2023.09.12 XIE, Qing (Natasha)、ZHANG, Chi (Austin)、LUO, Danchen
On September 1, 2023, the China Securities Regulatory Commission (“CSRC”) announced program trading reporting rules for stock market1. This followed the release on the same day of circulars by each of the three stock exchanges, i.e., the SSE, SZSE, BSE. According to the CSRC’s press release, the program trading reporting mechanisms and corresponding regulatory arrangements aim to facilitate the transparency of existing program trading activity and manage expectations regarding the supervision and regulation of program trading. This is a timely response to market concerns and certain doubts in the accountability of domestic quantitative traders to recent market volatility. These reporting mechanisms and regulatory arrangements seem having been brewing for years, though having not solicited public comments. The circulars released by the SSE, SZSE and BSE respectively (collectively, the "Circulars") provide time for existing program traders to perform their reporting obligations and reflect CSRC’s prudent and neutral attitude towards program trading. We believe this is a result of years of extensive study and research of the CSRC and is conducive to the long-term stability and healthy development of the market.
We have summarized the main contents of the Circulars below.
What is the background to the stock program trading reporting mechanisms and regulatory arrangements and some of the principles?
Article 45 of the Securities Law stipulates that program trading conducted through automatic generation or delivery of trade orders by computer programming shall comply with the rules prescribed by the securities regulatory authority of the State Council, be reported to the securities exchanges and shall not impact the security of the trading systems or the normal trading order of the securities exchanges. The Circulars aim to implement the provision outlined in the Securities Law in terms of program trading reporting.
In practice, program trading behaviors are monitored by the relevant exchange on a real-time basis. All three exchanges have established abnormal stock trading monitoring mechanisms covering all types of trading activities, including program trading; in addition, the SSE and the SZSE have implemented program trading reporting mechanisms for convertible bonds. In this sense, program trading reporting for stocks is going to come out just at CSRC’s call.
While outlining the reporting obligations of program traders, the CSRC also emphasizes the front line supervisory and regulatory duties of the exchanges as well as the client management responsibility of securities brokers. Exchanges are authorized to impose differentiated management requirements on high-frequency trading when exercising their supervisory and regulatory duties, including adjusting the criteria for determining abnormal trading and enlarging the content to be reported. The above-mentioned guiding principles for supervision and regulation of program trading remain unchanged.
What is program trading? What type of investors are program traders?
The Circulars elaborate on the definition of program trading as provided by the Securities Law. Program trading refers to the act of trading stocks on an exchange through automatic generation or delivery of trade orders by computer programming. This includes quantitative trading that follows pre-set strategies and automatically selects specific stocks and timings for trading, or algorithmic trading that follows pre-set algorithms and automatically executes trade orders, or any other acts with the characteristics of program trading.
According to the Circulars, program trading investors (the “Program Traders”) are broadly defined to cover all types of investor engaged in program trading, including (1) clients of securities brokers; (2) securities brokers engaged in business such as proprietary trading, market-making, or asset management; (3) fund management companies, insurance institutions, and other institutions that use the trading units of the relevant exchange; and (3) other program trading investors recognized by the relevant exchange. Theoretically speaking, an investor engaged in program trading via swap or similar arrangements may be deemed as a de facto program trader by the relevant exchange, if it can be looked through and identified by the relevant exchange based on the substance.
By a literal reading, any investor that engages in program trading would be in-scope of program traders, including Qualified Foreign Institutional Investors (“QFIs”) and Northbound Stock Connect investors. The Circulars state that detailed reporting requirements for program trading through Stock Connect will be separately formulated. We speculate that such specific program trading reporting rules for Stock Connect would largely refer to current provisions in the Circulars, so as to ensure the fair treatment of all program traders in the A share market. We also expect that the CSRC will announce specific program trading reporting rules for Stock Connect at the right moment.
What securities fall under the program trading reporting rules? What triggers program trading reporting obligations on program traders and are there are any exemptions?
Program trading reporting rules apply to stock trading on the three exchanges. It shall also apply to funds trading and depository receipts trading on the SSE and SZSE. Regarding convertible bonds, the Circular on Matters Concerning the Reporting of Program Trading of Convertible Bonds, issued by the SSE and SZSE respectively in 2021, still applies.
