CONTENTS

CONTENTS

PART I. OVERVIEW 3

PART II. SECURITIES MARKET 7

I. Securities Offering 7

II. Listing and Trading of Securities 13

III. Listed Companies 17

IV. Securities Intermediaries and Service Providers 22

V. Investors 26

VI. Securities Self-regulatory Organizations 32

PART III. FUTURES MARKETS 38

I. Market Overview 38

II. Futures Brokerage Companies 40

III. Futures Self-regulatory Organizations 41

PART IV. LEGAL FRAMEWORK 45

PART V. SECURITIES REGULATORY 50

COMMISSION

PART VI. OPENING UP & INTERNATIONAL 54

COOPERATION

ANNEX: Contact Information of Relevant Institutions 59

1 China,s Securities and Futures Markets

DIAGRAM LIST

, Table 1-1 Summary of China s Securities and Futures Markets (1992-2005) 6

Figure 2-1 Summary of Capital Raised by A Shares (1991-2005) 9

Table 2-1 B Share Market Summary (2000-2005) 11

Figure 2-2 Ratio of to GDP (1992-2005) 15

Table 2-2 Number of Listed Companies (1998-2005) 18

Figure 2-3 Listed Companies by Share Capital in 2005 18

Figure 2-4 Summary of Raised Capital by H shares (1993-2005) 21

Figure 2-5 Figures 2-5 Equity Structure of Companies Issuing H Shares 21

(As of December 2005)

Figure 2-6 Summary of Investment Funds Issuance (1998-2005) 29

Figure 2-7 Net Assets Value & Ratio in Tradable Market Capitalization (1998-2005) 29

Figure 2-8 Composite Index (1991-2005) 36

Figure2-9 Component Index (1995-2005) 37

Figure 3-1 Trading Volume and Turnover of Futures (1993-2005) 39

Figure 3-2 Trading Summary of Futures Market in 2005 ( based on the nature of 39

futures products)

Figure 5-1 Organizational Chart of the State Council 52

Figure 5-2 Organizational Chart of the CSRC 53

Table 6-1 List of MOUs Signed by the CSRC with Overseas Authorities 58

2 PART I

PART I. OVERVIEW China,s securities and futures markets1 have been developing since the late 1970s in tandem with the market reforms and the liberalization of national economy. The first joint- company in China, Beijing Tianqiao Department Store Co. Ltd., was founded in August 1984. The same month also witnessed the incorporation of Shanghai Feilo Acoustics Co. Ltd., the first Chinese company that went public. In December 1990, Shanghai and were both established. China,s first listed company, Shenzhen Anda Industry Co. Ltd2, had its shares listed on the Shenzhen Stock Exchange on December 1,1990, which marked the inception of A shares3. From then on, China,s securities and futures markets embark on a rapid track for developments.

In China,s securities market, besides the A shares, there are also B shares4 which, first introduced in 1991, are accessible to international investors. As of the end of 2005, there were 1,381 listed companies in China, out of which 109 companies issued B shares; a total of 762.95 billion shares were issued with an aggregate market capitalization of RMB 3,243 billion (among which the capitalization for tradable amounted to RMB 1,063.1 billion); and 73.36 million securities investment accounts were opened, mostly by retail investors. The Chinese authorities have been encouraging and nurturing the development of institutional investors. The leading institutional players include 116 securities companies, 53 securities management companies, 34 Qualified Foreign Institutional Investors (QFIIs), a number of insurance companies, corporate annuities and China National Social Fund. The offering and trading of stocks and close- end securities investment fund units are all dematerialized and executed in centralized trading and settlement systems.

A multi-tier trading market for bonds has taken shape in China including on-exchange market, interbank bond market and OTC market. In July 1981, the issuance of T-bonds was resumed in China and six years later, a secondary market for T-bonds was established and thereafter grows rapidly. In the year 2005, the total issuance of bonds reached RMB 704.2 billion , a significant increase compared with the RMB 4.9 billion yuan in 1981. Apart from the T-bonds, , 1. In this brochure China refers to the Mainland of the People s Republic of China, excluding Kong SAR, Macao SAR and Taiwan region. The terms “” and “securities and futures markets” are both used with roughly the same meaning. 2. First quoted as “Shenanda A”, the company was restructured and renamed as “Beidagaoke”. 3. Common shares denominated in RMB. 4. Domestically listed common shares quoted in US dollars or HK dollars.

3 China,s Securities and Futures Markets

there are also other kinds of bonds available, such as corporate bonds, financial bonds, convertible bonds and short-term corporate notes. In 2005, the turnover of on-exchange bonds reached RMB 2,836.7 billion yuan.

Currently there are 3 commodity futures exchanges and 183 futures brokerage companies in China. Twelve futures contracts, mainly on agricultural products (soybean, grain and cotton, etc.) and industrial products (copper, aluminum and fuel oil, etc.), are traded on the exchanges. In 2005, the futures trading volume reached 323 million lots with the turnover amounting to RMB 13,450 billion yuan. Currently, warrants are the only financial derivatives5 available on China,s capital market. More financial derivatives like stock index futures and T-bonds futures are expected to emerge, as the first financial futures exchange is now in the pipeline.

While supporting the steady growth of domestic markets, the Chinese authorities also encourage Chinese enterprises to access international capital markets. In 1993, became the first Chinese company listed in (H-shares6). As of the end of 2005, 122 domestic companies had issued H-shares and got listed on the international capital markets, raising a total capital of US$ 55.54 billion.

Meanwhile, China,s securities market is opening wider to the outside world. International investors have been allowed to invest into China,s B shares market since 1992. In 2002, foreign institutions were allowed to invest directly into China,s A shares market via the Qualified Foreign Institutional Investor (QFII) scheme. Besides, eligible foreign companies can offer and list A shares in China, s market since 2001. Foreign companies are also allowed to take over Chinese listed companies since 2002.

Chinese securities service industry has also been opening up gradually in recent years. By the end of 2005, 7 licensed joint venture securities companies and 20 joint venture fund management companies had been licensed. Participation by international investors has helped to promote Chinese capital market, in the meantime brought in long-term funds for the growth of Chinese companies. Plus, advanced investment philosophies and good expertise are accompanied into the market.

5. In October 1993, T-bonds futures on the were open for public trading. Given the immaturity of the futures market characterized by excessive market manipulation and speculations, the State Council of China ordered the suspension of T-bonds futures in May 1995. 6. H-shares are shares issued overseas by the domestically listed Chinese companies.

4 PART I

In terms of legal framework, a number of major laws such as Company Law7,Securities Law7and Securities Investment Fund Law8 have been passed. Besides, the CSRC, along with other authorities, has issued supplemental regulations, administrative rules, guidelines and codes (e.g. Provisional Regulations on Public Offering and Trading and Measures on the Administration of Futures Exchanges).

The protection of investor has always been on the top agenda of the CSRC. In 2005, the CSRC adopted a series of measures to protect the legitimate rights and interests of the investors, in particular, the Securities Investor Protection Fund (SIPF) was launched in the second half of 2005. Besides, the reform of non-tradable shares was also launched in an effort to better protect the investors.

Before the reform, the A shares were divided into tradable and non-tradable shares based on their tradability at stock exchanges; the latter were mainly state-owned shares. By the end of 2004, the non-tradable shares accounted for 64% of the total shares in Chinese capital market (among which the state owned 74%).

The negative impacts of such a share division are multifold: distorting the pricing mechanism of shares, failing to synergize the common interests of shareholders for corporate governance of listed companies, hindering the preservation, appreciation and transfer of state-owned assets as well as the restructuring of state assets management system, affecting the internationalization process and product innovation. Thus, these problems call for an action for changes.

In a listed company undergoing the non-tradable shares reform, a goodwill price is paid to the holders of tradable shares by holders of non-tradable shares in return for the right to trade. It should be clarified that the price paid by holders of non-tradable shares is neither a free gift nor a kind of compensation. In principle, the pricing of trading right is not determined by the regulatory authorities, instead it is decided through negotiations between and among holders of tradable and non-tradable shares, subject to the classified voting at the shareholders meeting. A pilot program was introduced in late April 2005, followed by a full-swing reform on all listed companies with non-tradable shares. By the end of March 2006, 768 listed companies had completed or engaged in the reform, accounting for 57% of the 1,349 listed companies eligible for the non-tradable

7. The Company Law was released on Dec. 29 1993 and took effect on July 1 1994. The Securities Law was promulgated on Dec. 29 1998 and took effect on July 1 1999.The latest amendments of the above two laws were both approved on Oct.27 2005 and became effective on Jan. 1, 2006. 8. The Securities Investment Fund law was promnlgated on Otc.28 2003and came into force on june 1 2004.

5 China,s Securities and Futures Markets

shares reform, or 63% of the whole market capitalization.

The non-tradable shares reform is expected to be completed, by and large, by the end of 2006. It is predictable that the Chinese capital market will be unshackled from the historical hangover afflicting the market for years. A new era for sound and rapid growths of the capital market is just on the horizon.

Table 1-1 Summary of China,s Securities and Futures Markets (1992-2005)

Year Indicator 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 No. of domestic listed 53 183 291 323 530 745 851 949 1088 1160 1224 1287 1377 1381 companies (A,B shares)

No. of B share companies 18 41 58 70 85 101 106 108 114 112 111 111 110 109

No. of H share companies N.A. 6 15 18 25 42 43 46 52 60 75 93 111 122

Total shares issued (100 68.87 387.73 684.54 848.42 1219.54 1942.67 2526.79 3088.95 3791.71 5218.01 5875.45 6428.46 7149.43 7629.51 million shares) Tradable shares (100 21.18 107.88 226.04 301.46 429.85 671.44 861.94 1079.65 1354.26 1813.17 2036.90 2269.92 2577.18 2914.77 million shares) Total cap. 1048.13 3531.01 3690.61 3474.28 9842.38 17529.24 19505.64 26471.17 48090.94 43522.20 38329.12 42457.72 37055.57 32430.28 (RMB 100 million yuan) Market cap. of tradable N.A. 861.62 968.89 938.22 2867.03 5204.42 5745.59 8213.97 16087.52 14463.17 12484.55 13178.52 11688.64 10630.53 shares(RMB 100 million yuan) Total stock trading volume 3795.39 23422.17 201333.91 70547.06 253314.06 256079.12 215411.00 293238.88 475840.00 315228.76 301619.49 416308.40 582773.29 662354 (100 million shares) Total stock turnover 681.25 3667.02 8127.63 4036.47 21332.16 30721.84 23544.25 31319.60 60826.65 38305.18 27990.46 32115.27 42333.95 31663.16 (RMB 100 million yuan) Shanghai Stock Exchange 780.39 833.80 647.87 555.29 917.01 1194.10 1146.70 1366.58 2073.48 1645.97 1357.65 1497.04 1266.50 1161.06 Composite Index(close price) Shenzhen Stock Exchange 241.2 238.27 140.63 113.24 327.45 381.29 343.85 402.18 635.73 475.94 388.76 378.62 315.81 278.74 Composite Index (close price) Securities accounts 216.65 835.17 1107.76 1294.19 2422.08 3480.26 4259.88 4810.63 6154.53 6965.90 7202.16 7344.41 7215.74 7336.07 (10 thousand) Amount issued of T-bonds 460.78 381.31 1137.55 1510.86 1847.77 2411.79 3808.77 4015.00 4657.00 4884.00 5934.30 6280.10 6923.90 7042.00 (RMB 100 million yuan) Amount issued of enterprise 683.71 235.84 161.75 300.80 268.92 255.23 147.89 158.20 83.00 147.00 325.00 358.00 327.00 654.00 bonds(RMB 100 million yuan) Cash T-bonds turnover 7.1276 61.02 468.37 775.20 5029.24 3582.75 6059.95 5300.87 4157.49 4815.59 8708.68 5756.11 2966.46 2779.05 (RMB 100 million yuan) Repurchase T-bonds Turnover 0.00 0.42 75.78 1248.52 13008.64 12876.06 15540.84 12890.53 14733.68 15487.63 24419.64 52999.85 44086.61 23621.18 (RMB 100 million yuan) No. of Securities 6 22 34 51 71 95 161 218 investment funds Amount issued of securities investme 120.00 510.00 562.00 804.23 1318.85 1614.67 3308.79 4714.00 -nt funds(RMB 100 million yuan) Turnover of securities investment 555.33 1623.12 2465.79 2561.88 1166.58 682.65 728.58 773.13 funds(RMB 100 million yuan) Futures transaction 890.69 12110.72 63612.07 34256.77 15876.32 10445.57 7363.91 5461.07 12046.35 13943.37 27992.43 30569.76 32287.41 volume (10000 lot) Futures turnover 5521.99 31601.41 100565.00 84119.16 61170.66 36967.24 22343.01 16082.29 30144.98 39490.28 108396.59 146935.32 134462.71 (RMB 100 million yuan )

Note: 1. Source: the CSRS; 2. Blanks in the charts represent that data are not available or existing. For the data related to shares, both A shares and B shares are covered.

