Client Briefing: CSRC Finetunes Regulations on Shareholders’ Reductions in Holdings of A-Share Listed Companies

To implement the policies proposed in the “State Council’s 9-Point Guidelines on China’s Capital Market”, on May 24, 2024, the China Securities Regulatory Commission (“CSRC”) issued the Interim Measures for the Administration of Shareholders’ Reductions in Holdings of Listed Companies (the “Measures”). The Measures maintain the framework and core content of the previous Certain Provisions on the Reduction of Holdings by Shareholders, Directors, Supervisors and Senior Executives of Listed Companies (the “Provisions”) issued by the CSRC in 2017, enhance the effectiveness of the Provisions and make various adjustments and improvements. The CSRC also transferred the provisions in the previous Provisions regarding shareholding reductions by directors, supervisors and senior executives of listed companies to the revised Provisions for the Management of Holding Shares and Shareholding Changes by Directors, Supervisors and Senior Executives of Listed Companies (the “Shareholding Change Provisions”), thereby abolishing the previous Provisions. A “1+2” share reduction regime has been formed, which centers on the Measures and is supplemented by the Shareholding Change Provisions (which regulate the reduction of shares by the directors, supervisors and senior executives of listed companies) and the Special Provisions on the Reduction of Shares by Venture Capital Funds of Listed Companies (which was released by the CSRC in 2020 to regulate the reduction of shares by venture capital funds). The Shanghai Stock Exchange and the Shenzhen Stock Exchange (collectively, the “Exchanges”) issued supporting guidelines (collectively, the “Exchange Guidelines") on the same day by incorporating and improving the existing self-disciplinary rules, circulars, and regulatory Q&As.

Below we highlight some of the new reduction rules:

1. Regulates Large Shareholders' Reductions

(1) Expands the definition of large shareholders: Under the new reduction rules, “large shareholders” are (i) shareholders who hold 5% or more of the shares of a listed company and (ii) de facto controllers of a listed company. Compared to the previous Provisions, the scope of large shareholders has been expanded to include de facto controllers, thus strengthening the regulation and constraints on de factor controllers’ reduction behaviors. To determine a 5% holding, Article 22 of the Measures requires the combination of the shares in an ordinary securities account and margin securities account, regardless of whether those are (i) held by the shareholder through other accounts, (ii) lent out through securities refinancing but not yet been returned, or (iii) sold through securities repurchase agreements but not yet bought back. Article 20 of the Measures further requires concert actors of large shareholders to abide by the same reduction regulations applicable to large shareholders.

(2) Improves the application scope of the reduction rules: Article 2 of the previous Provisions stipulated that these provisions do not apply to the reduction by large shareholders of the shares they bought through centralized bidding on the Exchange. Instead, the Measures differentiated the application of its provisions, depending on the different ways in which large shareholders obtain shares. That is, for large shareholders' reduction of shares they bought through centralized bidding on the Exchange and the shares they obtained through participation in public offerings (including initial public offerings (“IPOs”) and public offerings by a listed company to specific or non-specific targets), they must comply with the general provisions of Articles 4 to 8, 18, and 28 to 30 of the Measures. However, for the reduction by large shareholders of the shares they obtained through participation in public offerings, Articles 10 and 11 of the Measures will also apply, which set forth the reduction restrictions when the share price falls below the IPO price¹, or falls below the net asset value per share², or the listed company fails to meet dividend standards³.

(3) Clarifies when large shareholders are prohibited from reductions: Article 7 of the Measures clarifies when large shareholders are prohibited from reducing their holdings to those where they themselves have committed illegal or non-compliant acts, including: (1) the shareholder is under investigation by the CSRC or is being investigated by the judicial authorities for suspected securities and futures-related violations or crimes concerning the listed company, or it has been less than six months since administrative or criminal penalties have been imposed for securities and futures-related violations or crimes concerning the listed company; (2) it has been less than three months since the shareholder has been publicly censured by the Exchange for violations or illegal acts concerning the listed company; (3) the shareholder has been given an administrative penalty by the CSRC for securities and futures-related violations, but it has not yet fully paid the fines or fully returned the illegal gains, except as otherwise provided by laws and regulations or if the proceeds of the share reductions should be used to pay the fines or return the illegal gains; (4) other circumstances specified by the CSRC.

