Registration, reporting and liability for derivatives transactions in China

Liability and enforcement

What is the territorial scope of the laws and regulations governing listed, cleared and uncleared equity derivatives transactions?

Pursuant to article 2 of the Securities Law, the Securities Law and all the securities regulations and rules made thereunder apply to the issuance and trading of securities within the territory of mainland China. Accordingly, the following transactions fall outside the application of the Securities Law: offshore cash-settled OTC equity transactions referencing China-listed shares where neither of the parties is a Chinese entity or individual; and cross-border cash-settled OTC equity transactions referencing China-listed shares where one party is an offshore party and the other party is a Chinese party, and the Chinese party is not a regulated entity incorporated or licensed under the Securities Law (eg, a broker). Nevertheless, the capacity of a Chinese party to enter into derivatives transactions may be subject to other laws and regulations of China and not the Securities Law.

What registration or authorisation requirements apply to market participants that deal or invest in equity derivatives, and what are the implications of registration?

OTC equity derivatives transactions in China are normally between a dealer and its client. Based on the self-regulatory authorisation conferred on SAC by the CSRC, a dealer must make a filing with SAC in order to carry out OTC equity derivatives business, and SAC has prescribed for prudential criteria applicable to such dealers. Without filing with SAC, the relevant dealer entity should not enter into OTC equity derivative transactions with clients, and there is a legal risk that such transactions are invalid under Chinese law. There is no registration or filing requirement for clients.

What reporting requirements apply to market participants that deal or invest in equity derivatives?

SAC rules mandate securities companies to submit a monthly report of their equity derivatives trade information to China Securities Internet System Co Ltd (InterOTC), which publishes aggregate statistics in a monthly report on its website. Other dealers who are not securities companies are not subject to mandatory reporting requirements and they may report to InterOTC on a voluntary basis. Clients are not subject to such general reporting requirements. Nevertheless, where a client is subject to a regulatory reporting requirement by its own regulatory authority (ie, banking regulator or state-owned assets regulator), the client shall comply with the applicable reporting requirements. We understand that those reports are more entity prudential regulation in nature and do not serve a trade repository function.

CSRC and stock exchange rules mandate securities companies to submit daily reports to the stock exchange of their margin loan and stock loan information, and the stock exchanges publish aggregate statistics before the opening of the next exchange trading day. Clients are not subject to these general reporting requirements.

What legal issues arise in the design and issuance of structured products linked to an unaffiliated third party’s shares or to a basket or index of third-party shares? What additional disclosure and other legal issues arise if the structured product is linked to a proprietary index?

Depending on the issuer of such equity-linked structured products, the applicable regime would be different. If the issuer of the structured products is a bank, such structured products would likely take the form of a wealth-management product or structured deposit; and the sale of structured products by a bank to its clients will be regulated by the CBIRC. If the issuer of the structured products is a securities broker, these structured products would likely take the form of OTC equity derivatives transactions, which are subject to the self-regulating rules of SAC and the jurisdiction of the CSRC.

The relevant structured product would be subject to the same disclosure requirements as other shareholders if it is physically holding the underlying shares. The issuer or manager of the structured product needs to ensure that these structured product would not be considered as ‘acting in concert’ with the issuer or manager itself or any other products issued or managed by the same entity; otherwise shareholdings of entities or products who are ‘acting in concert’ need to be aggregated for the purpose of determining their disclosure obligations.

Describe the liability regime related to the issuance of structured products.

There are no structured product securities in China. The only structured products are structured deposits offered by commercial banks that are not ‘equity derivative transactions’ for the purposes of this chapter (see question 1).

What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is convertible for shares of the same issuer?

A listed issuer can issue only convertible security through public issuance with the publication of a prospectus.

The public issuance of convertible securities requires prior approval from the CSRC, and the issuer needs to meet conditions prescribed in the Securities Law or as provided for by the CSRC.

Optional convertible security is the only form of convertible security under Chinese law; it gives an investor the right to convert the security into the underlying equity. The maximum term for convertible security is six years and the minimum term is one year. Conversion for a convertible security can be settled only in cash.

The issuer shall convene a securities holders’ meeting on the occurrence of any of the following events:

• the issuer proposes to amend the prospectus;
• the issuer is unable to pay any interest or principal due under the convertible securities on time;
• the issuer undergoes a capital reduction, merger, division, dissolution or has applied for bankruptcy;
• there is a significant change in the guarantor or collateral; or
• any other matters that have an impact on the major rights and interests of security holders.

The issuer can also issue convertible securities where each of the debt instruments and the share option element in a convertible security can be traded and listed separately.

What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is exchangeable for shares of a third party? Does it matter whether the third party is an affiliate of the issuer?

Shareholders of listed company can issue exchangeable security subject to CSRC approval. Whereas the issuer of the exchangeable security has control over the listed company, it shall not directly transfer its power of control over the listed company by way of issuing exchangeable security.