The Circulars provide that investors meeting any one of the following criteria shall perform reporting obligations: (1) Highly automated order placement, i.e., the core elements of trade orders, such as securities codes, trade direction, trade quantity, and trade price, as well as the time of order placement, are automatically generated by computer; (2) High order placement/cancelation frequency, i.e., there are more than ten trade orders placed (or cancelled) within one second, which occurs more than ten times in one day; (3) Trade a large number of stocks with a high turnover rate, i.e., over the last 30 trading days, there has been an average daily trading of no less than 50 stocks per exchange, and the annualized turnover rate2 over the last 30 trading days is no less than 30 times; (4) Use self-developed or other customized software; (5) Other circumstances that need to be reported as determined by the relevant exchange.
The Circulars provide exemptions to program trading reporting obligations. Program traders engage in trading by using securities brokers’ software with certain automatic functions and do not trigger any of the above-mentioned criteria need not report.
We recommend that program traders carefully check whether they fall into any of the circumstances that trigger reporting obligations.
What basic information needs to be reported? Are there any detailed reporting requirements or reporting templates?
Program traders shall report the following basic information if they trigger reporting obligations: (1) the basic information of the account, including the investor’s name, securities account code, entrusted securities brokers, and product management institution; (2) the fund information of the account, including the scale and source of the funds in the account, and the scale and source of the leveraged funds and the leverage ratio; (3) the trading information, including the type and main content of the trading strategy, trade execution method, the maximum order placement/cancellation frequency, and the maximum number of daily order placements/cancellations; (4) information regarding trading software, including the name, version number, and the developer of the software; (5) other information, including the contact person and contact information of the securities broker and investor; and (6) other information stipulated by the relevant exchange.
We believe that the afore-mentioned reporting requirements will be imposed on a single account. For example, if multiple accounts are opened with a broker under a QFI, such as proprietary trading accounts and managed accounts, the QFI shall report the information regarding each account separately. Likewise, managers who manage multiple products shall report information for each product separately. Program traders are advised to ensure the authenticity, accuracy and completeness of the reported information so as to avoid being investigated for liabilities due to false information.
Program traders shall report any material change to the reported information within the first five trading days of the next calendar month, following the occurrence of the change. The following changes shall be deemed as “material” and shall be reported: (1) the fund scale of the account has increased by five times or more, and the increased amount exceeds 10 million yuan3; (2) the source of the leveraged funds has changed; (3) the scale of the leveraged funds has changed by more than one time, and the changed amount exceeds 5 million yuan4; (4) the contact person of the securities broker or the persons-in-charge of the investor has changed; (5) the maximum order placement/cancellation frequency or the maximum number of daily order placements/cancellations has changed; (6) the type of primary trading strategies has changed; (7) the information regarding the program trading software has changed5; and (8) the account will no longer engage in program trading. Notably, if fund management companies or their subsidiaries, securities brokers engaged in asset management business, or QFIs execute trade orders automatically by using pre-set order splitting algorithms for the purpose of reducing the market impact of large orders or ensuring the trade fairness of different investment portfolios, then in the event of any material change in the fund scale of the account, the source of the leveraged funds, or the scale of the leveraged funds that have been reported by them, the reporting period is extended, i.e., they are required to report such material changes within the first five trading days of the next quarter following the occurrence of the change.