(4) Strengthens the information disclosure requirements for large shareholders: Article 8 of the previous Provisions required large shareholders to disclose in advance plans to reduce its holdings through centralized bidding. Article 9 of the Measures requires that the pre-disclosure obligation should also apply to reductions through block trading by large shareholders; that is, large shareholders shall report to the Exchange and disclose their reduction plans 15 trading days before the first sale of shares through block trades. The Exchange Guidelines shortens the reduction period from six months to three months and requires large shareholders to state in the reduction plan that the circumstances do not exist whereby reductions are prohibited as stipulated in the Measures and the Exchange Guidelines. The Measures and the Exchange Guidelines no longer require disclosure when half of the reduction period has passed or half of the quantity has been reduced, and only requires large shareholders to disclose the situation within two trading days after the completion of the reduction plan or the expiration of the disclosed reduction period.

2. Clarifies the Reduction Requirements for Controlling Shareholders and De Facto Controllers

The Measures has rules specifically for the reduction of shares by controlling shareholders and de facto controllers, aiming to strengthen the responsibility of the “key minority” of listed companies. According to Article 8 of the Measures, the controlling shareholders and de facto controllers shall not reduce the shares if the listed company falls under one of the following illegal or non-compliant situations: (1) The listed company is under investigation by the CSRC or is being investigated by the judicial authorities for suspected securities and futures-related violations or crimes, or it has been less than six months since administrative penalties or criminal penalties for securities and futures-related violations or crimes have been imposed; (2) it has been less than three months since the listed company has been publicly censured by the Exchange; (3) the listed company may be delisting due to major violations and the shares are restricted by the Exchange from selling; and (4) any other circumstances specified by the CSRC. Compared to the previous Provisions with respect to the situation in (1) above, the scope of shareholders prohibited from reducing shares has been adjusted to only include controlling shareholders, de facto controllers and their concert actors, and does not include general large shareholders.

Articles 10 and 11 of the Measures incorporate the reduction restriction provisions for controlling shareholders and de facto controllers as provided in the CSRC’s Further Regulation of Share Reductions issued in August 2023 and the Circular on Matters Concerning Further Regulating Share Reductions issued by the Exchanges in September 2023. The controlling shareholders and the de facto controllers should not reduce their shares through centralized bidding or block trading when the share price falls below the IPO price, or falls below the net asset value per share, or the listed company fails to meet dividend standards (the above reduction restrictions triggered by “the share price falls below the IPO price” only apply to controlling shareholders, de facto controllers, and their concert actors at the time of the IPO). To encourage controlling shareholders and de facto controllers to increase their holdings in the secondary market, the above reduction restrictions do not apply to the reduction of shares acquired through centralized bidding, or the reduction of shares for which a reduction plan has already been disclosed in the absence of any relevant circumstances.

Article 20 of the Measures is consistent with the requirements for large shareholders and requires concert actors of controlling shareholders and de facto controllers to abide by the same reduction regulations applicable to the controlling shareholders and de facto controllers.

3. Clarifies the Reduction Requirements for Specific Shareholders

A “specific shareholder” is defined in the original Provisions to include not only shareholders holding pre-IPO shares, but also those holding private placement shares of a listed company. The reduction of holdings by specific shareholders must comply with the provisions in the original Provisions regarding the reduction quota, reduction proportion, and the holding period. Article 88 of the Administrative Measures for the Registration of Securities Issuance by Listed Companies, which was issued in 2023, clarifies that previous Provisions should not apply to the reduction of private placement shares of listed companies. The Measures retain this exemption and its definition in Article 2 of a "specific shareholder" only includes shareholders holding pre-IPO shares and excludes its application to the reduction of listed companies' private placement shares. The Exchanges previously stipulated that the shares issued by listed companies through private placement for asset acquisition and supporting financing in accordance with the Administrative Measures for the Major Asset Restructuring of Listed Companies are considered "private placement shares" under the Exchange’s Detailed Implementation Rules of the Shanghai Stock Exchange for the Reduction of Shares by Shareholders, Directors, Supervisors and Senior Executives of Listed Companies ( the "Implementation Rules"). Therefore the reduction of such shares shall be subject to the reduction rules for private placement shares in the Implementation Rules. Since the term “shareholders holding private placement shares of listed companies” in the definition of “specific shareholder” has been removed and the Implementation Rules have been abolished, we understand that the new reduction rules do not apply to the reduction of shares acquired through private placement for asset acquisition and supporting financing.