6 PART II

PART II. SECURITIES MARKET

I. Securities Offering 1. Stocks i. The A share market

The A shares refer to the common shares issued by the companies incorporated and registered in and traded by domestic entities or retail investors (excluding investors from Taiwan region, Hong Kong and Macau SARs) in Chinese currency. A company applying for a public offering of A shares has to submit its application to the CSRC and meet the requirements stipulated in the Company Law, Securities Law, Provisional Regulations on the Administration of Issuing and Trading of Stocks, and other relevant laws and regulations. An issuer can choose either a public or non-public offering. Below are several kinds of public offering: ¥ A public offering of securities to unspecified investors; ¥ A public offering of securities to accumulatively more than 200 specified investors; ¥ A public offering as prescribed by any law or administrative regulation. Advertising, public inducement or public offerings in any disguised form are forbidden in non-public securities offerings.

The public offering of stocks may be used to initiate a joint stock limited company, to make initial public offerings (IPOs) of established companies or follow-on offerings of listed companies.

To initiate a joint stock limited company means to establish such a company via public issuance of stocks for financing. The promoter subscribes a significant portion of the shares while the rest are offered to the public. Such a public offering shall meet the following requirements as prescribed in the Company Law as well as other requirements of the CSRC. ¥ There shall be no less than 2 but no more than 200 promoters, of whom half or more shall have domiciles in China; ¥ The shares subscribed by the promoters shall be no less than 35 % of the total shares. According to Article 13 of the Securities Law, an IPO of a company shall meet the following requirements: 7 China,s Securities and Futures Markets

¥ Have a complete and well-functioning organizational structure; ¥ Capable of making profits continuously in a sound financial condition; ¥ No record of false financial statements over the past 3 years, no record of other wrongdoings; and ¥ Meeting other requirements as prescribed by the CSRC. Listed companies can issue additional shares to the public by placing shares to their existing shareholders (hereinafter referred to “rights issue”) or by offering additional shares to the public (hereinafter referred to as “follow-on offering”). Both methods should comply with the Article 13 of the Securities Law.

The following review and approval procedures are adopted by the CSRC: ¥ The issuers are required to make public their application documents after being accepted by the CSRC; ¥ The Public Offering Supervision Department of the CSRC conduct preliminary reviews on the application documents; ¥ The application documents are subject to the review and examination of the Public Offering Review Committee9, which comprises both the CSRC staff and external experts. The Review Committee members vote by majority in order to recommend to the CSRC for a public offering; ¥ Taking into consideration the recommendation of the Review Committee, the CSRC finally decides whether to approve a public offering or not.

The current pricing mechanism for a public offering is a market-oriented one. Developing from the fixed pricing, P/E ratio-based pricing and controlled P/E ratio-based pricing, the Inquiry Pricing System is introduced on a trial basis from 1 January 2005. It is in essence a book-building pricing system which generally involves two stages. In the first stage, the issuer and its sponsor propose an initial price band to solicit price offers from institutional investors10. After receiving the first round of feedback, the issuer and the lead underwriter will adjust the price range and offer it to the institutional investors for a second-round feedback

9. The Public Offering Review Committee is now composed of 25 members. Five of them are the CSRC staff and the rest are non-CSRC experts. The tenure of a committee member is one year and the consecutive tenure shall be no more than 3 terms. Some of them are full- time members. 10. Here refers to the securities investment fund management companies firms, trust&investment firms, financial companies, insurance companies and QFIIs.

8 PART II

which sets the final price of the offering.

As of the end of 2005, listed companies in China had issued a total of 596.6 billion A shares, raising RMB 858.85 billion yuan in total. Given the fact that IPOs and other means of follow- on offerings for the listed companies were suspended since April 2005, only 15 companies made IPOs in the whole year, raising about RMB 5.674 billion yuan; 2 companies made rights issue, raising RMB 260 million yuan; and another 5 companies made follow-on offerings, raising RMB 27.88 billion yuan. Figure 2-1 summarizes the capital raised from the A share market in 1991-2005.

Figure 2-1 Summary of Total Capital Raised at the A Shares Market (1991-2005)

1800

1600

1400

RMB 100 million 1200

1000

800

600

400

200

0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

IPO rights issue followup offering convertible bond

Source: the CSRC

9 China,s Securities and Futures Markets

ii. The B share market

The inception of B shares marks the first step of internationalization in China,s capital market. Like the A shares, the B shares are also issued by joint-stock companies registered in China and listed on Chinese stock exchanges. The B shares are denominated in Chinese currency, but subscribed and traded in foreign currencies. Since 1992, the B shares have been issued and traded on both Shanghai (in US dollars) and Shenzhen (in HK dollars) Stock Exchanges. Domestic citizens are allowed to trade B shares in foreign currencies from February 2001. Therefore, the B share market enables Chinese companies to raise foreign currencies from both Chinese and international investors.

In accordance with the Company Law, the Securities Law, the Provisional Regulations on the Administration of Issuing and Trading of Stocks and State Council Rules Regarding the Domestic Listing of Foreign Owned Shares, B share issuers shall meet the following requirements: ¥ the capital raised by issuing B shares shall be used in a manner consistent with state industrial policy; ¥ to comply with regulations regarding fixed-asset investments; ¥ to comply with regulations on foreign investments; ¥ the promoters must hold at least 35% of the issued shares at the time when the company is set up; the capital contributions by promoters shall be no less than RMB 150 million yuan; ¥ the company must float at least 25% of the company's total shares; in the case of a company's total share capital exceeding RMB 400 million yuan, the public floating requirement may be reduced to no less than 15% of its total shares; ¥ Neither (a) any predecessor entity (entities) of which the joint-stock company is a part of; nor (b) any major promoter who is a state-owned enterprise, have committed any significant breaches against laws over the past three years.

As of the end of 2005, 109 companies had issued a total of 19.47 billion B shares, raising RMB 38.08 billion yuan. For more information on the B share market, please refer to Table 2-1.

10 PART II

Table 2-1 Summary of the B Share Market (2000-2005)

2000 2001 20022003 2004 2005

Number of B share 114 112 111111 110 109 companies Market cap. of B share companies(RMB 100 million yuan) 635.19 1276.65 802.57937.23 746.22 619.73 Market cap. of tradable B shares (RMB 100 million yuan) 563.31 1118.28 765.81872.60 690.17 602.08 Trading volume of B shares (100 million shares) 200.36 688.88 156.70170.80 154.82 152.86 Turnover of B shares (RMB 100 million yuan) 547.97 5063.13 848.42845.30 642.64 564.94

Source: Shanghai and Shenzhen Stock Exchanges

2. Bonds The issuance of bonds such as T-bonds, financial bonds and corporate bonds are subject to the approval of government authorities other than the CSRC. The issuance of convertible bonds and bonds of securities companies are subject to the approval of the CSRC and shall meet the following requirements. i. Convertible bonds

Convertible bonds refer to the corporate bonds which can be converted into shares under certain pre-agreed conditions. The issuance of convertible bonds should meet the requirements for new public offering as prescribed in Article 13 of the Securities Law, plus the following requirements regarding corporate bonds in Article 16: ¥ The net asset of a joint stock limited company is no less than RMB 30 million yuan and the net asset of a limited-liability company is no less than RMB 60 million yuan; ¥ The accumulated outstanding bonds constitute not more than 40 % of the net assets of a company; ¥ The average annual distributable profits over the latest 3 years are sufficient to pay 1-year interests of the bonds; ¥ The raised funds are invested in a manner consistent with the state industrial policies;

11 China,s Securities and Futures Markets

¥ The interest rate of bonds does not exceed the band of interest rates as set by the State Council.

The funds raised through public issuance of corporate bonds shall be used for the verified purposes only and shall not be used to cover any deficit or non-production expenditures.

ii. Bonds issued by securities companies

This type of bonds is issued by securities companies which agree to redeem both principals and interests within a certain period of time. Such bonds can be issued to the public or to qualified investors via private placement. The issuance of bonds by securities companies is subject to the review and approval of the CSRC.

Aside from the requirements as prescribed in the Securities Law, the securities company issuing bonds should also comply with the following requirements:

a) The latest un-audited assets shall be no less than RMB 1 billion yuan; b) The company made profits in the preceding year; c) All risk control indicators have met the requirements as prescribed by the CSRC; d) No material violation of laws or wrongdoing has been committed during the past 2 years; e) The shareholders, meetings and the Board of Directors are in sound operation and internal control systems are working effectively with proper firewalls and internal control technical support; f) Assets of the company have not been misappropriated by any controlling natural person, legal person, other organization or related party; and g) Other requirements as prescribed by the CSRC.

Securities companies that apply to issue bonds via private placement should comply with not only the requirements specified in the Securities Law, but also the above-mentioned requirements numbered c),d),e),f) and g). Meanwhile, the securities companies should also have latest un-audited net assets of no less than RMB 500 million yuan. Private placement can only be offered to the qualified investors capable of independent analysis and risk control over bond investments, and must meet the following requirements:

¥ It is a legal person or investment entity; ¥ It can invest on bonds according to related regulations and its articles of association;

12 PART II

¥ It has more than RMB 10 million yuan of registered capital and over RMB 20 million yuan of un-audited net assets.

II. Listing & Trading of Securities 1. Listing of Securities

According to Article 39 of the Securities Law, publicly issued stocks, corporate bonds or other securities shall be listed in a stock exchange or other securities marketplaces as approved by the State Council. A listing application shall be filed with a stock exchange for its review and approval. i. Listing of stocks

A joint stock limited company applying for a listing of securities shall meet the following requirements:

¥ The stocks have been publicly issued upon the approval of the CSRC; ¥ Its total share capital shall be no less than RMB 30 million yuan; ¥ The publicly issued shares shall exceed 25 % of the total shares; where the total share capital exceeds RMB 400 million yuan, the publicly issued shares shall be no less than 10% thereof; and ¥ The company shall commit no material violations of laws or false financial statements over the last three years.

A listing agreement shall be signed by an exchange and a listing applicant which mainly covers: the code of conducts requirement on the listed company, listing fees, suspending or terminating the listing, services provided by the exchange, etc. In other words, such an agreement sets forth and governs the relations between the listed company and the exchange. ii. Listing of corporate bonds

A company applying for a listing of corporate bonds shall meet the following requirements:

¥ The maturity of the corporate bonds shall be more than 1 year; ¥ The actual issuance is no less than RMB 50 million yuan; ¥ Meeting the issuing requirements. The listing of convertible bonds, in addition to the above requirements, shall meet the requirements for public offering of stocks as well.

