Description of the chinese stock market and its mechanisms: Shenzhen stock exchange, Shanghai stock exchange, trading rules, structure of the chinese equity market, size (2019), types of orders, circuit breakers and special mechanisms, T+0 and T+1 rules and discussion

1. Arthur MEUNIER – arthur.meunier@cpe.fr
https://www.linkedin.com/in/meunierarthur
The Chinese Equity Market
(Secondary)
January 2019
Prof. WeiXu

2. 2
Structure & size
1.1 Definition of Equity Market:
• Market in which shares are issued and traded, either through exchanges or over-the-counter
markets (OTC).
• Gives companies access to capital and investors a slice of ownership in it (and the opportunity to
realize gains based on future performances).
• Also known as Stock Market.
1.2 Structure of the Chinese Equity Market (Mainland)
Organigram of the main organs of the Chinese equity market
2 Kinds: Formal stock markets and OTC market.
SSE and SZSE: Shanghai and Shenzhen Stock
exchanges.
OTC market: Securities negotiated and sold
outside the supervision of stock exchanges
(NEEQ).
All markets under the regulation of the CSRC
(China security regulatory commission).

3. 3
A multi-layer market
SME Board OTC marketChiNext
Structure of the Chinese equity market: multi-leveled system
Mainboard Markets
Second Board Market
Third Board Market
Mainboard market
Well established
companies
(SOEs mainly).
Start-ups and SMEs
not yet listed
High Tech
companies and
active startups.
1990 2004 2009 2013
Small and
Medium-sized
Enterprises.
Highest listing
requirements
Same requirements
than Mainboard
Moderate listing
requirements
Lowest listing
requirements
Lowest Risks (SOEs) Normal Risks Risky Speculative
All investors All investors All investors Professionals:
Min 5 MRMB capital

4. 4
A-shares denominated in RMB and open to domestic investors only (Historically)
B-Shares denominated in foreign currencies (USD mostly) and open to foreign
investment only. (not very successful).
2001: B-shares opened to domestic investors.
2003: A-shares opened to selected foreign institutions (QFFI program)
Since 2014: The « Stock Connect » program between Hong Kong (HKex), Shanghai
(SSE) and Shenzhen (SZSE) allows both Chinese and international investors to
exchange and trade securities between markets through the clearing of their home
Exchange.
1.3 The A/B shares structure (1990)
Foreign investment and opening up

5. 5
Size
Size of the equity market (end year, trillion RMB), Source: Exchanges’ websites Number of companies listed by market (end year), Source: Exchanges’ websites
1.4 Size of the Chinese equity market (Dec 2018)
• A-B shares of SZSE stable over the period
• Growing A-shares listing on SSE
• Booming number of companies listed on OTC
markets (lower listing requirements)
• Relatively good performance after the 2008 crisis;
• Bear market in 2011: Fear of contagion of the European
sovereign debt crisis.
• Summer 2015: Market correction after over 1 year of
frenzie (-30% CSI 300 in 3 weeks)
• New market correction mid-end 2018: trade-war threat
and following bad performances of the US markets.

6. 6
Doesn’t represent the economy (only
about 1/3 of the economic output is invested
in stock)
For most developed economies, this value
is relatively at 100%
(Amadeo, 2018)
About 7% of the population owns stocks.
Only 20% of household’s wealth is
invested into the stock market
Mostly invested in the real estate market
or in personal savings.
(Holodny, 2015 & Amadeo, 2018)
Many companies listed are SOEs: tight
government control on the value of stocks
(Act as a buffer)
May have a dissuasive effect on
investors.
Some take aways
1.5 Comparison with the USA
GDP and Stock Market Investor’s Behaviors
SZSE Survey
75% of the investors are individuals with
investments bellow 500k RMB (on SZSE).
Individuals are becoming more rational:
stronger interest for long term positions
rather than short term trading.
(China Daily, 2018)
SOEs

7. 7
Exchanges
Definition
An exchange, or bourse also known as a trading
exchange or trading venue, is an organized market
where (especially) tradable securities, commodities,
foreign exchange, futures, and options contracts are
sold and bought.
Core Function
Ensuring fair and orderly trading (counter party),
improve liquidity, manage clearing and settlements as
well as incorporating price information efficiently for
any securities traded on the exchange.
2.2 Main Exchanges in China
Shanghai Stock Exchange (SSE)
Shenzhen Stock Exchange(SZSE)
The Hong Kong Exchange (HKEX)
Main Index: CSI 300
2.1 Definition

