On June 29, 2018, the China Securities Regulatory Commission (“CSRC”) promulgated the Interim Provisions on Securities and Fund Operation Institutions’ Engagement of Hong Kong Domiciled Institutions to Provide Securities Investment Advisory Services (the “Interim Provisions”), which were subsequently implemented from July 1, 2018.
The Interim Provisions aim to allow those domestic securities companies and fund managers that carry out public securities investment fund businesses (collectively “Domestic Securities and Fund Operation Institutions”) to engage Hong Kong domiciled institutions (“Hong Kong Institutions”) to provide securities investment advisory services for southbound trading of the Stock Connect (“Southbound Trading”). The Interim Provisions allow licensed Hong Kong Institutions to indirectly provide securities investment advisory services to domestic investors, marking a significant step in the improvement of China’s cross-border asset management regulations.
Below is a summary of the Interim Provisions.
I.Scope of Application
The Interim Provisions only apply to those stocks listed on the Hong Kong Stock Exchange and traded through the Southbound Trading (“Southbound Stocks”). For any securities other than the Southbound Stocks, the Interim Provisions expressly prohibit Hong Kong Institutions from providing research reports with investment analysis advice such as the valuation of securities or investment ratings to domestic securities companies, unless such advice is required in order to conduct comparable industry analysis for any Southbound Stock or otherwise stipulated by the CSRC.
One of the key differences when compared with the earlier Consultation Paper on the Interim Provisions is that the final version includes a new paragraph stipulating that a Domestic Securities and Fund Operation Institution that engages an overseas institution to provide investment advisory services for the underlying securities of Chinese depository receipts shall be regulated by reference to the Interim Provisions.
II.Legal basis
The higher-level laws and regulations of the Interim Provisions are listed to include the Securities Law, the Securities Investment Fund Law, the Interim Measures on Administration of Securities and Futures Investment Consultancy and Certain Provisions on Stock Connect between Mainland China and Hong Kong Stock Markets and other provisions of the CSRC.
III.Type of Business
The Interim Provisions list two business categories:
“Southbound Stock Research Report Business” refers to a Hong Kong Institution that authorizes a domestic securities company or its subsidiary to distribute any Southbound Stock research report it has issued;
“Southbound Stock Investment Advisory Business” refers to a Domestic Securities and Fund Operation Institution that entrusts a Hong Kong Institution to provide investment recommendations to securities investment funds under its management that invest in Southbound Stocks (which can be either public funds or private products under its management).
IV.Qualification Requirements and Filing
The Interim Provisions provide details of the qualification requirements for relevant institutions:
(i)Domestic securities companies that are qualified to issue securities research reports may forward Southbound Stock research reports to their clients. There is an exclusion on those domestic securities companies that have received any administrative punishment for illegally issuing securities research report or material administrative regulatory measures in the preceding three years.
(ii)Hong Kong Institutions that have been granted a securities advisory license by the Securities and Futures Commission of Hong Kong (“SFC”) and have experience in the business of issuing securities research reports are qualified to provide Southbound Stock research reports.
(iii)Hong Kong Institutions that have been granted a securities advisory license by the SFC and have experience in asset management business are qualified to engage in Southbound Stock Investment Advisory Business.
The Interim Provisions draw a distinction between the circumstances in which only filing is required compared with those in which, in addition to the filing, a special report needs to be filed with and an assessment be conducted by the CSRC’s local office. By imposing further regulatory burden on reporting for those institutions that fail to meet certain criteria, the Interim Provisions actually limit the extent of Hong Kong Institutions that are potentially qualified.
Pursuant to the Interim Provisions, a Domestic Securities and Fund Operation Institution would only need to file with the CSRC’s local office if the Hong Kong Institution selected by the Domestic Securities and Fund Operation Institution falls into at least one of the following circumstances:
(i)The Hong Kong Institution controls or is controlled by the Domestic Securities and Fund Operation Institution, or is under the control of the same financial institution as the Domestic Securities and Fund Operation Institution;
(ii)The Hong Kong Institution has engaged in providing securities research reports for more than three years and has more than twenty licensed representatives approved by the SFC to advise on securities; or
(iii)The Hong Kong Institution has engaged in the asset management business for more than five years and the securities assets under its management in the most recent fiscal year is no less than HKD 10 billion or equivalent.
If a Hong Kong Institution does not fall into any of the aforementioned three circumstances, the Domestic Securities and Fund Operation Institution selecting the Hong Kong Institution is required to submit a special report that provides the reasons for choosing such Hong Kong Institution to the CSRC’s local office in which it is domiciled or operates. The CSRC local office will make the decision about whether to raise an objection by carefully assessing the risks and, within one month of the execution of a relevant agreement, CSRC officials will conduct an onsite inspection to observe how the Domestic Securities and Fund Operation Institution uses the investment advisory services provided by the Hong Kong Institution.
V.Obligations of Both Parties Involved in the Southbound Stock Research Report Business
The Interim Provisions impose regulatory obligations on both parties. A domestic securities company, being the licensee, shall establish a review mechanism and shall comply with the relevant regulatory requirements for forwarding research reports on Southbound Stocks; a Hong Kong Institution, being the licensor, shall ensure that its activities are in compliance with the rules of the SFC. Meanwhile, a domestic securities company is obliged to inform the Hong Kong Institutions with relevant rules regarding the release of research reports in Mainland China, while a Hong Kong Institution shall make sure that the information sources, research methods, and results of analysis of its research reports on Southbound Stocks are in compliance with such rules.
The Interim Provisions also explicitly require domestic securities companies to comply with any relevant rules on the release of research reports in Mainland China in aspects including, among others, treating the recipients of the research reports fairly, preventing conflicts of interest, information disclosure, managing crossing the firewall, the arrangements for the “quiet period” and record-keeping. A Hong Kong Institution shall only be responsible to the domestic securities companies for the contents of its research reports on Southbound Stocks and the release of such reports, while a domestic securities company shall bear direct responsibilities to its clients.
Moreover, where the Interim Measures allow a representative of a Hong Kong Institution licensed to provide advice on securities to communicate with the client of a domestic securities company on the contents of the research reports on Southbound Stocks by means of conference calls or in other indirect ways, such securities company shall ensure the means and content of the communication are in compliance with the relevant rules of Mainland China and maintain appropriate records of the communication. Unless falling within any of the aforementioned permissible situations, the Interim Provisions prohibit licensed representatives of Hong Kong Institutions from communicating with the clients of domestic securities companies on the contents of any Southbound Stock research reports.
VI.Obligations of Both Parties Involved in the Southbound Stock Investment Advisory Business
The Interim Provisions require Hong Kong Institutions to comply with the relevant regulations of both Mainland China and Hong Kong, and to file basic information in accordance with the rules of the Asset Management Association of China. The Interim Provisions provide the clarification that Hong Kong Institutions shall not directly execute investment orders since these would fall outside the scope of Southbound Stock Investment Advisory Business that is permitted to undertake. Moreover, Hong Kong Institutions are required to cooperate with any regulatory requirements of CSRC and its local offices and to provide business related materials and information as requested.
VII.Record-keeping
The Interim Provisions require Domestic Securities and Fund Operation Institutions to keep files of the relevant business for at least five years following the termination of any relevant agreements.
VIII.Cross-border Regulatory Cooperation
The Interim Measures stipulate that in the case of any violation by a Hong Kong Institution or responsible person, the CSRC and the SFC may conduct investigations and enforce laws through the cross-border regulatory cooperation mechanism.