13 China,s Securities and Futures Markets

2. Trading of Securities

Market size. As of the end of 2005, the market capitalization of China,s stock market reached RMB 3,243 billion yuan, equivalent to 17.79% of China,s GDP. The market capitalization for the tradable shares amounted to RMB 1,063.1 billion yuan, roughly 5.83% of the GDP (see Figure 2- 2). The turnover of exchange-traded bonds registered RMB 2,800 billion yuan, of which the turnover of T-bonds, corporate bonds and convertible bonds accounted for 94.1%, 4.3% and 1.6% respectively. The turnover of bonds repurchase accounted for more than 88% of the total bond turnover.

Trading instruments. Currently the following financial instruments are available for trading on the stock exchanges: stocks (both A shares and B shares), bonds (cash T-bonds, T-bonds repo, cash corporate bonds, corporate bonds repo and convertible bonds)11, securities investment funds (close-ended funds, open-ended funds, ETF, LOF) and warrants, etc.

Market participants. The major market participants include securities companies, insurance companies, securities investment fund management companies, trust & investment companies, non-financial institutional investors, and retail investors.

Means of trading. Securities are traded on stock exchanges where an open, centralized and computerized matching method is adopted based on the principle of “price precedence and time precedence”. Other means of trading include collective bidding and block trading bidding. The block trading can be adopted for large-volume stock transactions (no less than half a million shares for A shares).

Trading fees. Investors purchase or sell securities through the brokerage of securities companies. The commissions12 paid to securities companies shall not be higher than 3 of the trading value (but no lower than the total amount of the trading regulatory fee and the charges by the stock exchanges). Furthermore, according to the prevailing taxation law, both buyers and sellers are levied a stamp duty of 1 of the trading value.

Daily caps on the stock fluctuations. At present, except Specially Treated Shares (shares of

11. Bonds at the interbank market include T-bonds, financial bonds, corporate bonds, convertible bonds, short-term corporate notes and international bonds. 12. For any trading value (of A shares or securities investment funds) less than RMB 5 yuan, the minimum commission is RMB 5 yuan. For trading value of less than US$1 or HK$5 (of B shares), the minimum commission is US$1 or HK$5.

14 PART II

listed companies in poor financial or operating conditions that require special treatments) which are subject to the daily price limit of 5%, all other shares are subject to the daily price limit of 10%.

Registration and clearing. The registration and clearing of securities are centralized through China Securities Depository and Clearing Corporation Ltd. (CSDCC). Before trading on a stock exchange, an investor must place all the securities (fully dematerialized) into an account opened with the CSDCC. Currently, the settlement for A shares is T+1 and the settlement for B shares is T+3.

Market indices. The commonly cited stock indices include Shanghai Composite Index, Shanghai 50 Index, Shanghai 180 Index, Shenzhen Component Index, Shenzhen Composite Index and SME Index, etc.

Figure 2-2 Ratio of Market Capitalization to GDP (1992-2005)

% 60

50

40

30

20

10

0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

market cap./GDP market cap. of tradable shares/GDP

Source: the CSRC

15 China,s Securities and Futures Markets

3. Delisting of Securities i. delisting of stocks

Where a listed company is under any of the following circumstances, the stock exchange shall suspend the listing of its stocks:

¥ Where the share capital or shareholding structure of the company changes and thus fails to meet the listing requirements; ¥ Where the company fails to publicize its financial statements or contains false information in its statements which may mislead the investors; ¥ Where the company has committed any major wrongdoing; ¥ Where the company has been operating at a loss for the latest 3 consecutive years; or ¥ Under any other circumstance as prescribed in the listing rules of the stock exchange. Where a listed company is under any of the following circumstances, the stock exchange shall terminate the listing of its stocks:

¥ Where the total amount of share capital or shareholding structure of the company changes and thus fails to meet the listing requirements, and still unable to meet the listing requirements after the rectification period set by the stock exchange; ¥ Where the company fails to publicize its financial statements or contains false information in its statements, and refuses to rectify; ¥ Where the company has been operating at a loss for the latest 3 consecutive years and fails to make profits for another year; ¥ Where the company is disbanded or is declared bankrupt; or ¥ Under any other circumstance as prescribed in the listing rules of the stock exchange. When the stocks of a listed company are de-listed from an exchange, they have to be transferred to a special trading system-Share Transfer System (STS). The STS is an independent system where securities companies provide brokerage services for the shares of de-listed joint-stock companies. The first company in STS was quoted on July 16, 2001. As of the end of 2005, 33 de-listed companies were quoted on STS.

ii. de-listing of corporate bonds

After the listing, where the bond issuer is under any of the following circumstances, the stock exchange may suspend the listing of its corporate bonds:

16 PART II

(a) Where the company has committed any wrongdoing; (b) Where a major change takes place in the company which fails to meet the listing requirements; (c) Where the funds raised through the issuance of corporate bonds are used other than the verified purposes; (d) Where the company fails to fulfill its obligations according to the covenant of corporate bonds; or (e) Where the company has been operating at a loss for the latest 2 consecutive years.

Where a company is under any of the circumstances as described in item (a) or (d) of the preceding Article with deemed serious violations, or where a company is under any of the circumstances as described in item (b), (c), or (e) of the preceding Article and fails to rectify within a specified timeframe, or where a company is disbanded or declared bankrupt, the stock exchange shall terminate its listing of corporate bonds.

III. Listed Companies 1. Domestically-listed Companies i. Overview

The domestically-listed companies have been growing rapidly. In 1990 there were only 10 listed companies in China. But by the end of 2005, the number had already reached 1,381, of which 1,240 companies issuing A shares only, 23 companies issuing B shares only, 86 companies issuing both A shares and B shares, and 32 companies issuing both A and H shares (see Table 2-2 and Figure 2-3). The share capital of domestically listed companies is mostly between RMB 100 million and RMB 1 billion yuan, with only 108 listed companies owning more than RMB 1 billion yuan of share capital. Listed companies are located in different parts of Mainland China and across various industrial sectors (mainly machinery, metallurgy, chemicals, electronics, infrastructure, transportation and energy).

17 China,s Securities and Futures Markets

Table 2-2 Number of Listed Companies (1998-2005)

1998 1999 2000 2001 20022003 2004 2005

Issuing A shares only 727 822955 10251085 1146 1237 1240

Issuing A and H shares 18 1919 2328 30 30 32

Issuing A and B shares 80 8286 8887 87 86 86

ssuing B shares only 26 2628 2424 24 24 23

Total 851 9491088 11601224 1287 1377 1381

Source: the CSRC

Figure 2-3 Listed Companies by Share Capital in 2005

300

236 250 201

No.ofListCo. 182 200 142 150 126 123 103

100 76 70 41 42 38 50

0 under 100 100-200 200-300 300-500 500-1000 more than 1 million million million million million billion

Shanghai Shenzhen

Source: the CSRC

18 PART II

ii. Regulatory framework , The CSRC s supervisions over listed companies cover information disclosure, corporate governance, related parties transactions, M&A, etc. A geographically-based supervisory system has been adopted in supervising listed companies. The Listed Company Supervision Department of the CSRC shoulders the major responsibilities including rules making, policy studies, regulatory coordination, inspection and supervision of regional bureaus and stock exchanges, etc. A local regulatory bureau is responsible for daily supervision of the listed companies within its jurisdiction. Its major tasks include on-spot inspection, risks detection and disposal, etc. Corporate governance, information disclosure, M&A and refinancing of listed companies are also subject to the routine supervision of local regulatory bureaus. Stock exchanges are the forefront regulators as many important issues in relation to a listed company, such as information disclosure, risk warning, suspension, resumption and termination of listing, are subject to their supervision.

a) Information disclosure. The information disclosed by issuers and listed companies shall be authentic, accurate and complete and shall contain no false, misleading statement or major omissions (Article 63, Securities Law). The information disclosed by a listed company can fall into 3 categories: public offering information, periodic reports, and ad hoc reports. The public offering information includes prospectus, stock listing announcement, bonds issuance scheme and bond listing announcement, etc. Periodic reports include annual reports, interim reports and quarterly reports. In the case of a material event, the listed company shall immediately submit an ad hoc report to the CSRC. Such routine reports as notification of shareholders, meeting and its decision can also be regarded as ad hoc reports.

b) Corporate governance. The Code of Corporate Governance for Listed Companies was issued in January 2002. The Code sets forth, among others, the basic principles for corporate governance of listed companies, including: ¥ Independent Directors. A listed company shall introduce independent directors to its board of directors. In a domestically listed company, independent directors shall accountant for at least one third of the board. Related party transactions must be endorsed by independent directors. As of the end of 2005, almost all listed companies had introduced independent directors to their boards.

19 China,s Securities and Futures Markets

¥ Independence of Listed Company. A listed company shall be separate from its controlling shareholders in such matters as human resources, assets and financial affairs and independent in organization, and accounting issues to independently bear risks and obligations. ¥ Specialized Committees. The board of directors may establish a strategy committee, an audit committee, a nomination committee, a remuneration committee and an appraisal committee pursuant to the resolutions of shareholders' meetings. The audit committee shall have at least one accounting professional as its independent director.

c) Related party transactions13. Timely information disclosure is required by the CSRC, whereas ¥ the transaction value between a listed company and its related natural person exceeds RMB 300,000 ; or ¥ the transaction value between a listed company and its related legal person14 exceeds RMB 3 million yuan and accounts for 0.5% or above of the latest audited net assets of the listed company.

The director representing a related party shall withdraw from voting when the board or the shareholders, meeting is deliberating and voting on the related party transaction.

d) Mergers & Acquisitions. Investors can acquire a listed company by a public offer, agreement-based offer and other legitimate ways. In such an acquisition, the stocks of the target company held by an acquirer cannot be transferred within 12 months following the acquisition.

2. Overseas Listed Companies i. Overview

On July 15, 1993, Tsingtao Brewery Co. Ltd. was successfully listed in Hong Kong, which marked the first overseas listing by a Chinese enterprise. As of the end of 2005, a total of 122 domestic companies had issued shares overseas, raising US$ 55.54 billion in total (see Table 2-4). 103 of them were listed only on the Hong Kong Exchanges and Clearing Ltd. (including 40 stocks at GEM); 12 dually-listed in Hong Kong and New York; 4 dually-listed in Hong Kong and London; 1 triply-listed in Hong Kong, New York and London; and 2 solely listed

13. Related party transaction refers to the issues regarding resources or obligations transfers between a listed company or a subsidiary under its control and its related party. 14. Please refer to Rules on Stock Listing issued by stock exchanges for the definitions of “ related natural person”

20 PART II

in Singapore. Table 2-5 shows the equity structure of overseas listed companies as of the end of 2005.

Figure 2-4 Summary of Raised Capital by H shares (1993-2005)

250 20

206.47 200 16

US$ 100 million

150 12

100 8 77.61 67.9 64.92 46.85 50 4 22.34 23.23 12.12 10.49 3.79 4.57 5.69 8.82 0 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

raised capital No. of IPO

Figures 2-5 Equity Structure of Companies Issuing H Shares (As of December 2005)

A shares other 2% 1%

H shares state-owned 43% shares 54%

Source: the CSRC

21 China,s Securities and Futures Markets

Previously the overseas listed companies were primarily large SOEs that were critical to the national economy. Recently, with the increasing overseas listing of small and medium-sized enterprises (SMEs), particularly privately owned enterprises, these companies have exhibited truly diversified ownership structures and industrial sectors with a higher degree of transparency and compliance. These companies have not only raised a significant amount of capital, but also optimized the capital structure and corporate governance.

ii. Requirements for applying to list in overseas main boards

Where a domestic enterprise directly or indirectly issues or lists any securities abroad, it is , subject to the CSRC s approval according to the Article 238 of Securities Law. After restructuring into joint-stock companies, all state-owned companies, collectively-owned companies and enterprises of other ownership that have met the specific requirements are entitled to apply for overseas listing.