8. 8
Three Main Exchanges
• History
1891: "SH share brokers' association"
Stop: Japan war & Cultural
Revolution
1990: SSE re-established
• Structure
"A" shares （RMB）
"B" shares （U.S. dollars）
• Index: SSE Composite
Weighted composite：size
Constituents：all listed stocks (A
A shares and B shares)
Market composition between SZSE and SSE by sectors (Source: HKEX, 2017)
• History
stock market (established in 1891)
derivatives market (1976)
In 1986, four stock exchanges merged
to form the HKEx
• Index: Hang Seng Index (HSI)
tracks the performances of the 50 main
companies
• Linked with SSE & SZSE
allows Chinese citizens & institutions
access to foreign stocks , foreign
investors to invest
• History
1990: Main board
2004: SME board
2013: ChiNext board (Tech)
• Structure
smaller, more entrepreneurial companies
（technology & manufacturing）
more innovative and more profitable
• Index: SZSE Composite
a market-cap weighted index

9. 9
Trading Arrangement
Note: For securities market (not derivatives) – Shanghai & Shenzehn

10. 10
Price determination mechanisms
• Two different ways to match transactions and settle prices.
Call Auction Mechanism
• Interested buyers set the maximum price they
intend to buy and sellers the minimum price they
intend to sell for the upcoming trading day.
• Transaction Completion Principles
- All buy orders with higher bid price and all sell
orders with lower offer price matched and executed;
- Price which allows to minimize the difference
between the number of buy orders with identical or
higher price and the number of sell orders with
identical or lower prices become the Execution price
• Transaction Matching Principles
‒ price priority
‒ time priority
• Increase liquidity;
• Decrease volatility;
• Set opening and closing prices.
Continuous Auction Mechanism
• Orders can be placed freely at any point of time.
• Real-time price determination:
‒ Displays the price of every minute’s last
transaction per minute
• Price Determination Principles:
‒ If highest purchase price = lowest sale price, then
this price = transaction price;
‒ If bid price > the lowest currently available ask
price, ask price = execution price (mistakes
protection for buyer);
‒ If ask price < the instant highest bid price, bid
price = execution price (mistakes protection for
seller).
• Same transaction matching principles than
for the call auction.
9:15 to 9:25 and 14:57 to 15:00 9:30 to 11:30am and 13:00 to 14:57pm

11. 11
Types of Orders
Buy or sell at the current market price.
• Only set the shares number;
• Common, easy to execute;
• Fulfilled quickly;
• No control on final Price;
• During continuous auction only;
Market Order Limit Order
Buy or sell at a specified price or better.
‒ Define price requirements:
1. Limit Order to Buy = at or below the market
2. Limit Order to Sell = at or above the market
‒ Usually longer to fulfill entirely, especially
for big orders.
‒ Limit can also never be reached (lower deal
closing rate).
Basic
Orders
SSE limit order placement toolbox
Orders types for in China and HK are limited compared to
other important stock exchanges worldwide like NYSE
which is more flexible (stop loss orders, OCO, OTO…)
In China: Market order = Limit order

12. 12
Market Order in SSE
Two types:
1- Executed VS the current 5 best
prices (opposite side)
 portion not filled cancelled.
2- Executed VS the current 5 best
prices (opposite side)
 portion not filled is changed into
limit order (price limit = last executed
price)
Types of Orders
Market Order in SZSE:
Five types:
1- Same than (1) on SSE
2- Same than (2) on SSE
3- Price set at the opposite side’s best price.
4- Price set at the same side’s best price
5- Fill or Kill (FOK): Executed fully VS all
the orders of the opposite side at the time the
order is placed. If not totally filled 
cancelled entirely.
Seller’s opposite side
Buyer’s opposite side
Typical « live » order book (continuous auction)
5 current best
buying prices
5 current best
selling prices

13. 13
Circuit breakers: Introduction
• Introduced first in the US after the 1987’s crash (Black Monday) to protect the market from
speculations, trading mistakes and potential errors;
• Built on Indexes and/or on single stocks;
• Stop the trading on the whole market/stock for a defined period of time if Index/stock
goes up and/or down X% of its previous close or X% within a given time interval;
• Circuit breakers implemented in 24 out of 40 exchanges in 2008 (WFE):
Breaks if: 𝐗% < 𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑐𝑙𝑜𝑠𝑒 × %𝐶ℎ𝑎𝑛𝑔𝑒𝑡 < X%
Or 𝐗% < 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑟𝑖𝑐𝑒𝑡−𝑋 𝑚𝑖𝑛,𝑡 × %𝐶ℎ𝑎𝑛𝑔𝑒𝑡 < X%

14. 14
Circuit breakers: China
CB on CSI 300:
On Jan 1, 2016: after one year of discussion between regulators and stakeholders, the first
circuit breaker mechanism on CSI 300 Index was implemented on SHSE & SZSE.
On Jan 7: Abolished – Market reopened circuit-breaker free on Jan 8.

