China is proposing to expand the Shanghai-London Stock Connect program to include companies listed on the Shenzhen Stock Exchange, as well as Swiss and German stock exchanges.
The amendment also proposes expanding the types of shares that can be listed on domestic stock exchanges, aiming to attract more foreign-listed companies. If passed, the amendment could greatly expand the number of Chinese stocks available to foreign investors and enable foreign-listed companies to raise capital in China.
On December 17, 2021, the China Securities Regulatory Commission (CSRC) began soliciting public opinion on a proposed expansion to the London-Shanghai Stock Connect Program.
Specifically, the CSRC is seeking feedback on an amendment to a document called the Provisions on the Supervision and Administration of Depository Receipts under the Stock Connect between Shanghai Stock Exchange and London Stock Exchange (for trial implementation) (henceforth referred to as “the amendment”).
The idea of expanding the Shanghai-London Stock Connect program was first floated in April 2021, when the General Manager of the Shanghai Stock Exchange (SSE) Cai Jianchun said in a panel discussion at the annual Boao Forum in Hainan, “We are preparing to make important efforts in Switzerland going forward and we believe that the first batch of the trial will succeed this year”.
At the time, Cai did not provide more details on his statement, but was viewed as “another move to diversify China’s financing resources and deepening ties of the two countries”.
An explainer released along with the amended regulations – while not providing specific details on participating stock exchanges or when the expanded program will launch – confirmed plans to expand the Shanghai-London Stock Connect to include the Shenzhen Stock Exchange (SZE) and stock exchanges in Germany and Switzerland.
Below we provide an overview of the existing China stock connect programs and what the new amendment means for foreign investors and companies.
The stock connect is an investment channel that allows overseas investors to trade in shares on domestic mainland Chinese stock exchanges and vice versa.
Below is an overview of how the stock connect programs work and who is involved.
There are currently three stock connect programs:
Under the two Hong Kong stock connect programs, companies can float shares directly on each other’s stock exchanges.
Under the Shanghai-London Stock Connect, shares are traded as depository receipts (DRs) through designated local brokers. Chinese companies listed on the SSE can list general depository receipts (GDRs) on the London Stock Exchange (LSE), foreign companies listed on the LSE can list Chinese depository receipts (CDRs) on the SSE.
The stock connect allows individual investors to trade in stocks in China through local brokers. There are no requirements for foreign individual investors to participate in the stock connect programs, although Chinese individual investors seeking to participate in overseas stock exchanges must meet certain eligibility criteria.
There are currently four Chinese companies that have listed GDRs on the LSE: Huatai Securities (Ticker: HTSC), China Pacific Insurance, (Ticker: CPIC), China Yangtze Power (Ticker: CYPC), and SDIC Power Holdings Co (Ticker: SDIC). In total, these four companies have raised US$5.84 billion in funds through the stock connect.
So far, no London-listed companies have listed CDRs on the SSE.
Below are the eligibility criteria for securities and investors to take part in the three stock connect programs.
(Hong Kong and overseas investors trading in SZSE-listed stocks)
Constituent stocks of the SZSE Component Index and SZSE Small/Mid Cap Innovation Index with a minimum market cap of RMB 6 billion (US$928 million).
SZSE-listed A-shares that are not included in the above indices but have corresponding H-shares listed on the HKEX.
Excludes:
SZSE-listed shares under risk alert or delisting arrangements and SZSE-listed shares that are not traded in RMB.
Only institutional investors are permitted to trade in ChiNext market stocks.
(Chinese mainland investors trading in HKEX-listed stocks)
Constituent Stocks of the Hang Seng Composite LargeCap Index, the Hang Seng Composite MidCap Index, and constituent stocks of the Hang Seng Composite SmallCap Index with a minimum market cap of HKD 5 billion (US$642 million).
H-shares with corresponding A-shares listed on the SZSE.
Excludes:
H-shares that have corresponding A-shares under risk alert, H-shares that have corresponding shares on another mainland exchange, and HKEX-listed shares that are not traded in HKD.
Constituent stocks of the SSE 180 Index and SSE 380 Index.
All SSE-listed A-shares that have corresponding H-shares listed on HKEX.
Excludes:
SSE-listed shares under risk alert and SSE-listed shares that are not traded in RMB.
Only institutional investors are permitted to trade in STAR market stocks.
(Chinese mainland investors trading in HKEX-listed stocks)
Constituent Stocks of the Hang Seng Composite LargeCap Index and the Hang Seng Composite MidCap Index.
H-shares with corresponding A-shares listed on the SSE.
Excludes:
H-shares that have corresponding A-shares under risk alert, H-shares that have corresponding shares on another mainland exchange, and HKEX-listed shares that are not traded in HKD.
(LSE-listed companies listing CDRs on the SSE Main Board)
Have a minimum market cap of RMB 20 billion (US$3.1 billion).
Have been listed on LSE for at least 3 years with a minimum of 1 year on the Premium Segment of the Main Market.
Issue a minimum of 50 million units of CDRs representing RMB 500 million (US$77.3 million) worth of underlying shares.
Hold or acquire sufficient underlying shares (new capital raising is not permitted for CDRs).
Obtain permission from CSRC and comply with SSE requirements.
Have a minimum market cap of RMB 20 billion (US$3.1 billion)
Received a CSRC follow-on offering approval.
Have new shares admitted to listing on the SSE.
Meet Financial Conduct Authority (FCA) listing rules.
