Steady as she goes China's new Securities Law

SCOPE OF SECURITIES

Whilst the Old and New Securities Laws both fail to give an accurate definition of what constitutes securities, Article 2 of the latter does appear to expand the applicability of respective regulations. The New Securities Law applies not only to stocks and corporate bonds but also to government bonds, securities investment fund units and securities-related derivatives. Applicability of the New Securities Law to any new eligible categories of securities is still subject to separate identification by the State Council.

Unfortunately, the issues in connection with identities of securities issuers that have long been discussed in the past are still left open to further disputes. It is still unclear whether a foreign entity is allowed to offer, publicly or privately, securities in the PRC under the New Securities Law. It appears that there is no breakthrough in this regard and, therefore, a foreign entity may not offer securities within the PRC unless and until expressly permitted by applicable laws or regulations or specific approvals granted by relevant PRC authorities. For example, on February 18 2005 the People's Bank of China, the Ministry of Finance, the National Development and Reform Commission and the China Securities Regulatory Commission (CSRC) jointly issued the Interim Measures for the Administration of the Issuance of Renminbi-denominated Bonds by International Development Institutions ('RMB Bond Measures'), which allow the issuance of renminbi bonds ('Panda Bonds') by international development institutions, such as the International Finance Corporation (IFC) or Asia Development Bank (ADB). However, the RMB Bond Measures do not apply to other foreign entities.

DERIVATIVES RELATED TO SECURITIES

The Old Securities Law only permits spot trading of securities, while Article 42 of the New Securities Law provides that securities may be traded on a spot basis or by other means as stipulated by the State Council. This implies that the State Council may formulate rules for trading securities on a forward basis. In addition, under paragraph 3 of Article 2 of the New Securities Law, the State Council may formulate administrative measures on issuance and trading of securities derivatives products. All of these changes have paved the way for securities-related derivatives transactions.

In fact, on July 18 2005, both the Shanghai and Shenzhen stock exchanges respectively issued Interim Measures on the Administration of Warrants where 'warrants' are defined as the rights to which a holder may exercise within a specified period to buy from or sell to an issuer (which may be the securities issuer or a third party) securities, or to receive the settlement balance of securities in cash.

In August 2004, the CSRC issued the Circular of Relevant Issues regarding Enhancing Innovative Activities in the Securities Sector, which authorized the Securities Association of China (SAC) to set criteria for evaluating and confirming the qualifications required for eligible securities companies to develop innovative securities-related products on a pilot basis. Innovative securities-related products and investment plans can be launched into the market upon verification of the SAC.

PUBLIC OFFERING

'Public offering' is not defined in the Old Securities Law. Article 10 of the New Securities Law provides that any of the following will constitute a public offering:

· Issuing securities to unidentified offerees;

· Issuing securities to more than 200 (accumulatively) identified persons; or

· Carrying out any other issuance activities as stipulated by laws or administrative regulations.

However, the New Securities Law does not make clear what constitutes unidentified or identified offerees and how long the 200 identified persons will be calculated on an accumulative basis. It may leave room to the State Council or CSRC to formulate specific implementing rules.

For non-public offering activities, the New Securities Law provides that they may not be made through advertisements, public invitation or other alternatives of public nature. We note that pursuant to Article 78 of the amended PRC Company Law (中华人民共和国公司法), also approved by the Standing Committee of the NPC on October 27 2005, a company limited by shares can be established through private placement of shares to targeted persons. This may be interpreted as one form of non-public offering. Presumably, establishment of a company limited by shares by way of private placement or other non-public offering activities are required to follow the requirement under Article 10 of the New Securities Law.

OVER THE COUNTER TRADED SECURITIES

Pursuant to the Old Securities Law, securities must be offered and traded on legally established stock exchanges. The New Securities Law has amended these provisions to the effect that publicly issued securities may be traded on legally established stock exchanges and in such other places as stipulated by the State Council. This amendment implies the possibility that securities can be traded on an over the counter (OTC) basis, which will meet the needs of the market.

STOCK LENDING

Stock or cash lending is prohibited under the Old Securities Law. Pursuant to Article 142 of the New Securities Law, with approval of the CSRC, securities companies can provide stock/cash lending services to their clients in accordance with the relevant regulations of the State Council. It is worth noting that Article 142 only allows securities companies to provide stock/cash lending services to their clients and does not apply to commercial banks.

While the New Securities Law reiterates the current regulatory regime whereby different financial sectors are separately regulated, it does leave room for mixed operation or multi-sectored operation in the future by adding an exception in Article 6 of the New Securities Law: "unless otherwise stipulated by the state".

While currently lending businesses are generally regulated by the China Banking Regulatory Commission (CBRC), the New Securities Law does not require securities companies intending to provide financing to their clients to obtain approval from the CBRC. It will be interesting to see how the State Council addresses this issue in the regulations it will enact in response to Article 142 of the New Securities Law; particularly taking account the open-ended provisions for conducting multi-sectored financial services prescribed in Article 6 of the New Securities Law. Equally, how the CBRC as the regulatory body of commercial banks will regulate flow of bank funds into stock trading is also influencing the market with Article 133 of the Old Securities Law prohibiting such movement.

Notwithstanding Article 142, PRC domestic companies that issue shares in foreign currencies within the PRC ('B shares') are subject to special regulations of the State Council pursuant to Article 239 of the New Securities Law. It is unclear whether stock/cash lending is also applicable to B shares.

Presumably Article 142 only applies to domestic transactions and not cross-border transactions. However, since foreign entities may trade A shares and other listed securities through the regime of qualified foreign institutional investors ('QFIIs'), it is unclear how Article 142 will apply to QFIIs in the future.

BETTER PROTECTION OF INVESTORS

The New Securities Law provides that the state will set up a Securities Investor Protection Fund, the source, management and use of which will be subject to respective implementing rules to be promulgated by the State Council. Interestingly, one month before the promulgation of the New Securities Law, the CSRC, the Ministry of Finance and the People's Bank of China issued the Measures for the Administration of the Securities Investor Protection Fund ('Protection Fund Measures'). The Protection Fund Measures provide that the PRC Securities Investor Protection Fund will be set up to be in charge of the protection fund. The protection fund will be primarily used to compensate creditors of securities companies that are cancelled, closed down, or subject to insolvency liquidation, etc.

To better protect the interests of investors, the New Securities Law strengthens the liabilities of directors, senior management personnel and supervisors of listed companies. The directors and senior management personnel are required under the New Securities Law to put their opinions in the periodic reports of the company they serve for.

The New Securities Law also follows the trend of legislation in the securities area by placing border liability and more restrictions on sponsors and investment consultation entities. A good example in this regard is that an investment consultation entity or its employees will be held liable under the New Securities Law if they make up or disseminate any false or misleading information through broadcasting or other media. The PRC people's courts for a long time have had to turn to general legal principles and judicial interpretations issued from time to time by the PRC Supreme People's Court when deciding cases involving the dissemination of false or misleading information. Such situations will change significantly in light of the promulgation of the New Securities Law.

CONCLUSION

In general, certain liberalization reforms have been adopted in the New Securities Law with a view to further developing China's capital markets. Implementation of most of these reforms, however, is left to the direction of the State Council to promulgate specific regulations.