A listing at overseas main boards shall meet the following requirements: ¥ The capital raised shall be used in a manner consistent with the state industrial policy and compliant with regulations regarding fixed-asset investments as well as foreign investment policies; ¥ The company must own a net capital of no less than RMB 400 million yuan; with no less than RMB 60 million yuan of post-tax profits. Meanwhile, it shall have great potentials for growth based on reasonable P/E ratio, and the capital raised shall be no less than US$ 50 million; ¥ The company has a sound corporate governance and internal control regime, sufficient senior executives with acceptable management skills; ¥ The company has reliable foreign exchange resources for dividends distribution.

IV. Securities Intermediaries and Service Providers 1. Securities Companies15

Securities companies are the leading intermediaries in China,s capital market. By the end of 2005, there were 116 securities companies with 3,090 retail branches nationwide under the supervision of the CSRC, regional regulatory bureaus, stock exchanges, securities association and the securities depository & clearing house.

15. They are often termed as “investment banks” in the United States, or “merchant banks” in the United Kingdom.

22 PART II

, The CSRC s supervisions over securities companies cover their establishment, business scope, capital adequacy, risk control indicators, internal control and clients, funds management, etc. The Intermediary Supervision Department of the CSRC shoulders the major responsibilities including rules making, policy studies, regulatory coordination, etc. A local regulatory bureau is responsible for daily supervision of the securities companies (and their branches) registered within its jurisdiction regarding their brokerage, proprietary and asset management businesses. Such matters as corporate governance, internal control, risk disposal plans and senior management are also subject to the routine supervision of local regulatory bureaus. The trading activities of securities companies are directly under the surveillance and supervision of stock exchanges. China Securities Depository and Clearing Corporation Ltd., while providing depository and clearing services to securities firms, is also responsible for controlling risks in these areas. i. Establishment requirements.

A securities company shall apply to the CSRC for a license provided that it meets the following requirements: ¥ Its major shareholders have the ability to make profits continuously, have a good reputation, and commit no major violation of laws or wrongdoings over the past 3 years with a net asset of no less than RMB 200 million yuan; ¥ Its registered capital satisfying the provisions of the Securities Law; ¥ Have a sound risk control system as well as an internal control system; and ¥ Meeting any other requirement as prescribed by laws and regulations as well as by the CSRC. ii. Business scope.

A securities company may undertake some or all of the following businesses upon the approval of the CSRC:

(a) Securities brokerage; (b) Securities investment consultation; (c) Financial advising relating to securities trading or securities investment; (d) Underwriting and sponsorship of securities; (e) Securities proprietary trading; (f) Securities asset management; and (g) Any other business concerning securities.

23 China,s Securities and Futures Markets

iii. Registered capital.

Where a securities company engages in the business operations as prescribed in the abovementioned item (a), (b) or (c), its registered capital shall be no less than RMB 50 million yuan. Where a securities company engages in any of the business operations as prescribed in item (d), (e), (f) or (g) therein, its bottom-line registered (paid-in) capital shall be RMB 100 million yuan; Where a securities company engages in two or more business operations as prescribed in item (d), (e), (f) or (g), its minimum registered (paid-in) capital shall be 500 million yuan.

iv. Risk control indicators.

As prescribed by the Securities Law, the CSRC shall formulate provisions on the risk control indicators of a securities company, such as net capital, the ratio between net capital and liabilities, the ratio between net capital and net assets, the ratio between net capital and proprietary trading, underwriting and asset management, the ratio between liabilities and net assets, as well as the ratio between current assets and current liabilities.

v. Internal control.

A securities company shall establish an internal control system, and build up effective Chinese walls so as to prevent any conflict of interest between the company and its clients or between different clients. It shall segregate its securities operations on brokerage, underwriting, proprietary trading and asset management.

vi. Funds of the clients.

The clients, trading settlement funds of a securities company shall be deposited in a commercial bank and managed through separate accounts under the clients, names. A securities company shall by no means incorporate any settlement funds or securities of its clients into its own assets. Meanwhile, any entity or individual is prohibited from misusing the funds or securities of its/his clients in any form. Where a securities company is under bankruptcy or liquidation procedures, the settlement funds or securities of its client shall not be defined as its insolvent assets or liquidation assets. Unless for paying the liabilities of its clients or prescribed by laws, the funds or securities of its clients shall not be sealed up, frozen, deducted or enforced compulsorily. A securities company shall not provide any financing or guaranty for its shareholders or any related person.

24 PART II

The CSRC started in the second half of 2004 a campaign to consolidate all securities companies for compliant operations. The campaign is estimated to last for around 2 years and its major tasks include: conducting an in-depth evaluation of corporate risks and structural reforms, tightening supervision over senior management and shareholders, pressing ahead differentiated regulation over securities firms and optimizing the industrial structure. These efforts are aimed to cultivate more competitive and innovative securities companies in China and have proved to bear fruits. Financial conditions of many securities companies have been improved and turned to be more reliable.

2. Securities trading service institutions

Securities trading service institutions refer to the entities that provide services to issuers and investors, etc. They can be divided into different groups based on the type of services they provide, such as securities depository and clearing house, investment advisers, credit rating agencies, financial advisory companies, accounting firms, asset appraisal agencies and law firms. Any of the above institutions except law firms shall be licensed by the CSRC for securities-related businesses. As of the end of 2005, there were 108 securities investment advisers and 70 accounting firms engaging in securities-related businesses. i. Securities depository and clearing house

The establishment of a securities depository and clearing institution is also subject to the approval of the CSRC. In March 2001, China Securities Depository and Clearing Corporation Ltd. (CSDCC), the only institution of its kind in China, was established. Starting from 1 October 2001, the CSDCC takes charge of all the depository and clearing of listed securities, which marked the establishment of a unified securities depository and clearing system subject , to the CSRC s supervision. The General Manager, who reports to the Board of Directors, is responsible for the corporate operations. Headquartered in Beijing, the CSDCC has two subsidiaries, respectively in Shanghai and Shenzhen16.

In addition, the CSDCC is responsible for the depository and clearing of other exchange- listed instruments as well as the open-ended funds. Its business scope covers the opening and managing of securities accounts and settlement fund accounts, securities registration and

16. These two subsidiaries were restructured respectively from Shanghai Depository and Clearing Corporation and Shenzhen Depository and Clearing Corporation.

25 China,s Securities and Futures Markets

transfer, securities depository, securities/payment clearing and delivery, acting as the agent for securities interests distribution, internet information services, and any other businesses approved by the CSRC. At present, the settlement is T+1 for A shares, and T+3 for B shares.

ii. Other securities trading service institutions

Where an investment consulting institution, financial advisor, credit rating agency, asset appraisal institution, or accounting firm engages in any securities trading service, it shall be licensed by the CSRC and other competent authorities. Such a kind of institution is subject to ex ante licensing, ongoing supervision and afterwards sanctions. Although a law firm does not have to obtain a license from the CSRC for securities services, it is still subject to the , CSRC s ongoing supervision and sanctions.

The employees of an investment consulting institution, financial advisory institution or credit rating agency who engage in securities trading services shall have the securities expertise as well as related work experiences for more than 2 years.

An investment consulting institution as well as its practitioners shall not have any of the following acts: ¥ Engaging in any securities investment on behalf of its entrusting party; ¥ Signing any agreement with any entrusting party on sharing the gains or bearing the loss of securities investments; ¥ Purchasing or selling any stock of a listed company, for which the consulting institution provides services; ¥ Providing or disseminating any false or misleading information to investors through media or by any other means; or ¥ Other act as prohibited by any law or regulation.

V. Investors As of the end of 2005, a total of 73.66 million securities investment accounts (including A shares and B shares) had been opened. Since its inception, China,s securities market has been dominated by individual investors. In recent years, the CSRC has made vigorous efforts to nurture the growth of institutional investors.

26 PART II

1. Institutional Investors i. Securities investment funds

Overview. In 1998, the first five contractual closed-ended funds were launched, marking the birth of China,s securities investment fund industry. In 2001, the first contractual open-ended fund was rolled out. After eight years of development, the fund industry has achieved remarkable progresses with a growing market visibility. As of the end of 2005, there were 54 closed-ended and 154 open-ended securities investment funds under the management of 53 (including 20 joint ventures) fund management companies (see Figure 2-6). Statistics show that the total net assets of these funds (RMB 469.1 billion) and market value of securities they held accounted for 44% and 17% respectively of the total tradable share market capitalization in China.

Categories of funds. A diversified pool of funds was put forward over the past few years, covering most fund products available in developed markets. At present, besides equity funds, there are bond funds, index funds, monetary market funds, umbrella funds, principal guaranteed funds, exchange traded funds and listed open-ended funds.

Division of regulatory responsibilities. The CSRC and self-regulatory organizations jointly supervise the securities investment fund industry. The Fund Supervision Department of the CSRC shoulders the major responsibilities on rules making, policy studies, review and approval of administrative license items, supervision of fund managers, custodian, fund sale agents, etc. A local regulatory bureau is responsible for daily supervision of fund managers within its jurisdiction with the regulatory tasks on corporate governance, internal control, senior management, fund sales, information disclosure, etc. Stock exchanges are supervising the trading activities and information disclosure of listed funds at the forefront. The Securities Association of China is empowered to self-regulate fund managers, sales agents, custodians and licensed professionals in the fund industry. Some relevant regulatory requirements are as follows:

a) Fund manager and custodian. Fund managers shall be assumed by fund management companies while custodians assumed by qualified commercial banks. A fund manager is required to be licensed by the CSRC, while a custodian needs to be jointly licensed by the CSRC and China Banking Regulatory Commission. A fund custodian and a manager cannot be the same party or invest on each other or cross hold shares. According to the

27 China,s Securities and Futures Markets

Article 13 of Securities Investment Fund Law, the following conditions shall be met in order to establish a fund management company: ¥ having a registered capital of no less than RMB 100 million yuan; ¥ principal shareholders demonstrating a good track record and public reputation in the securities business, securities investment consultation, trust assets management or other financial assets management, committing no violation of law within the preceding 3 years, and having a registered capital of no less than RMB 300 million yuan; and ¥ the number of licensed fund professionals meeting the statutory requirement. b) Placement of fund. A fund manager should, before its fund placement, submit its application and relevant documents to the CSRC. The fund placement shall start within 6 months from the date of receiving the ratification.

c) Fund operation. In managing its properties, a fund manager shall apply portfolio investments on listed stocks, bonds and other instruments permitted by the CSRC. According to the Article 59 of Securities Investment Fund Law, fund properties should not be used in the following investments or activities: ¥ Underwriting of securities; ¥ Providing loans or guarantees to others; ¥ Engaging in investment with unlimited liability; ¥ Trading other fund units, unless otherwise approved by the State Council; ¥ Making capital contribution to the fund manager and custodian, or trading the stocks or bonds issued by the aforesaid manager and custodian; ¥ Trading the securities issued or underwritten by the shareholders controlling the fund manager or custodian, or by the companies with other significant interests with the aforesaid manager or custodian; ¥ Insider dealing, market manipulation or other wrongdoings; and

28 PART II

Figure 2-6 Summary of Investment Funds Issuance (1998-2005)

250

number 200

150 164

107 100 51 3 17 0 50 0 48 54 59 54 54 0 34 22 5 0 1998 1999 2000 2001 2002 2003 2004 2005

closed-end fund open-ended fund

Figure 2-7 Net Assets Value & Ratio in Tradable Market Capitalization (1998-2005)

5600 50 4691 45 4800 40

100 million 4000 35 3238 30 3200 25 2400 20 1699 15 1600 1186 575 847 809 10 800 104 5 0 0 1998 1999 2000 2001 2002 2003 2004 2005

fund net assets fund net assets / Mkt.cap.of tradable shares (%)

Source: the CSRC

29 China,s Securities And Futures Markets

ii. Qualified Foreign Institutional Investors (QFII)

The pilot scheme of Qualified Foreign Institutional Investors (QFII) was launched in December 2002. Based the approved investment quota, a QFII can invest on such financial instruments as A shares, treasuries, convertible bonds and corporate bonds listed in China's stock exchanges as well as other financial instruments approved by the CSRC. In order to become a QFII, an applicant should meet the following criteria:

¥ The applicant should be in a sound financial and credit status, meeting the requirements set by the CSRC on assets size and other indicators17; and its risk control indicators should meet the requirements under its home jurisdiction; ¥ Its employees should meet the professional qualification requirements in its home jurisdiction; ¥ With a sound management and internal control system, the applicant should have a good track record without being imposed any substantial penalties by its home regulators over the last three years prior to application; ¥ Its home jurisdiction should have a sound legal and regulatory regime, and its securities regulator has signed Memorandum of Understanding with the CSRC and maintained an efficient co-operative regulatory relationship.

