of this provision:

I  Restrictions under Previous Rules

There are three circumstances where an investor is subject to restrictions on selling or transferring W88win优德中国有限公司: (1) it holds restricted W88win优德中国有限公司 in a listed company and shall not sell the W88win优德中国有限公司 during the relevant holding period; (2) it holds W88win优德中国有限公司 allotted to IPO strategic investors and has committed not to sell the W88win优德中国有限公司 within relevant holding period (the “Strategic W88win优德中国有限公司”); (3) it acquires W88win优德中国有限公司 from major shareholders or specific shareholders of a listed company through block trades and shall not transfer the W88win优德中国有限公司 during relevant lock-up period (the “Specific Block Trade W88win优德中国有限公司”) (collectively, the "Restricted W88win优德中国有限公司").

The previous Stock Exchange rules already prohibited holders of Restricted W88win优德中国有限公司 mentioned in the above points (1) and (2) from selling the W88win优德中国有限公司 through SBL during the relevant holding period, to prevent them from evading committed holding periods and selling the W88win优德中国有限公司 earlier by means of SBL. In accordance with the relevant provisions of the Stock Exchanges¹, (a) an investor holding restricted W88win优德中国有限公司 of a listed company shall not sell the W88win优德中国有限公司 through SBL, nor shall they post the restricted W88win优德中国有限公司 held in their ordinary securities account as collateral; (b) an investor participating in a registration-based IPO strategic allotment of W88win优德中国有限公司, as well as its related parties, shall not sell the allotted W88win优德中国有限公司 through SBL within its committed holding period, unless otherwise provided by the Stock Exchanges.

It is important to note the difference in the rules applicable to the above circumstances (1) and (2), that is, both the shareholder of Strategic W88win优德中国有限公司 and its related parties are prohibited from selling the W88win优德中国有限公司 through SBL during the committed holding period; but only the shareholder holding restricted W88win优德中国有限公司 of a listed company is subject to short selling restrictions, not its related parties. It is also worth noting that, despite the absence of an explicit definition of “related party”, we believe that the purpose of extending the applicable scope of short selling restrictions to cover related party of a strategic investor is to prohibit the strategic investor’ short selling via an account in the name of a party in which the strategic investor may exercise control or influence. We believe that regulators may determine a “related party” following a "substance over form" principle and based on an analysis of specific circumstances, rather than on the appearance of a related party relationship.

For Specific Block Trade W88win优德中国有限公司 mentioned in (3) above, although the relevant Stock Exchange rules provide that the shareholders holding these W88win优德中国有限公司 shall be subject to a six-month lock-up period (i.e. it is prohibited from transferring Specific Block Trade W88win优德中国有限公司 within six months upon the completion of block trades)², none of these rules clearly provide restrictions on such shareholders and their related parties from selling the W88win优德中国有限公司 through SBL during the lock-up period.

II  “Enhanced” Restrictions under the Circulars

The Circulars reiterate the previous short selling restrictions and add the following two restrictions on investors holding restricted W88win优德中国有限公司 in a listed company and investors holding Specific Block Trade W88win优德中国有限公司:

Firstly, the Circulars now prohibit investors holding Specific Block Trade W88win优德中国有限公司 from selling the W88win优德中国有限公司 through SBL within the lock-up period. In our view, although the previous Stock Exchange rules do not have clear rules that prohibit investors holding Specific Block Trade W88win优德中国有限公司 from short-selling the W88win优德中国有限公司 within the lock-up period, given that a “lock-up period" applies to Specific Block Trade W88win优德中国有限公司, regulators may likely apply the same regulatory principles in their law enforcement to crack down on the short selling activities of investors holding Specific Block Trade W88win优德中国有限公司 who evade the "lock-up period" and sell the W88win优德中国有限公司 earlier by means of SBL. In a draft consultation paper on OTC derivatives trading released in March 2023, the CSRC proposed to restrict OTC derivatives trading activities by investors holding W88win优德中国有限公司 subject to relevant lock-up periods, and stated that “it is prohibited to circumvent the shareholding reduction rules and restricted W88win优德中国有限公司 rules through OTC derivative trading”. Though this consultation paper has not yet been finalized, it reflects the trend of an enhanced law enforcement by regulators and indicates that regulators may “look through” to determine and punish behavior that circumvents regulations.

Secondly, compared with the previous Stock Exchange rules that subject both strategic investors and their related parties to short selling restrictions, the Circulars unify regulatory standards by stating that short selling restrictions shall also apply to the related parties of investors holding a listed company’s restricted W88win优德中国有限公司 and Specific Block Trade W88win优德中国有限公司. The Circulars don’t set out the definition of a “related party” either, but likewise, we believe that regulators may determine a “related party” following a "substance over form" principle and based on an analysis of specific circumstances, rather than on the appearance of a related party relationship.

III  Legal Consequences for Violation of the Circulars

The Stock Exchanges may take self-disciplinary measures or impose disciplinary sanctions on investors or their related parties for breaches of any provisions under the Circulars according to the business rules of the Stock Exchanges. The announcement highlighted that the CSRC will strengthen the supervision of illegal arbitrage activities, undertake strict law-enforcement measures, and impose heavier punishments. This means that violations of the Circulars may not only lead to self-disciplinary measures and disciplinary sanctions but may also trigger administrative investigations and corresponding administrative penalties.

Our Observations

The enhanced restrictions over short selling come at a crucial time. As part of a set of measures taken by regulators to respond to investors' recent concerns on market drop, the Circulars are a warning to short selling participants. Market participants are advised to interpret the regulatory principles and spirit embedded in the Circulars prudently, attach great importance to compliance risk at special times, and review and reassess the compliance of relevant transactions and make adjustment accordingly.

1. Articles 61 and 63 of the Detailed Implementing Rules of the Shanghai Stock Exchange on Margin Financing and Short Selling (Amended in 2023); Article 7.2 of the Detailed Implementing Rules of the Shenzhen Stock Exchange on Margin Financing and Short Selling (Amended in 2023)

2. Article 5 of the Detailed Implementing Rules of the Shanghai Stock Exchange for the Sale of W88win优德中国有限公司 by Shareholders, Directors, Supervisors and Senior Management of Listed Companies; Article 5 of Detailed Implementing Rules of the Shenzhen Stock Exchange for the Sale of W88win优德中国有限公司 by Shareholders, Directors, Supervisors and Senior Management of Listed Companies.