The exchanges have released reporting templates to the market, i.e., the Program Trading Reporting Form (the “Reporting Form”). According to the Reporting Form as well as the detailed reporting requirements, the “source of funds” is categorized into "self-owned funds", "raised funds", "leveraged funds", or "others". Program traders must select one or more of the foregoing options for the “source of funds” and specify the source of funds if they select "other". Of note, "leveraged funds" shall refer to the financing obtained through margin financing and securities lending, or OTC derivatives trading with securities brokers (such as swaps). With respect to the “trading information”, quantitative traders shall report the main strategy type, auxiliary strategy type and the contents of the strategies, while program traders not engaging in quantitative trading only need to report the trade execution methods, without the need to report quantitative strategies. In addition, program traders shall also report the futures account name and code if hedging in the futures (options) market. With respect to the “maximum order placement/cancellation frequency” and the “maximum number of daily order placements/cancellations”, program traders shall comprehensively determine the “maximum order placement/cancellation frequency” and “maximum number of daily order placements/cancellations” that they expect to reach according to their strategies and systems, and select the given options for the range of the “maximum order placement/cancellation frequency” and “maximum number of daily order placements/cancellations”. It should be noted that, additional reporting requirements are triggered if program traders select “≥500/second” or “300/second(inclusive)~500/second(exclusive)” for the “maximum order placement/cancellation frequency”, or if program traders select “≥25,000 orders” or “20,000 orders (inclusive)~ 25,000 orders (exclusive)” for the “maximum number of daily order placements/cancellations”, in this case, program traders are required to report the server location of the program trading system and submit the system testing reports and system contingency plans, and shall file any changes to the reported information/documents.
What triggers additional reporting obligations for program traders? What program trading behavior will be closely monitored by the exchange during the real-time monitoring process? Should an investor’s trading behavior reaches the monitoring thresholds, can the relevant exchange adjust the criteria for determining abnormal trading behavior and the threshold for additional reporting obligations against such investor?
If a program trader’s reported maximum order placement/cancellation frequency is 300 orders per second or higher, or the reported maximum number of daily order placements/cancellations is 20,000 or more, even though such program trader’s actual trading activities do not reach its reported thresholds, the relevant exchange will pay special attention on the program trader’s trading behavior and require the program trader to report additional information as follows: (1) the server location of the program trading system; (2) testing reports of the program trading system; (3) contingency plans for a program trading system failure; and (4) other information stipulated by the relevant exchange. That means, such additional disclosure obligations will be triggered at the time of reporting. The exchange may, based on self-disciplinary management needs, adjust the afore-mentioned thresholds and the contents of the additional reports.
With respect to the real-time monitoring of program trading behavior, the following trading behavior will be closely monitored by the relevant exchange: (1) Abnormal trading behavior that may affect the securities trading price, volume or security of the exchange's trading system, as stipulated in the business rules of the relevant exchange; (2) Trading behavior with the maximum order placement/cancellation frequency reaching 300 orders per second or higher, or the maximum number of daily order placements/cancellation reaching 20,000 or more; (3) Multiple securities’ trading prices or volumes are significantly abnormal, and program trading is largely involved during this period; and (4) Other activities as identified by the relevant exchange that need to be closely monitored. When conducting real-time monitoring, the relevant exchange will not only consider whether the trading behavior triggers the above-mentioned thresholds (i.e., the maximum order placement/cancellation frequency reaches 300 orders per second or higher, or the maximum number of daily order placements/cancellations reaches 20,000 or more), but also consider the impact of program trading on the trading prices and volumes.
In addition, in the event that certain program trader’s trading activities actually reach the above-mentioned thresholds (i.e., the maximum order placement/cancellation frequency reaches 300 orders per second or higher, or the maximum number of daily order placements/cancellations reaches 20,000 or more), the possibility cannot be excluded that the relevant exchange may, depending on the situation, adjust the criteria for determining abnormal trading behavior and/or impose additional reporting requirements on such program trader.
Though the above-mentioned provisions on real-time monitoring of program trading overlap slightly with the current abnormal trading monitoring rules of the relevant exchange, they will be applied in parallel. Exchanges may adjust the criteria for abnormal transactions specifically for certain program traders, determine certain trading behaviors as being abnormal, and take self-disciplinary measures against certain program traders in accordance with both the Circulars and the current abnormal trading monitoring rules. The Circulars reflect exchanges’ greater discretion over high frequency program traders, i.e., exchanges may impose more restrictions on their trading activities and require them to undertake obligations of prudent trading according to market conditions.
What management responsibility shall securities brokers assume?