As of the end of 2005, 34 overseas financial institutions had been licensed as QFIIs with a total investment quota of USD 5.6 billion, and eleven banks (including four overseas banks) were licensed as the QFIIs, custodians. The securities assets of the QFIIs amounted to RMB 34.7 billion yuan, accounting for 90% of their investment quota. Of their investment portfolios, RMB 22.3 billion yuan (64%) was invested in A shares, RMB 6.0 billion(17%) in funds, RMB 2.6 billion (7%) in convertible bonds and RMB 3.7 billion (11%) in Treasury bonds.

17. The criteria of assets scale and other factors are: (1)for fund management institutions: having operated fund business for over 5 years with the most recent accounting year managing assets of no less than US$10 billion; (2)for insurance companies: having operated insurance business for over 30 years with paid-in capital of no less than US$1 billion and managing securities assets of no less than US$10 billion in the most recent accounting year; (3) for securities companies: having operated securities business for over 30 years with paid-in capital of no less than US$1 billion and managing securities assets of no less than US$10 billion in the most recent accounting year; (4) for commercial banks: ranking among the top 100 of the world in the total assets for the most recent accounting year and managing securities assets of no less than US$10 billion. The CSRC may adjust the aforesaid requirements subject to the developments of securities market.

30 PART II

iii. Other major institutional investors

Besides securities investment funds and QFIIs, there are other institutional investors such as National Social Security Fund, insurance companies, corporate annuity funds and securities firms authorized for proprietary trading and assets management business, etc.

a) National Social Security Fund

The National Social Security Fund (“NSSF”) is an important institutional investor in China. According to the Provisional Measures on the Administration of National Social Security Fund, the National Council for Social Security Fund (“NCSSF”) in charge of the NSSF entrusts fund management companies to invest up to 40% of total assets in funds and stocks. At the end of December 2004, the total net assets of NSSF amounted to approximately RMB 150 billion, of which RMB 13 billion were invested in stocks and RMB 100 billion in fixed- income instruments.

b) Insurance companies

Insurance companies are another important group of institutional investors in China. Insurance assets may be invested in capital market by two means: a) directly purchasing stocks up to 5% of total insurance assets; and b) buying securities investment funds up to 15% of total insurance assets. At the end of 2004, the total insurance assets reached approximately RMB 1.2 trillion with RMB 67.3 billion investments on funds.

c) Corporate annuity funds

Corporate annuity funds are about to become key players in the unfolding social security reform and development of institutional investors. According to the Provisional Measures on the Administration of Corporate Annuity Funds, these funds may invest up to 30% of total assets in the capital market. At the end of 2004, these funds had approximately RMB 50 billion of assets, with estimated maximum investments of RMB 15 billion in the capital market.

2. Securities Investor Protection Fund

The Securities Investor Protection Fund (SIPF) was launched with a paid-in capital of RMB 6.3 billion in the second half of 2005 in order to protect the interests of securities investors against the losses from failing securities companies. Meanwhile, China Securities Investor Protection

31 China,s Securities And Futures Markets

Fund Corporation Limited (SIPFC) was established to initiate, manage and develop the SIPF. The board of SIPFC consists of nine directors and the Chairman is recommended by the CSRC subject to the approval of State Council.

The SIPF revenues primarily come from five sources: (1) 20% of the transaction fees submitted by Shanghai and Shenzhen Stock Exchanges when their risk reserves reach the stipulated upper limits; (2) 0.5% to 5% of operating revenues of securities companies; (3)the interest income from the “locked” funds subscribing for stocks or convertible bonds; (4) proceeds from the compensation of liable parties and the liquidation of securities companies; (5) donations of domestic and foreign institutions, organizations and individuals as well as other legitimate incomes.

In case that the SIPF is used to dispose of risks in securities companies, the CSRC will work out risk disposal plans based on the nature of the risk, then the SIPFC shall formulate the implementation plan and execute it accordingly upon the approval of the State Council. After compensating the creditors of securities companies, the SIPFC obtains corresponding claims and the right to participate in liquidation of securities companies. The SIPF can only be invested on bank deposits, treasury bonds, central bank bonds (including central bank notes), financial bonds issued by central financial institutions and other means approved by the State Council.

VI. Securities Self-Regulatory Organizations 1. Securities Association of China

The Securities Association of China (SAC), established on 28 August 1991, is a non-profit self- regulatory organization with a legal person status subject to the guidance, supervision and administration of the CSRC and the Ministry of Civil Affairs.

The highest authority of the SAC is its general assembly of members, and the board of governors is its executive body. As of the end of 2005, the SAC had 282 members, including 116 securities companies, 33 securities investment fund management companies, 3 financial assets management companies, and 86 securities investment consulting agencies.

The SAC shall perform the following functions: ¥ to educate its members and ensure the enforcement of laws and regulations governing securities ¥ to safeguard the legitimate rights and interests of members and report to the CSRC about

32 PART II

suggestions and requests of members; ¥ to collect and process securities information in order to service members; ¥ to formulate rules governing its members, organize professional trainings and facilitate exchange of ideas among members; ¥ to mediate in the event of disputes between members or between members and their clients; ¥ to organize researches and surveys on the development and operation of securities industry; ¥ to supervise and inspect members, professional conduct and impose disciplinary sanctions on any member that violates articles of association and self-regulatory rules; ¥ to promote international cooperation and exchanges in the securities industry; ¥ to undertake some responsibilities empowered by the CSRC: i) to facilitate the industry innovations and compliance, and organize the selection of innovation-type securities companies; ii) to mange the professional qualification system, and organize the qualification exams for securities professionals; iii) to keep a record of sponsors in underwriting business and the ex ante filing of membership-based securities investment consulting business ; iv) to supervise members, information disclosure; v) to promote the standardization, communication and training in the field of securities information technology; vi) to supervise and manage the Share Transfer System.

2. Stock Exchanges

The Securities Law and Administration Measures on Stock Exchanges define a stock exchange as a self-regulatory legal person entity that provides the site and facilities for centralized securities trading and supervises the trading activities. At present, there are two stock exchanges in China, both Shanghai and Shenzhen Stock Exchanges are under the supervision of the CSRC. Each stock exchange has a general assembly of members and board of governors. The former is the highest authority while the board of governors is the executive body with Chairman and Vice Chairman nominated by the CSRC subject to election by the board. Besides, the president of each exchange is appointed by the CSRC.

The major functions of a stock exchange include: ¥ providing the site and facilities for securities trading; ¥ formulating business rules; ¥ accepting listing applications and arranging listing issues; ¥ organizing and supervising the activities of securities trading;

33 China,s Securities And Futures Markets

¥ supervising the conduct of the members and listed companies; ¥ managing and disclosing market information; and ¥ other functions permitted by the CSRC. According to the Measures on the Administration of Stock Exchanges, a stock exchange shall monitor securities trading activities as follows: ¥ formulating detailed trading rules; ¥ publishing the real-time quotations and daily charts; ¥ compiling and circulating transaction data in a timely manner; ¥ ensuring investors an equal opportunity to trade and an equal access to market trading information; ¥ suspending or resuming the trading of listed securities; ¥ restricting or prohibiting the trading of specific securities investors; ¥ dealing with any violation of the business rules immediately; ¥ establishing a computer system capable of market supervision and real-time monitoring; and ¥ setting up a specific unit for market surveillance. According to the Measures, a stock exchange shall discipline its members as follows: ¥ formulating specific rules governing its members; ¥ exercising stringent administration over the trading seats of members; ¥ supervising its members, proprietary business (such as monitoring its members to use designated stock accounts and fund accounts with the help of technical means; requesting members to report monthly securities inventory before the 5th of the following month; adopting specific risk control measures over proprietary trading, etc.); ¥ supervising its members, brokerage business (such as drafting the format of a brokerage agreement between a member and its clients and verifying its contents; providing for its members the procedures and responsibilities in accepting a client,s orders and selectively inspecting its members, compliance periodically; requesting its members to report their monthly brokerage business and clients' complaints before the 5th of the following month, etc); ¥ selectively or extensively inspecting its members' financial conditions, internal risk control system and compliance with the exchange rules, and reporting the results to the CSRC; and ¥ imposing sanctions against the violating members. According to the Measures, a stock exchange shall monitor companies listed at its marketplace as below:

34 PART II

¥ formulating specific listing rules for different types of securities; ¥ signing listing agreements with listed companies clarifying respective rights and obligations; ¥ supervising the listing sponsors who ensure the listed companies to meet all listing requirements and guide them to fulfill their post-listing reporting obligations; ¥ reviewing the rights issue statement, listing announcement and other public documents, and ensuring the listed companies to publish the above documents in a timely manner; ¥ urging the listed companies to publish their annual reports and interim reports pursuant to the timeframe and the uniform format set by the CSRC, and keeping on monitoring after their disclosures; ¥ examining and verifying ad hoc reports submitted by the listed companies; ¥ suspending the trading of the shares of a listed company under certain circumstances (e.g. i. abnormal fluctuations occur in the share trading of the said company; ii. one or more investors offer to acquire the shares of the said company; iii. the listed company itself requests for the suspension pursuant to its listing agreement; iv. when a stock exchange deems necessary, etc.); ¥ keeping a record of the shareholding structures of listed companies, compiling accurate statistics on the changes of shareholdings and overseeing the changes; ¥ punishing a listed company,s failure to fulfill the information disclosure obligation, and if necessary, referring the listed company to the CSRC with proposed penalties. i. Shanghai Stock Exchange (SHSE)

The Shanghai Stock Exchange (SHSE) was founded on November 26, 1990. As of December 2005, a total of 834 companies with 878 equities were listed at the SHSE; and the total market capitalization amounted to RMB 2,310 billion. In terms of membership, the SHSE had 156 members, including 137 domestic securities firms or equivalent, 15 other domestic companies concurrently providing certain securities services and 4 overseas special members. In addition, special B-share trading seats had been granted to 39 overseas securities companies.

The SHSE has 16 departments in charge of office administration, trading management, listed companies, market surveillance, member supervision, bonds & funds, legal affairs, IT, research, etc. and two subsidiaries18 . The SHSE is running an advanced trading system capable of handling 16,000 transactions per second. Please refer to Figure 2-8 for Shanghai Composite Index movements.

18. Securities Telecommunication Co., Ltd. and SSE InfoNet Co., Ltd.

35 China,s Securities And Futures Markets

Figure 2-8 Shanghai Composite Index (1991-2005)

Price CNY

1800

1500

1200

900

600

300

91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 06 year Source: Reuters

ii. Shenzhen Stock Exchange (SZSE)

Shenzhen Stock Exchange (SZSE) was established on December 1, 1990 as a non-profit membership institution. On May 27, 2004, the Small and Medium Enterprises (SME) Segment was launched at the SZSE, which observes the same IPO criteria as other segments of the main board. The SME Segment provides a direct financing platform for hi-tech or rapidly growing small and medium enterprises with competitive core businesses.