15. 15
1. CB on single stocks (Dec 1996: SSE and SZSE)
• Daily price limit calculated as % of change from last closing price
• Once the limit is reached, trading is still possible if deals are made within the limits,
Limit for: X% < 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑑−1 × %𝐶ℎ𝑎𝑛𝑔𝑒 𝑑 < X%
 Different with USA & HK (Calculated over the last 5min, breaks for 5min)
• With X =
- 10% for “regular” stocks (not ST/ST*) and mutual funds;
- 7% for stocks listed on SME board (Small and median enterprises);
- 5% for stocks under Special Treatment (ST: Financial distress & ST*: under risk of
delisting).
• In the particular case of IPOs (A-shares), both exchanges introduced in 2015 a cap
limit for the first day gains and losses at +44% and -36%.
• No limits on the next day once the limit has been reached.
Circuit breakers on individual stocks

16. 16
Daily Price Limits and Destructive Market Behavior (Chen and Al, 2017)
Chen and Al use account-level data from the Shenzhen Stock Exchange and found that
daily price limits may lead to unintended, destructive market behavior: large investors
tend to push stocks price up in order to hit the 10% upper price limit and then sell off on
the next day (market manipulation, leveraged by the T+1 trading rule);
Discussion
Note/Explanation: The Shenzhen stock market is dominated by
individuals. Institutions have sufficient funds to manipulate
prices. Because of the T+1 trading rule (see after), a security
bought today can only be sold on the next day. By pushing up
the price of a stock by 10%, Institutions can manipulate the
market by sending misleading signals to individual traders
about the value of a stock or potential inside trading. On the
following day, as daily traders that are using technical analysis
and sensible to momentums, some will get in the trap and start
buying attracted by a potential fast return, so the price of the
security is likely to keep going up. At the end of the day (or at
any point they estimate maximizing their profit), institutions will
sell off their shares at a higher price they paid the previous day.
But daily traders that are following this security at the time
cannot follow and sell to limit their loss because of the T+1 rule.
Consequently, those rules favor market manipulations.
This strategy is also called « pump and dump » and
is considered as a fraud by the SEC in the US or the
ESMA in Europe. Institutions might be responsibles for market volatility

17. 17
17
Other special mechanisms
1 – Trading suspensions:
• Companies or Stock Exchanges (CSRC) may suspend the trading of stocks from 10 days to 6
months.
• “Freeze” the trading of the stock and consequently its value.
• Analysts report abusive use of this option, particularly to protect SOEs.
• In 2015, 1400 companies filled for a halt after the CSI 300 felt by 30% over 3 weeks (June):

18. 18
2 – Stabilization fund:
• Created in 2015 after the crash (128 billions RMB injected into « China Securities Corp »
fund);
• Can be unlocked to temporary cool off the market and reduce panic effect;
• Intend to act as buffer;
3 – Currency devaluation:
• Used as proxy for market’s fluctuations;
• Send messages to investors about economy
and especially exports;
• Currency’s depreciation boost exports
(lower costs for foreign importers) In August 2015, the PRC conducted three successive devaluations of the RMB dropping its value
by 3% against the dollars in an attempt to cool down the stock market.
Other special mechanisms

19. 19
Introduction to “T + 0”
■Generally, a settlement rule.
■“T + 0”: transaction date plus zero day settlement
“T” - Transaction date; “0” - Days it takes to settle a financial
transaction
■Transaction date & settlement date
– Transaction date is the date at which transaction
happened
– Settlement date refers to the date at which the buyer must
settle the payment and the ownership transferred
Buy
Can sell
Settled
1st
DAY
“T+0”(Settlement)

