(Article from Registered Funds Alert, September 2015)
For more information, please visit the Registered Funds Alert Resource Center.
In November 2014, China launched the Shanghai-Hong Kong Stock Connect (“Stock Connect”), which allows foreign investors to trade shares listed on the Shanghai Stock Exchange (“SSE Shares”). While the launch of Stock Connect was greeted with enthusiasm, many investors have expressed concerns about the legal regime governing the program. In particular, there has been doubt over whether Chinese law recognizes the concept of beneficial ownership, and if the concept is recognized, whether investors can enforce their ownership rights.
Under the rules governing Stock Connect, the SSE Shares acquired by foreign investors are held in an omnibus account with Hong Kong Securities and Clearing Company Limited (“HKSCC”). Governed by a civil law system, China traditionally lacked the concepts of beneficial ownership and trusts. Therefore, initially it was unclear whether HKSCC merely holds the SSE Shares in trust for investors, and whether investors have beneficial ownership in the SSE Shares.
In response to investor concerns, the Chinese Securities Regulatory Commission (the “CSRC”) published a “Frequently Asked Questions on Beneficial Ownership” in May 2015. In the FAQ, the CSRC identifies the basis for nominee shareholding under Chinese law and concludes that, for purposes of the Stock Connect, overseas investors “are entitled to proprietary interests” in the SSE Shares held through HKSCC. These investors must exercise their rights over the SSE Shares, such as the right to participate in shareholders’ meetings and the right to receive dividends, through HKSCC as the nominee holder.
With regard to the question of enforcement, the CSRC acknowledges there is some legal ambiguity: “Mainland law does not expressly provide for a beneficial owner under the nominee holding structure to bring legal proceedings, nor does it prohibit a beneficial owner from doing so.” Nonetheless, based on its interpretation of China’s civil procedure, the CSRC stated its position that a foreign investor “may take legal action in its own name in Mainland courts,” as long as the investor can “provide evidential proof of direct interest as a beneficial owner.”