As of the end of 2005, a total of 544 companies with 586 equities were listed in the SZSE, including 50 companies listed in SME Segment; and the total market capitalization reached RMB 933 billion. Among its 177 members, there were 141 domestic securities firms or equivalent, 32 domestic companies concurrently providing certain securities services and 4 overseas special members. Additionally, 19 overseas securities companies had special B-share trading seats at the SZSE.

36 PART II

The SZSE also has 16 departments in charge of market surveillance, member supervision, fund & bond and so on as well as 5 subsidiaries19.

The daily capacity of its trading system stands at 20 million trades with a double backup system. A comprehensive and highly computerized forefront surveillance system has been put in place in order to detect, terminate and punish wrongdoings in a timely manner. The SZSE has also set up an extensive information network on market data and listed company news, which ensures the timely dissemination of market information.

Please refer to Figure 2-9 for Shenzhen Component Index movements.

Figure2-9 Shenzhen Component Index (1995-2005)

5200 4800 4400 4000 3600 3200 2800 2400 2000 1600 1200

96 97 98 99 2000 01 02 03 04 05 06 Year

Source: Reuters

19. Five subsidiaries include Research Center, Securities Satellite Co., Ltd., Securities Information Co., Ltd., etc. For more information, please refer to the website (http://www.sse.org.cn/main/en/Catalog_1377.aspx).

37 China,s Securities And Futures Markets

PART III. FUTURES MARKETS

I. Market Overview China,s commodity futures market started almost simultaneously with the stock market. In October 1990, as the first commodity futures market in China, Zhengzhou Grain Wholesale Market introduced its first . However, due to the lack of a sound legal and regulatory framework, the following years saw disorders and other problems in the market. From 1994, the CSRC was mandated to consolidate the whole market. Today, the market has 3 exchanges (Shanghai Futures Exchange, Zhengzhou Commodity Exchange, and Dalian Commodity Exchange) and 183 brokerage firms, compared with 50 exchanges and 1,000 brokerage firms at the peak time in 1994. The traded products have been downsized from 35 to 12 products.

China,s financial derivatives market is still in its infancy. At present there is only one kind of financial derivatives, namely warrant, traded on stock exchanges. In fact, in the 1990s the trading of Treasury futures was attempted on stock exchanges. But at that time the spot market was premature, the regulatory framework was unclear, and there were vicious competitions in the market, so the trading of Treasury futures was halted in 1995. In recent years, some profound changes have taken place in China, in particular, Chinese financial market is increasingly market- oriented with more frequent and wider price fluctuations, which calls for developing financial derivatives to meet the demands of market participants for price discovery and risk control. Recently, the CSRC is accelerating the founding of a financial futures exchange in Shanghai where such derivatives as stock index futures and Treasury futures are likely to list.

With regard to the performance of commodity futures market in recent years, a recovering growth in the turnover and trading volume is recorded since 2001. In 2005, the total trading volume and turnover reached 323 million lots (a year-on-year increase of 5.63%) and RMB 13.45 trillion (a decrease of 8.48%). Please refer to Figure 3-1 for details.

Both Zhengzhou Commodity Exchange (ZCE) and Dalian Commodity Exchange (DCE) trade contracts on agricultural products, such as wheat, cotton, corn, soybean, mung bean, bean oil, sugar, etc, while Shanghai Futures Exchange (SHFE) provides futures contracts on other commodities such as copper, aluminum, rubber, fuel oil, etc. Figure 3-2 shows the trading statistics of the futures products in 2005.

38 PART III

Figure 3-1 Trading Volume and Turnover of Futures (1993-2005)

160000 70000

140000 60000

10000 lots 120000 50000 RMB 100 Million 100000 40000 80000 30000 60000 20000 40000

20000 10000

0 0 19931994 1995 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005

Annual turnover Annual trading valume

Source: the CSRC

Figure 3-2 Trading Summary of Futures Market in 2005 (based on the nature of futures products)

70000

60000

50000 42.61% 57.39% 40000 73.45% 30000

20000 26.55% 10000

0 turnover 100 million trading volume (10,000 lots) agricultural products 69060.68 25529.12 industrial products 65402.03 6757.95

Source: the CSRC.

39 China,s Securities And Futures Markets

II. Futures Brokerage Companies Futures brokerage companies are the leading intermediaries in the futures market. By the end of 2005, 183 futures brokerage companies were operating in China.

The CSRC adopts a geographically-based supervisory system in supervising futures brokerage companies. The Futures Supervision Department of the CSRC shoulders the major responsibilities including rules making, policy studies, regulatory coordination, and supervising regional bureaus and stock exchanges, etc. A local regulatory bureau is responsible for daily supervision of the futures brokers and their senior management within its jurisdiction, including their corporate governance, internal control, financial status and compliance; meanwhile it also takes charge of risk detections and disposals. The regulatory requirements concerning a futures brokerage company,s establishment, business scope and risk control are as follows:

1. Establishment. According to the Provisional Regulations on the Administration of Futures Trading and the Measures on the Administration of Futures Brokerage Companies, the establishment of a futures broker is subject to the approval by the CSRC. Besides the relevant provisions in the Company Law, an applicant shall also meet the following conditions: ¥ a registered capital of no less than RMB 30 million; ¥ senior executives and main employees are qualified professionals in futures business; ¥ an immobile business venue and sufficient trading facilities; ¥ a well-established management system; ¥ other conditions as stipulated by the CSRC. Futures brokerage companies can, based on their business needs, apply to the CSRC to establish their branches/subsidiaries.

2. Business scope. A futures brokerage company may engage in the following futures businesses: ¥ futures brokerage business; ¥ futures consultation and training; ¥ other businesses as approved by the CSRC. Futures brokers are prohibited to openly or disguisedly engage in futures proprietary trading.

3. Risk control. A futures broker shall set up a specific department or positions for risk

40 PART III

control which check its own financial condition, business operation and compliance as well as drafts risk control reports. It shall also recruit qualified accounting firms to audit its financial and operating statements annually.

III. Futures Self-regulatory Organizations 1. China Futures Association

China Futures Association (CFA), established on 29 December 2000, is a self-regulatory organization for the futures industry. It is a non-profit legal person entity subject to the guidance, supervision and administration of the CSRC and the Ministry of Civil Affairs.

The highest authority of the CFA rests with its general assembly of members and the board of governors is its standing executive body. The CFA is led by the Secretary General with important decisions made by Working Meetings of Heads. As of the end of 2005, the CFA consists of 185 institutional members (mainly futures brokerage companies), 3 special members (futures exchanges) and a number of licensed individual members.

The CFA shall perform the following functions: ¥ to formulate self-regulatory rules, industry criteria and professional norms for the futures industry and supervise their implementation, to educate its members and ensure the enforcement of laws and regulations governing futures; ¥ to protect the legitimate rights and interests of members, assist members in their operations and report to the CSRC about suggestions and requests of members; ¥ to mediate in the event of disputes between members or between members and their clients and deal with the complaints against its members; ¥ to arrange for the vocational training, qualification exam and issuance of certificate for professionals in the futures industry to improve their skills and ethics; ¥ to actively carry out surveys and researches on the futures market, organize its members to exchange experiences in operation and management, and report to the CSRC about members°Ø suggestions and requests of developing the futures market; ¥ to promote the knowledge and public awareness of the futures market, and educate the investors of basic knowledge on futures and risk controls; ¥ to supervise and inspect members, business conducts, reward outstanding members/individuals, and impose disciplinary sanctions against any member that violates the CFA articles of

41 China,s Securities And Futures Markets

association or self-regulatory rules; ¥ to collect and process information from futures markets at home and abroad for consultation services to members, and publish futures-related publications; ¥ to promote international communications and cooperation of the futures industry; ¥ other responsibilities determined by the general assembly of members or empowered by the CSRC.

2. Futures Exchanges

According to the Provisional Regulations on the Administration of Futures Trading and the Measures on the Administration of Futures Exchanges, futures exchanges are self-regulatory legal entities performing functions pursuant to their articles of association. All the three futures , exchanges SHFE, ZCE and DCE are under the CSRC s supervision.

In a futures exchange, the general assembly of members is the highest authority, and the board of governors is the executive body whose Chairman and Vice Chairman are nominated by the CSRC and elected by the board. The CSRC is entitled to appoint and discharge the general manager of an exchange.

The future exchanges shall fulfill the following functions: ¥ providing the venues, facilities and services for futures transactions; ¥ designing futures contracts and arranging the listing of futures contracts; ¥ organizing and supervising futures transactions, settlement and delivery; ¥ ensuring the honoring of futures contracts; and ¥ establishing and running the risk management system (e.g. regarding margins, daily debt-free netting, price fluctuation limit, position limit, large positions reporting, risk reserves, etc).

According to the Measures on the Administration of Futures Exchanges, the supervisions and administrations of a futures exchange over its members include: ¥ Formulating the administration rules of its members; ¥ Formulating the administration rules on trading seats and prohibiting members to transfer the seats entirely or partly in the form of lease or subcontract; ¥ making selective or extensive inspections over the members' compliance with the exchange business rules and report the results to the CSRC. All members are compelled to cooperate.

42 PART III

According to the above mentioned Measures, the supervisions and administrations of a futures exchange over futures trading include: ¥ Implementing the systems of margins, daily debt-free netting, investor trading coding, hedging positions review and speculative positions limit, arge positions reporting, price fluctuation limit, etc; ¥ Promulgating market information on real-time quotations, the ranking in terms of positions and trading volume, etc. in an appropriate manner; ¥ Compiling and publishing relevant trading statements in a timely manner; ¥ Taking the following provisional measures to prevent the ongoing violations by a member or a client: (1) to limit the injection of margins; (2) to limit the withdrawal of margins; (3) to limit the opening of new positions; (4) to raise the margins ratio; (5) to close positions before a designated date; (6) to immediately close positions. When the exchanges take the foregoing measures in (4) (5) and (6), they should report to the CSRC immediately. i. Shanghai Futures Exchange (SHFE)

Shanghai Futures Exchange (SHFE), originated from the merging of Shanghai Metal Exchange, Shanghai Cereal and Oils Exchange and Shanghai Commodity Exchange, started its operation in December 1999. As of December 2005, the SHFE had a total of 215 members, of which 175 were brokerage firms (81%) and 34 were proprietary traders (15%). It had 248 remote trading terminals nationwide.

At present, copper, aluminum, rubber and fuel oil contracts are traded in the SHFE. In 2005, the trading volume hit 67.58 million lots, and the turnover registered RMB 6,540.2 billion, 49% of the national total.

There are 17 departments under the SHFE in charge of office administration, market surveillance, trading, settlement, delivery, legal affairs, information, enforcement , research, financial futures and so on. ii. Dalian Commodity Exchange (DCE)

Dalian Commodity Exchange (DCE) was established on February 28, 1993. As of December 2005, it had a total of 195 members, among which 93% are futures brokerages companies. The DCE had 163,837 registered investors, including 44,385 new investors in 2005.

The corn, soybean, bean meal and bean oil contracts are traded at the DCE. Among them, the

43 China,s Securities And Futures Markets

soybean is the most actively traded product and its price in the DCE has become an important indicator for China,s soybean production and sales. In 2005, the trading volume at the DCE amounted to 198.35 million lots (61% of the national total) with turnover at RMB 4,741.7 billion (35% of the national total).

There are 14 departments under the DCE, including departments on trading, delivery, settlement, market surveillance, technology, and Beijing office, etc.

iii. Zhengzhou Commodity Exchange (ZCE)

Zhengzhou Commodity Exchange (ZCE) was established in October 1990. By the end of 2005, it had 222 members, including 179 futures brokers and 44 proprietary traders.

The traded products on the ZCE include wheat, cotton, mung bean and sugar, among which wheat and cotton are the most actively traded. In 2005, the ZCE registered a trading volume of 56.95 million lots (a 17.49% year-on-year increase) with the turnover at RMB 2,165 billion (a year-on-year increase of 86%).

The ZCE has 12 departments respectively in charge of trading, delivery, settlement, options, market development, research development, etc.