20. 20
“T + 0” as “Day Trade” in China
■Things can be different in China: a Day Trade rule
Wu & Wang (2007) points out that for most domestic Chinese
investors even researchers, “T + 0” means “Day Trade” instead
of a rule of “settlement”.
■“Day Trade”
A rule that the purchase and sale (or the short sale and cover)
of the same security on the same day, also called “daylight
trade”(Wu & Wang, 2007).
■History
Initially, A & B, T + 0
1995 A to T + 1; 2001 B to T + 1
Buy
Can sell
Not Settled
1st
DAY
“T+0”(Day Trade)
Time A-share B-share
Convertible
Bonds*
May. 1992 – Nov. 1993 T + 0 T + 0
Jan. 1995 T + 1 T + 0 T + 1
Dec. 2001 T + 1 T + 1 T + 0
Aug. 2008 T + 0
* Listed for comparson
Buy
Can sell
Settled
1st
DAY
“T+0”(Settlement)

21. 21
Comparison with other countries
Country
(District)
Day Trade
(“T + 0”)
Standard
Settlement
Notes
U.S. Yes T+2 Depends on account; PDT and other rules
U.K. Yes T+2 Small size
JP Yes T+2 Limits on frequency
TW Yes T+2 Only for margin accounts and other rules
HK Yes T+2 coordinate with brokers
India Yes T+3 Only for individuals and other rules
Thailand Yes T+2 Up to 4 * Margin for individuals
Canada Yes T+2 Special regulation
Netherlands Yes T+2 License
Germany Yes T+2 Special trading instructions
China No T+1-3 See after

22. 22
Settlement Cycle: U.S. vs. CN
Transaction
3rd
DAY
4th
DAY
T + 0
Transaction
Can’t sell
Can sell
Settled
2nd
DAY
1st
DAY
CN(A-share)
T +1
Settlement
Transaction
T + 0
Transaction
T + 2
Settlement*
Can sell*
2nd
DAY
3rd
DAY
1st
DAY
Settled
U.S.
• From T + 3 to T + 2: SEC adopts T + 2 settlement cycle at Sept. 5th 2017 according to
lately announced Rule 15c6-1 see: https://www.sec.gov/news/press-release/2017-163
T + 0
Transaction
T + 3
Settlement
Can’t sell
Can sell
2nd
DAY
3rd
DAY
1st
DAY
Settled
CN (B-share)
4th
DAY
T +1

23. 23
Debates on “T + 0”(Day Trade) in China
Pros
• Allows error’s correction
“T + 0” rule provides a chance for investors to correct their
errors quickly especially in some highly volatile situations.
• Enhance pricing efficiency
“T + 0” rule ensures that stocks’ prices effectively represent
their real prices at a specific moment, which is a benefit for
investors, market efficiency, stock exchange (liquidity) and
listed companies themselves.
• Accelerating funds cycling
Investors can adjust their holdings in a single day to
accelerates the existing funds of a stock market.
• Fairness for investors
Different regulation in futures may be discriminative
especially regarding individual investors with lowest
investment capacities.
Cons
• Risks of settlement
“T + 0” brings frequent trades and
settlements which raise the settlement risk
for security companies, settlement
companies (costs), and even the whole
market (fees).
• Speculation
The great amount of individual investors
acting on China’s stock market should still
be considered as a leverage for speculative
trades
• Price volatility
Since China’s stock market is relatively
active and volatile, allowing day trades may
lead to even higher volatility.

24. 24
Empirical Implications
■ Chen, Liu, and Zeng (2017) found that “T + 1” INVOLVES MORE SPECULATION and
REDUCE PRICE EFFICIENCY when the market liquidity is not in a shortage.
■ Zhiyong Tu, an associate professor of PHBS, found that “T + 1” REDUCES TRADING
VOLUMES and PRICE VOLATILITY (Guo and al., 2012).
Fig. Differences of volumes and volatilities under ‘‘T + 0’’and ‘‘T + 1’’Trading Rules, 1999–2003. (Guo, M., Li, Z.,
& Tu, Z., 2012)
Trading Volume
𝑃 < 2.2𝑒−16
Price Volatility
𝜎ℎ𝑖𝑔ℎ−𝑙𝑜𝑤
< 2.2𝑒−15
Price Volatility(STD)
𝜎 𝑠𝑡𝑑
< 2.2𝑒−15

25. 25
Conclusion
• Still underdevelopped compared to western economies;
• Lack of private insurances, pension funds and mutual funds to manage
individuals’ wealth and eventually invest it in the equity market.
• To some extent, controlled by the government and dominated by SOEs;
• Speculative with an important proportion of individuals;
• Highly regulated which may bridle domestic and foreign investments;
• More reforms expected with progressive economic opening.