The Circulars impose management responsibilities on securities brokers, such as requiring them to identify, manage and report a client’s suspected abnormal trading activities in a timely manner, and to report to the relevant exchange in a timely manner if they become aware of any suspected illegal act or violation, or any program trading that may affect the security of the trading system or the normal trading order, in which case securities brokers may also take measures such as refusing to accept a client’s program trading orders and/or canceling the relevant orders.
With respect to the reporting of program trading, securities brokers are required to (1) formulate internal management rules and procedures for their own program trading; (2) enter into a supplementary agreement with the client engaged in program trading, clarify the rights and obligations relating to program trading, specify that the client shall perform reporting obligations in a truthful, accurate, complete and timely manner, and specifying that a client's program trading orders may be refused in accordance with the agreement if the client refuses to perform or fail to perform the reporting obligations as required; (3) fully verify the information reported by clients, and urge clients to perform the reporting obligations if the reported information is found to be false; (4) establish a monitoring and controlling mechanism for program trading, timely identify clients who trigger reporting requirements and urge such clients to perform the reporting obligations; (5) refuse to accept a client's program trading orders in accordance with the agreement entered with the client and report to the relevant exchanges if the client still fails to report as required after being urged; and (6) timely contact clients to explain the situation and conduct verification and analysis if their program trading activity or trading volume is found to be obviously abnormal.
What is the level of legal force of the Circulars? What are the legal consequences of breaching these Circulars? What measures can exchanges take?
The Circulars are self-disciplinary rules of exchanges. Breaching these Circulars may lead to the exchanges taking self-disciplinary measures against the program traders in accordance with the exchanges’ relevant trading and business rules. However, the fact that exchanges have taken self-disciplinary measures does not exclude relevant program traders’ administrative liabilities or even criminal liabilities for the same behavior in accordance with the Securities Law.
According to the Circulars, the relevant exchange will conduct data screening on a regular basis and check the consistency of program traders’ trading activity with the information they have reported, such as trading strategies, size and frequency. For any incompleteness of the reported information, inconsistency between the reported information and trading activities, or failure to report information as required, the relevant exchange will first urge and remind the program traders to make rectification and may then take self-disciplinary measures depending on the situation. The relevant exchange will focus supervision and inspection on frequent inconsistencies between the reported information and the trading activity.
Based on their self-disciplinary management needs, exchanges may conduct on-site and off-site inspections of securities brokers and/or program traders to monitor whether their activities follow these Circulars. The relevant securities brokers and program traders shall cooperate and provide required materials in a truthful, accurate, complete and timely manner.
Is there a grace period?
The Circulars are going to take effect on October 9, 2023. Existing program traders, who have engaged in program trading prior to the implementation of the Circulars and intend to continue program trading thereafter, will have time to prepare for reporting, i.e., they are required to complete reporting within 60 trading days after the implementation of the Circulars (i.e., the deadline should be immediately after the New Year holidays in 2024).
Investors who engage in program trading for the first time shall report to the securities brokers they entrust and shall not be permitted to undertake program trading until the securities brokers have fully verified and confirmed the accuracy of the information they reported. Securities brokers shall timely confirm the program trading information reported by their clients and report to the relevant exchange within five trading days, and the exchange will give confirmation only after accepting the reports from securities brokers. By contrast, securities brokers or other institutions that directly use the trading units of the relevant exchange are required to directly report to the exchange before they engage in program trading for the first time and shall only undertake program trading upon confirmation of the exchange.
Although securities brokers are obligated to verify and confirm the program trading reports submitted by clients and clients may carry out program trading upon such verification and confirmation, clients shall still assume and fully discharge their reporting obligations. That being said, clients will not be exempted or relieved from the responsibility for the authenticity, accuracy and completeness of any information they report. Nevertheless, if a QFI client and its securities broker have agreed in their brokerage agreement that the securities broker may, at its sole discretion, choose to automatically generate or place trade orders through computer programs, the securities broker may assume the program trading reporting obligations on behalf of the QFI client.
As an important disclaimer, the Circulars highlight that the exchanges’ receipt, comparison and management of the information reported by program traders does not represent the relevant exchanges’ judgment or guarantee of the compliance, appropriateness and availability of the program traders or their program trading strategies, trade execution methods or relevant systems.