44 PART IV

PART IV. LEGAL FRAMEWORK The establishment of a sound regulatory framework has been the cornerstone as well as the basis for China,s capital market development. On 27 October 2005, Chinese top legislator, the National People,s Congress, passed the revised Company Law and Securities Law which came into effect from 1 January 2006. The revision, based on the accumulative past experiences and in-depth studies, made a number of significant changes to the provisions and laid out a series of wide- ranging and far-sighted mechanisms, which marked a new era for China,s capital market legal framework.

By the end of 2005, such a legal framework had taken shape focusing on three pieces of legislation: Company Law, Securities Law, and Securities Investment Fund Law. They were supplemented by 13 regulations and administrative rules such as Provisional Regulations on Public Offering & Trading and Provisional Regulations on Futures Trading as well as over 300 departmental rules, guidelines and codes.

Within this framework, there were regulations that govern: ¥ securities offering, listing, and disclosure; ¥ securities and futures trading; ¥ corporate governance, mergers and acquisitions of listed companies; ¥ securities and futures intermediaries; ¥ supervision of securities investment funds; ¥ securities and futures markets supervision & legal liabilities. I. Securities Offering, Listing, and Disclosure

The Articles 2 & 3 of Securities Law govern public offering and listing of shares as well as information disclosure, including: the definition of public offering, the requirements on IPOs and issuance of corporate bonds, the requirements on securities underwriting, pricing and listing (including suspension and delisting), information disclosure requirements on issuers and listed companies. The Chapter 5 of Company Law also sets forth a number of principles on the issuance of a joint stock company,s shares. Meanwhile, the Articles 238 of Securities Law authorizes the State Council to issue rules regarding a Chinese enterprise directly or indirectly issuing and listing securities overseas for trading.

Other rules and regulations in this area include:

45 China,s Securities And Futures Markets

¥ Provisional Regulations on Public Offering and Trading; ¥ State Council,s Special Rules on Overseas Offering and Listing of Joint Stock Companies; ¥ The CSRC Public Offering Approval Procedures; ¥ Interim Measures on the Sponsor System for Securities Public Offerings; ¥ Notice on Overseas Listing Applications ¥ Guidelines on Approval and Supervision of Chinese Companies Listing on Hong Kong GEM ¥ Standards for Content and Format of Information Disclosure of Public Companies.

II. Securities and Futures Trading

The Articles 3 of Securities Law sets forth the principles for securities trading, which fall into two categories:

¥ general regulations on trading, including trading venue, modes, commissions, eligible participants, etc; ¥ regulations on prohibited behaviors such as insider dealing, market manipulation, making up and circulating false information, etc.

Other relevant rules and regulations include the Measures on the Administration of Stock Exchanges, Measures on the Administration of Futures Exchanges, and Notice on Issues of Tightening Control over Members, Settlement Risks.

III. Corporate Governance, Mergers and Acquisitions of Listed Companies

The Article 4 of Securities Law sets forth the M & A methods and information disclosure requirements, the content of M & A report, post-acquisition shares arrangements, etc.

Besides, the Chapter 4 of Company Law also provides general principles on organizational structure, independent directors, board secretary and related party transaction of listed companies.

There are a number of other rules and regulations governing this area, such as the Guidelines for Establishing Independent Directors of Listed Companies, Code of Corporate Governance for Listed Companies, Measures on the Merger and Acquisition of Listed Companies, Measures on the Administration of Information Disclosure on Shareholding Changes of Listed Companies, Notice on Some Issues about Transfer of State-Owned Shares and Legal-person Shares of Listed

46 PART IV

Companies to Foreign Entities, Rules on Strengthening Protection of Private Shareholders' Rights and Interests, Notice on Improving Listed Companies, Quality, Measures on Administration of International investors, Strategic Investment on Listed Companies, Provisions on Article of Association for Overseas Listed Companies, and Guidelines on Article of Association for Listed Companies.

IV. Securities and Futures Intermediaries 1. Regarding Securities Companies

The Article 6 of Securities Law sets forth principles for securities firms on their establishment criteria, business scope, capital requirements, risk control indicators, nomination of board directors, board supervisors and senior executives, internal control system, safekeeping of trading settlement funds, and penalties on wrongdoings. Other related rules and regulations include the Measures on the Administration of Securities Companies, Provisional Measures on Clients, Asset Management by Securities Companies, Administration Measures on Senior Management of Securities Companies and Administration Measures on Clients, Settlement Fund Management.

2. Regarding Futures Brokerage Houses

The Provisional Regulations on Futures Trading enacted from 1 September 1999 governs the futures brokerage houses on their establishment criteria, approval procedure, business scope, liquidation, etc. There are also a number of other rules and regulations governing this area, such as the Administration Measures on Futures Brokerage Houses, Administration Measures on Senior Management of Futures Brokerage Houses, Code of Governance of Futures Brokerage Houses (provisional). They set forth details on the founding, modification and termination of futures brokerage houses, basic operation rules, appointment of senior executives, performance evaluation and incentive scheme, etc.

3. Regarding Other Service Providers

The Article 7 of Securities Law lays out principles for other specialized services providers on their establishment criteria, liquidation, functions, operation, safekeeping of documents, and settlement. Besides, Administration Measures on Stock Exchanges also lays out details on the establishment, organizational structure and functions of securities registration and settlement institutions. The Article 8 of Securities Law sets forth the principles for investment advisors,

47 China,s Securities And Futures Markets

financial advisors, credit rating agencies, assets evaluation institutions and accounting firms engaging in securities services. In addition, the Provisional Measures on Securities and Futures Investment Consultancy and corresponding implementation rules give details on how to govern securities and futures investment consultancy business.

V. Supervision of Securities Investment Funds

The Securities Investment Fund Law stipulates the provisions regarding fund managers, custodians, placement and trading of funds, subscription and redemption of funds, operations and information disclosure, modification and termination of contracts, liquidation of funds, rights and interests of fund holders and their ways of exercising, supervision and administration of funds, and legal liabilities, etc.

Corresponding to the Securities Investment Fund Law, the CSRC in 2004 promulgated 6 Measures respectively regulating the information disclosure, operation and sales of securities investment funds, namely, Administration Measures on Information Disclosure of Securities Investment Funds, Administration Measures on Operation of Securities Investment Funds, Administration Measures on Sales of Securities Investment Funds, Administration Measures on Securities Investment Fund Companies, Administration Measures on Senior Management in Securities Investment Funds Industry and Administration Measures on Securities Investment Fund Custody. These regulations have helped to constitute the legal framework governing China,s securities investment fund industry.

VI. Securities and Futures Markets Supervision & Legal Liabilities

The Securities Law sets forth specific provisions regarding stock exchanges, securities industry association and securities regulator. The CSRC is mandated to be the regulatory authority for China,s securities and futures markets. The securities and futures exchanges are front-line regulators in addition to providing trading facilities; and the securities association and futures associations, as self-regulatory organizations, supervise and discipline securities companies and futures brokerage houses respectively.

In December 2005, the CSRC published the Implementation Measures on Freezing and Sealing , which sets forth details for the CSRC s enforcement powers and procedures in freezing and sealing the illegal funds, assets and important evidences.

48 PART IV

The Securities Law, Company Law, Securities Investment Fund Law and Criminal Law expressly lay out the civil, administrative and criminal liabilities of a party guilty of securities and futures offenses and crimes, including fraudulent practices, insider dealings and market manipulations. Meanwhile, the Supreme Court issued a number of legal explanations such as the Certain Rules on Dealing with Civil Compensation Cases Related to False Statement and Rules on Dealing with Futures Dispute Cases, which sets rules on handling civil liability lawsuits in relation to capital market.

In addition, the SROs including stock and futures exchanges, securities and futures associations, have established their own legal system governing their members and activities as a supplement to the capital market legal framework.

49 China,s Securities And Futures Markets

PART V. CHINA SECURITIES REGULATORY COMMISSION

I. Regulatory Regime and Organizational Structure

In October 1992, the State Council Securities Committee and its executive arm the CSRC were established and mandated to regulate China,s securities and futures markets. In 1998, the State Council Securities Committee terminated operations and its functions were transferred to the CSRC which becomes the sole regulator supervising nationwide securities and futures markets. The CSRC is now one of the 14 organizations directly under the State Council (see Figure 5-1).

The top executive body of the CSRC is composed of one Chairman, five Vice-Chairmen, and one Assistant Chairman. The Commission consists of 16 functional departments and 3 affiliate centers. Headquartered in Beijing, the CSRC has 36 regulatory bureaus throughout China,s provinces, municipalities, autonomous regions and key cities, as well as 2 supervisory offices in Shanghai and Shenzhen (see Figure 5-2). At present, there are 1,905 staff in the CSRC with an average age of 35 years old, and 41% of the staff hold master degrees or above.

II. Major Functions & Powers of the CSRC

According to the Article 179 of the Securities Law, the CSRC is mandated to perform the following supervisory functions and duties: ¥ Formulating the relevant rules and regulations on the supervision and administration of the securities market and exercising the power of examination or verification; ¥ Carrying out the supervision and administration of the issuance, listing, trading, registration, custody and settlement of securities; ¥ Carrying out supervision and administration of the securities activities of the securities issuers, listed companies, stock exchanges, securities companies, securities registration and clearing houses, securities investment fund management companies and securities trading service providers; ¥ Formulating the standards for securities practice qualification and code of conduct and carrying out supervision and implementation; ¥ Carrying out supervision and examination of information disclosure regarding the issuance, listing and trading of securities; ¥ Offering guidance for and supervising the activities of the securities industry associations;

50 PART V

¥ Investigating into and punishing any violation of any law or administrative regulation on the supervision and administration of the securities market; and ¥ Performing any other functions and duties as prescribed by any law or administrative regulation. The CSRC may establish a cooperative mechanism with the securities regulators of other jurisdictions for cross-border supervision and administration.

And according to the Article 180 of the Securities Law, where the CSRC performs its duties and functions, it has the power to take the following measures: ¥ Carrying an on-the-spot examination to a securities issuer, listed company, securities company, securities investment fund management company, securities trading service provider, stock exchange or securities registration and clearing institution; ¥ Making investigation and collecting evidence in a place where any suspected irregularity has happened; ¥ Consulting the parties concerned or any entity or individual relating to a case under investigation and requiring the relevant entity or person to give explanations on the matters relating to a case under investigation; ¥ Referring to and photocopying such materials as the registration of property right and the communication records relating to the case under investigation; ¥ Referring to and photocopying the securities trading records, transfer registration records, financial statements as well as any other relevant documents and materials of any entity or individual relating to a case under investigation; sealing up any document or material that may be transferred, concealed or damaged; ¥ Consulting the capital account, securities account or bank account of any relevant party concerned in or any entity or individual relating to a case under investigation; in the case of any evidence certifying that any property as involved in a case, such as illegal proceeds or securities, has been or may be transferred or concealed; or where any important evidence has been or may be concealed, forged or damaged, freezing or sealing up the foregoing properties or evidence upon the approval of the principal of the securities regulatory authority under the State Council; ¥ When investigating into any major securities irregularity such as market manipulation or insider trading, upon the approval of the principal of the securities regulatory authority under the State Council, restricting the securities trading of the parties concerned in a case under investigation, whereby the restriction term shall not exceed 15 trading days; under any complicated circumstance, the restriction term may be extended for another 15 trading day.