Pursuant to Articles 12-14 of the Measures and the provisions in the Exchange Guidelines, specific shareholders reducing their holdings of pre-IPO shares through centralized bidding, block trading, or transfer by agreements, shall comply with the different provisions on reduction quotas and reduction proportions applicable to the different reduction methods.

4. Strengthens the Supervision of Circumvention on Reduction Restrictions

According to the CSRC’s statement in the Opinions on Strengthening the Supervision of Listed Companies (Trial), the CSRC will enhance supervision according to the principle of “substance over form” and effectively guard against the circumvention of share reduction restrictions through changing identities, entering transactions, and using alternative schemes.

(1) Closely monitors suspected circumvention of the reduction restrictions through “changing identity”: Pursuant to Article 16 of the Measures and the Exchange Guidelines, except as otherwise provided by laws, regulations, and the CSRC’s requirements, if a large shareholder reduces its holdings due to divorce, the termination of a legal person or non-legal person organization, or company division, both the party transferring the shares and the party receiving the shares are required to disclose the matters in a timely manner prior to the share transfer. After the share transfer, in order to comply with the share reduction rules applicable to large shareholders (or controlling shareholders and de facto controllers, if the large shareholder is the controlling shareholder or de facto controller) they must take into account their aggregated shareholdings. If a large shareholder (or a controlling shareholder or de facto controller) terminates the relationship with their concert actors, Article 21 of the Measures and the Exchange Guidelines requires them to jointly comply with the applicable share reduction rules within six months of the termination.

(2) Prohibits circumvention of reduction restrictions or regulatory requirements by entering transactions: To prevent shareholders from evading the reduction restrictions through transferring shares by agreement, Article 13 of the Measures and Exchange Guidelines sets out a new provision that prohibits the transferee to a share transfer agreement reducing the shares it receives within six months of the transfer. If the transferor will no longer be a large shareholder as a result of the share transfer, the transferor shall continue to comply with the requirements of Article 9, Article 12, and Article 14 of the Measures regarding the pre-disclosure of the reduction, the reduction quota, and the reduction price within six months of the transfer. If the transferor will no longer be a controlling shareholder or de facto controller as a result of the share transfer, they shall still comply with the reduction restrictions if the share price falls below the net asset value per share, or the listed company fails to meet dividend standards, within six months of the transfer. The Exchange Guidelines specify that the foregoing requirements on the reduction of shares through transferring shares by agreement shall be referenced in the case of shareholders’ donating shares. Article 15 of the Measures further clarifies that in the event of a reduction in holdings due to judicial enforcement or due to the disposal of shares in a default scenario in an equity pledge, securities borrowing and lending, or securities repurchase transactions, the provisions on reductions through centralized bidding, block trading, or share transfer by agreements shall be applied respectively depending on the enforcement/disposal methods. If a large shareholder’s holdings are forcibly disposed by the People's Court through centralized bidding or block trading on the Exchanges, the large shareholder shall disclose the reductions within two trading days of receiving the enforcement notice from the People’s Court, while prevailing over the pre-disclosure requirements in Article 9 of the Measures.

(3) Prohibits circumvention of reduction restrictions through alternative schemes: The Measures reiterates the prohibition on shareholders using various “tools” such as securities borrowing, securities refinancing, and OTC derivatives transactions to circumvent the restrictions and requirements for the reduction of shares. For example, pursuant to Articles 17 and 18 of the Measures and the Exchange Guidelines, (1) large shareholders are prohibited from short selling the listed company’s shares or engaging in OTC derivatives transactions referencing the listed company’s shares; (2) shareholders who hold lock-up shares or other circumstances if reduction is not allowed, are prohibited from lending out such shares through securities refinancing, nor shall it engage in the short selling of the listed company's shares. Shareholders are required to settle short selling contracts for the listed company’s shares before obtaining restricted shares; and (3) it clarifies that the requirements on reduction through centralized bidding shall apply to shareholders who reduce shares due to participating in the subscription or purchase of ETFs.