Issue GDRs to meet the 25% free float requirement.
A GDR is a kind of DR under which shares are listed in one or more markets, most frequently, the US market and the European markets.
The depositary receipts themselves are a kind of financial instrument to avoid trading and legal barriers in direct listings and to facilitate trading for investors. For example, if a Chinese company issue shares abroad to raise funds, it entrusts a certain number of shares to an intermediary institution (usually a bank), and the depositary bank notifies the local depositary bank (equivalent to a salesman) of the foreign country to issue depositary receipts representing the shares. Investors can buy and sell these shares directly through intermediaries.
From the investor’s point of view, DRs are transferable stock certificates issued by depositary banks, which prove that investors have a certain number of shares of a foreign company in custody.
Chinese companies listed on a domestic Chinese stock exchange can therefore issue GDRs in a foreign stock exchange, such as the LSE, to raise capital overseas.
CDRs, on the other hand, are DRs issued by overseas-listed companies and listed on a mainland China stock exchange. This system was introduced primarily to incentivize Chinese companies that are incorporated and listed overseas to raise capital on domestic stock exchanges, but it has also been expanded to non-Chinese companies in some scenarios.
However, currently, no overseas-listed companies have floated CDRs in China through the Shanghai-London Stock Connect program.
The new amendment proposes two main changes to the Shanghai-London Stock Connect. These are expanding the number of stock exchanges participating in the program and allowing foreign companies to issue new CDRs on Chinese stock exchanges.
Currently, only companies listed on the Shanghai and London stock exchanges can participate in the stock connect. The amendment proposes expanding the program to include companies listed on the Shenzhen Stock Exchange (SZE), as well as stock exchanges in Switzerland and Germany.
The amended rules do not indicate which stock exchanges in Switzerland and Germany will participate in the program.
The second change will be the type of product that foreign companies can list on Chinese stock exchanges. Under the current rules, Chinese companies are permitted to list new GDRs on the LSE, but London-listed companies can only list CDRs that are backed by existing shares. This means London-listed companies are not able to raise any fresh capital through the stock connect.
The new amendment will allow London-listed (and those listed on the newly added exchanges) to list new CDRs that are not backed by existing shares on the foreign exchanges and thereby raise fresh capital in China.
Below is a brief overview of the expanded scope.
Shanghai Stock Exchange
GDRs (for China-listed companies)
Germany (stock exchange TBC)
Switzerland (stock exchange TBC)
In addition to the expansion of the scope of the Stock Connect, the amendment also seeks to further facilitate listing and trading by proposing changes to the reporting and disclosure rules.
One such facilitation is amending the requirements for accounting standards. Under the new proposed rules, overseas issuers of CDRs will not need to disclose the difference between the accounting standards used and the Chinese Accounting Standards for Business Enterprises (CAS), if the accounting standards used are recognized as equivalent to CAS (such as the International Financial Reporting Standards, or IFRS). Instead, the financial data prepared in accordance with the equivalent accounting standards can be used to calculate financial indicators.
However, if other accounting standards are adopted, the issuer will need to additionally disclose the major differences between the accounting standards used and the CAS, as well as the information that was adjusted in accordance with the CAS.
Accounting firms will also be permitted to issue assurance opinions on the internal control of overseas issuers in accordance with the rules of the place of the overseas listing.
The amendment seeks to improve annual reporting requirements to better inform domestic investors. This means overseas issuers that use annual reports from the place of their overseas listing must evaluate and explain the differences in the requirements for content of the annual report from China’s annual reporting guidelines and standards (Guidelines for the Content and Format of Information Disclosure by Companies Offering Securities to the Public No. 2 – Content and Format of Annual Reports).
In addition, they must also evaluate and explain whether these differences will have a significant impact on investors’ value judgments and investment decision-making, including getting a lawyer to make a legal opinion on the matter.
Most observers still consider China to be an emerging financial market despite its huge size and potential (the SSE was the third-largest stock exchange in the world by market capitalization in 2021). This is partly due to the fact that China’s securities markets are still much more tightly regulated than those in most developed countries, and foreign participation is strictly controlled.
However, China has been actively implementing a series of policies to open its financial markets since 2018. The amendment to the Shanghai-London Stock Connect is just the latest example of this trend, with recent years seeing the launch of several other programs aimed at strengthening cross-border trading, such as the Wealth Management Connect program in the Greater Bay Area. In addition, several foreign financial institutes were granted permission to set up wholly-owned foreign entities in China in 2021, signaling a more open financial market for foreign companies.
Opening will take time, however. The Chinese government is wary of the impact that fast and uncontrolled opening will have upon the economy and wants foreign capital to help serve its economic goals, rather than the other way round. Foreign capital should help develop the sectors of the economy deemed the most important and should be kept away from ‘sensitive’ industries that are linked to national security.
The stock connect programs are a major channel for foreign investors to participate in China’s capital markets, and it is likely this is one of the areas that will continue to expand and open in the coming years, either through expanding the number of stock exchanges that are participating or relaxing rules to facilitate stock listings on the different exchanges.
Investors interested in trading in Chinese stocks on both Chinese and overseas stock exchanges are advised to closely monitor the latest policy updates and regulations for news on investment channels and rules, in particular those issued by relevant regulatory authorities, such as the CSRC and State Administration of Foreign Exchange (SAFE) in China, the Securities and Exchange Commission (SEC) in the U.S., the FCA in the U.K, and the European Securities and Markets Authority (ESMA) in the European Union.
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