51 China,s Securities And Futures Markets

Figure 5-1 Organizational Chart of the State Council

State Council

Spcial Institutions directlyunder Organizations directly Ministries and Commissions Institutions directly under the Working Organs of the the State Council(1) under the State Council(19) under the State Council(28) State Council (14) State Council(4)

State-owned Assets Supervision and General Administration Minister of Foreign China Banking Regulatory Overseas Chinese Affairs Administration Commission of Customs Affairs Commission (CBRC) Office of the State Council

State Administration of National Development and China Securities Regulatory HongKong and Macao Affice Taxation Reform Commission Commission (CBRC) office of the State Council

State Administration for China Insurance Regulatory Legislative Affairs Office of Minister of Finance Industry and C0mmerce Commission (CBRC) the State Council

Minister of Labour and National Council for Social Research Office of the State Social Security Security Fund Council

Minister of Commerce

, People s

52 PART V

Figure 5-2 Organizational Chart of the CSRC

Chairman

5 Vice Chairmen 1Assistant Chairman

Direct Affilliates Functional Departments Regional Bureaus

Internal Service Center Center Service Internal Center Research Center Information Public Of Public 1. General Office Beijing Tianjin Hebei 2. Public Offering Supervision

fering Review Committee Review fering 3. Market Supervision Shanxi Inner Mongolia Liaoning 4. Intermediary Supervision Jilin Heilongjiang Dalian 5. Risk Control Office of Securities Companies Shanghai Jiangsu Zhejiang

Administration Center Administration 6. Listed Company Supervision Ningbo Shandong Anhui 7. Investment Funds Supervision Henan Qingdao Hubei 8. Futures Supervision 9. Enforcement Bureau I Hunan Jiangxi Guangdong (Office of Chief Enforcement Fujian Guangxi Xiamen 10. Officer) 11. Enforcement Bureau II Shenzhen Hainan Sichuan 12. Legal Affairs(Office of General Chongqing Guizhou Yunnan Counsel) Tibet Shaanxi Gansu 13. Accounting(Office of General Accountant) Qinghai Ningxia Xinjiang

14. International Cooperation Shanghai Supervisory Office 15. Personnel and Education Shenzhen Supervisory Office Office of Coordination Committee 16. for Regional Bureaus Bureau of Internal Compliance

53 China,s Securities And Futures Markets

PART VI. OPENING UP & INTERNATIONAL COOPERATION

I. Opening up to the Outside World Ever since the birth of China,s capital market, great importance has been attached to its opening up to the outside world. For over a decade, a series of measures have been adopted in this regard in a gradual and steady approach.

1. Market Opening-up i. Overseas listing

Since 1992, the B shares have been issued, subscribed and traded by international investors in foreign currencies at Chinese stock exchanges. Chinese enterprises are also allowed to go public at overseas markets starting from 1993. As of the end of 2005, 111 companies had issued a total of 19.47 billion B shares, raising 5 billion US dollars. Meanwhile, a total of 122 domestic companies had issued H shares overseas, raising 55.54 billion US dollars in total. 120 of them were listed on the Hong Kong Exchanges and Clearing Ltd. (of which 11 were dually-listed in Hong Kong and New York; 4 dually-listed in Hong Kong and London; 1 triply-listed in Hong Kong, New York and London; and 2 solely listed in Singapore); and 32 companies out of the 122 H share companies issued A shares as well.

ii. Domestic listing of foreign-invested companies

Starting from November 2001, foreign-invested companies registered in China can apply for stock issuance and listing in China. They are eligible for a national treatment provided that their business plans are consistent with the national industrial development guidelines for foreign investments20. Up to date, a number of such companies21 have been listed at Chinese stock exchanges.

iii. Investing in Chinese A share market by foreign investors

In December 2002, China launched the Qualified Foreign Institutional Investor (QFII) scheme, which opened up China,s domestic A shares market to international investors. Given the non-

20. The guidelines are made by the Ministry of Commerce. 21. The exact number is not available as the shareholders are subject to changes.

54 PART VI

convertibility of Chinese currency under the capital account at present, such a move is a transitional measure to attract foreign portfolio investments and goes beyond China,s commitments upon WTO entry. As of the end of 2005, 34 overseas financial institutions had been licensed as the QFIIs with a total investment quota of 5.65 billion US dollars, and 11 banks (including 4 overseas banks) were licensed as the QFIIs, custodians. iv. Foreign strategic investors of domestically-listed companies

Starting from November 2002, the state-owned shares and legal person shares can be transferred to international investors. From 2003 to the end of 2005, 26 such transfers had taken place. Besides, starting from January 2006, international investors are also allowed to become medium to long-term strategic investors of listed companies that have concluded non-tradable share reform or post-reform newly listed companies. In such a case, foreign initial investment should be no less than 10% of the outstanding shares for a lockup period of 3 years. v. Overseas Futures Trading by Chinese Entities

Transactions in overseas futures contracts by Chinese entities are allowed under a strict control. They have to be approved by both the State Council and the CSRC, and for the purposes of hedging only. To date, 31 such companies have been approved which have discretions in choosing qualified overseas futures exchanges and brokers for investments, however, the products they trade have to be approved by the Ministry of Commerce.

2. Opening up of Services Industry

The WTO commitments on capital market upon China,s accession are: (1) foreign securities institutions may engage directly (without Chinese intermediary) in B share business; (2) representative offices in China of foreign securities institutions may become Special Members of all Chinese stock exchanges; (3) foreign service suppliers are permitted to establish joint ventures with foreign investment up to 33 per cent to conduct domestic securities investment fund management business. Within three years after China's accession, foreign investment can be increased to 49 per cent; (4) within three years after accession, foreign securities institutions will be permitted to establish joint ventures, with foreign minority ownership not exceeding 1/3, to directly engage in underwriting A shares and in underwriting and trading of B and H shares as well as government and corporate debts, launching of funds.

55 China,s Securities And Futures Markets

As of the end of 2005, Shanghai and Shenzhen Stock Exchanges had 3 and 4 overseas special members respectively. In addition, special B-share trading seats were respectively granted to 39 and 19 overseas securities companies by two Exchanges. 7 joint venture securities companies22 and 20 joint venture fund management companies had been established. The latter were managing 69 funds (31.7% of all funds) with a total of 121.6 billion units (25.8% of market share).

In addition, mainland China has a special arrangement with the Hong Kong SAR and Macao SAR in the field of financial services, which allows wider opening-up of Chinese capital market to these two regions. According to the Closer Economic Partnership Arrangement (CEPA): (1) since 1 January 2004, licensed professionals for securities and futures businesses from Hong Kong and Macao, in order to practice in mainland China, don,t need to take professional exams; instead they only need to take exams on laws, rules and regulations. By the end of 2005, 75 professionals from Hong Kong and 9 professionals from Macao had obtained mainland China licenses; (2) from 1 , January 2005, Hong Kong and Macao services providers meeting the CSRC s requirements are allowed to hold a stake in Chinese futures brokerage houses, and the first application of this kind had been approved; (3) starting from 1 January 2006, Highly compliant Chinese securities firms are allowed to set up subsidiaries in Hong Kong, and qualified Chinese futures brokerage houses are allowed for businesses in Hong Kong, including setting up subsidiaries.

II. International Exchange and Cooperation

The CSRC has always been attaching great importance to the exchange and cooperation with overseas counterparts and international organizations. Through joining international organizations, signing bilateral MOUs, exchange of visits, holding training programs, hosting or participating in international conferences, the CSRC has developed strong ties with overseas regulatory authorities.

The CSRC joined the International Organization of Securities Commissions (IOSCO) as an ordinary member in 1995 and has been sitting in the IOSCO,s Executive Committee since September 1998 for 4 consecutive terms (1998-2006). Shanghai and Shenzhen Stock Exchanges joined the IOSCO as affiliate members in 1996 and later joined the World Federation of Exchanges. The three futures exchanges also joined a number of international bodies, such as Futures Industry

, 22. Including 3 JV securities firms prior to China s WTO accession

56 PART VI

Association, International Option Market Association, Futures and Options Association, etc. By active involvements in the above organizations, these organizations can introduce to the world Chinese market developments and draw on international regulatory expertise and operation experiences.

As of December 2005, the CSRC had signed 29 MOUs with securities regulators from 26 jurisdictions (please refer to Table 6-1). The MOUs facilitate information exchange, cross-border assistance, and dialogue on policies and regulation. These MOUs also pave way for the overseas listing of Chinese enterprises, investing in China,s securities market by qualified foreign institutional investors, and the establishment of joint-venture securities companies and fund management companies. The stock and futures exchanges, industry associations and the clearing house also entered into MOUs with overseas counterparts concerning information exchanges, staff trainings and research cooperation. In summary, the MOUs establish an effective channel of communications that helps to improve mutual understandings and facilitate exchanges between Chinese and overseas counterparts.

In June 2004, the CSRC established its think tank International Advisory Council (“IAC”) consisting of over ten international experts and scholars. The mission of the IAC is to collect the views and advice of international financial experts regarding the reform and growth of China,s capital markets, and to keep the CSRC abreast of the latest issues and trends in the global financial markets. The IAC normally holds a meeting annually, and its first and second meetings were held in Beijing (September 2004) and Shanghai (June 2005) respectively.

57 China,s Securities And Futures Markets

Table 6-1 List of MOUs Signed by the CSRC with Overseas Authorities (As of December 2005)

Date Overseas Authorities MOU Titles

19 June 1993

4 July 1995

U.S. Securities and Exchange 28 Apr. 1994 Commission

30 Nov. 1995

23 May 1996

7 Oct. 1996

18 Mar. 1997

18 Apr. 1997

13 Nov. 1997

22 Dec. 1997

4 Mar. 1998

18 May 1998

8 Oct. 1998

3 Nov. 1999

22 June 2000

19 June 2001

18 Jan.2002

27 June 2002

29 Oct. 2002

1 Nov. 2002

26 Nov. 2002

21 Mar. 2003

22 May 2003

9 Dec. 2003

20 Feb. 2004

14 Oct. 2004

26 Oct. 2004

14 June 2005

27 June 2005

58 PART VI

Annex: Contact Information of Relevant Institutions

Name Address Website Telephone Fax Email

China Securities Focus Place, 19 Jin Rong Regulatory Street,Xicheng District, www.csrc.gov.cn 8610-88061000 8610-66210119 [email protected] Commission Beijing 100032, China

F22-23 Investment Plaza 27 www.chinaclear. webmaster@chinaclear. Jinrong Street, Xicheng 8610-66210988 8610-66210938 CSDCC com.cn com.cn District Beijing, 100032, China

Securities B Focus Place, 19 Jin Association Rong StreetXicheng District, www.sac.net.cn 8610-88087770 8610-88087084 [email protected] of China Beijing 100032, China Taiyang Securities Building, China No. 34 Fu Wai Da Jie Futures www.cfachina.org 8610-68573109 8610-68571529 [email protected] Street,Xicheng District Association Beijing 100037, China

Shanghai 528 Pudongnan Road, webmaster@secure. Stock Shanghai, www.sse.com.cn 8621-68808888 8621-68804868 sse.com.cn Exchange 200120, China

Shenzhen 5045 Shennan East Road Stock www.szse.cn 86755-82083333 86755-82083947 [email protected] Shenzhen, 518010, China Exchange

Shanghai 500 Pudian Road, Futures Pudong New Zone www.shfe.com.cn 8621-68400000 8621-68401198 [email protected] Exchange Shanghai 200122, China

Dalian No. 18, Huizhan Road Commodity Dalian 116023, China www.dce.com.cn 86411-84808888 86411-84808880 [email protected] Exchange

Zhengzhou 69 Weilai Avenue Commodity Zhengzhou, 450008, www.czce.com.cn 86371-5610069 86371-5613068 [email protected] Exchange China

China Securities Focus Place, 19 Jin Rong Investor 8610-88060055 8610-88060107 [email protected] Protection Street Xicheng District, Fund Co. Beijing 100032, China

Special thanks are hereby acknowledged to the “Securities Knowledge Manual” (Editor-in-chief: ZHOU Zhengqing). All rights reserved by China Securities Regulatory Commission (CSRC). Unauthorized publication or any commercial use without a prior consent of the CSRC is strictly prohibited. The information contained herein is for readers, references only, and the CSRC shall not be held liable for any consequences arising from its use.

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