5. Unifies and Strengthens the Provisions for Directors, Supervisors, and Senior Executives

Prior to these new reduction rules, the reduction requirements for listed company’s directors, supervisors, and senior executives mainly lay in the previous Shareholding Change Provisions and the previous Provisions. The previous Shareholding Change Provisions detailed the restrictions on the proportion and timing of the transfer of shares by directors, supervisors, and senior executives stipulated in Article 160 of the PRC Company Law. It clearly defined the "window period" during which trading in the listed company's shares is suspended when the listed company discloses periodic reports, performance forecasts, and performance express reports. The previous Provisions set forth the circumstances in which directors, supervisors, and senior executives are not allowed to reduce their shares due to their illegal or non-compliant conduct, as well as the requirements for pre-disclosure before reduction through centralized bidding.

The revised Shareholding Change Provisions incorporate the above requirements in the previous Provisions and make the following adjustments:

(1) Shortens the "window period" for the suspension of shares trading to encourage directors, supervisors, and senior executives to increase their shares in accordance with the law.

(2) Consistent with the provisions of the Measures, requires that (i) the directors, supervisors, senior executives and persons involved shall jointly continue to comply with the reduction restrictions after the share transfer due to divorce; (ii) the directors, supervisors, and senior executives should not, in accordance with the provisions, reduce their holdings if they commit illegal or non-compliant conduct; if the listed company commits illegal or non-compliant conduct, the listed company may be delisted due to major violations, or if they fail to pay fines or return illegal gains in full; and (iii) the directors, supervisors, and senior executives should disclose share reduction plans in advance before reducing holdings through centralized bidding or block trades.

(3) Enhances legal liabilities. In accordance with the Measures, the regulatory measures and administrative penalties for the illegal reduction of shares by directors, supervisors, and senior executives are generally consistent with those applicable to large shareholders, controlling shareholders, and de factor controllers.

6. Refines Liabilities for the Illegal Reduction of Shares

The Measures set forth new regulatory measures for the illegal reduction of shares. Article 29 states that the CSRC may order the responsible person to purchase the shares back and return the price difference to the listed company and authorizes the CSRC to take regulatory measures such as regulatory talks and warning letters. It also clarifies that the short-term profit provisions of Article 44 of the PRC Securities Law do not apply if the responsible person is required by the CSRC to purchase back shares in accordance with the preceding provision. Article 30 refines the specific circumstances when administrative penalties should be imposed for the illegal reduction of shares and points out that Article 186 of the PRC Securities Law should be referenced for administrative penalties. This includes ordering corrections, issuing warnings, confiscating illegal gains, and imposing fines up to the equivalent value of the securities traded; for serious cases, the CSRC may also impose a ban on market entry.

The illegal reduction of shares may also lead to self-disciplinary measures and disciplinary penalties by the Exchanges. Pursuant to the Exchange Guidelines, such self-disciplinary measures or disciplinary penalties include written warnings, trading restrictions, public criticism, and public condemnation. If the illegal reduction of shares leads to abnormal fluctuations in the stock price and seriously affects the normal market order or harms the interests of investors, the Exchanges should impose heavier penalties. The Exchanges may take measures such as restricting trading against investors who commit abnormal trading activities. If reductions in shares are suspected of violating laws and regulations, the Exchange should report it to the CSRC for further investigation.

7. Our Observations

The new reduction rules, including the Measures, Shareholding Change Provisions, and Exchange Guidelines, will be implemented from the date of promulgation. These rules aim to foster a comprehensive and refined share reduction regime, safeguarding the interests of small and medium investors and boosting investors’ confidence by enhancing the regulation on the reduction of holdings by large shareholders, particularly controlling shareholders and de facto controllers. These rules also aim to prohibit various forms of indirect reductions and the circumvention of reduction restrictions, closing regulatory loopholes.

1. In the last 20 trading days, the closing price of the stock (adjusted for rights) on any given trading day is lower than the IPO price.

2. In the last 20 trading days, the closing price of the stock (adjusted for rights) on any given day is lower than the net asset value per share attributable to the shareholders of the listed company at the end of the most recent fiscal year or the most recent financial reporting period.

3. In the last three fiscal years for which audited annual reports have been disclosed, no cash dividends have been implemented, or the total amount of cash dividends is less than 30% of the average annual net profit attributable to the shareholders of the listed company during the same period. However, fiscal years in which the net profit is negative should not be included in the calculation.