The recent announcement by the Shanghai and Shenzhen stock exchanges regarding updates to their business guidelines has garnered surprisingly little attention, yet it holds significant implications for the capital marketsThese updates aim to clarify and enforce regulations concerning major shareholders of listed companies, particularly those who hold more than 5% of a company's shares.

Under the new guidelines, even if a major shareholder lends out their shares through a financing mechanism and temporarily drops below the 5% holding threshold, they are still required to have their lent shares included in their total ownership calculationThis adjustment ensures that these shareholders are still governed by the same rules that pertain to larger stakeholders, maintaining a level of oversight that is crucial for market stability.

Furthermore, when companies disclose shareholder changes in their annual, semi-annual, or quarterly reports, they must now include detailed information about the number and percentage of shares lent out via this financing mechanism by both major shareholders and the top ten shareholders

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This requirement enhances transparency, offering a clearer picture of important stakeholders' activities and aiming to prevent potential misinterpretations similar to past occurrences where locked-in shareholders seemingly vanished from shareholder lists.

To delve deeper into this context, we should clarify what this financing method, known in China as 'Zhuanrongtong,' actually entailsThis mechanism is administered by the China Securities Finance Corporation (CSFC), which provides loans of funds and securities to brokerages to facilitate their margin trading servicesThe Zhuanrongtong system consists of two primary components: the 'Zhuanrongquan' (which allows for the lending of shares) and the 'Zhuanrongzijin' (which enables the lending of funds). Essentially, it provides necessary resources for brokerages when they face funding or securities shortages.

Though this mechanism appears straightforward, it presents complexities that can sometimes blur the lines of accountability

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When a major shareholder, typically defined as someone holding over 5% of a listed company's shares, utilizes this system, it complicates their role and responsibilities within the companyThe designation of a major shareholder is serious; their ability to freely transact can have ripple effects throughout the marketIf these shareholders were allowed unfettered access to sell their shares, there's a risk of creating panic among investors, which could lead to an exodus of capital, causing significant volatility that threatens the stability of the market.

Thus, to mitigate risks associated with the hasty and unpredictable selling of shares by major stakeholders, regulatory constraints are necessaryFor instance, if a major shareholder intends to sell their stake through a central auction, they are mandated to announce their intentions at least 15 trading days in advanceAdditionally, the total amount of shares sold within a 3-month window cannot exceed 1% of the total company shares, which is a protective measure against large-scale sell-offs.

This revision of the rules stems from the identification of a loophole within the existing framework that allowed for undesirable practices

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Previously, a shareholder who lent out 1% of their holdings could technically report that they held less than 5% of the company, thereby evading the restrictions that typically apply to large shareholdersBy effectively temporarily removing their shares from the market through lending, they could sidestep the regulatory framework related to sellingThis led to a misrepresentation of their actual holdings.

The exchanges have recognized the detrimental effect such practices have on the integrity of the market and have moved to close this gapUnder the new provisions, a major shareholder must now include any shares lent out in their overall shareholding calculationThis adjustment ensures that the shareholder's status does not change, closing the door on previous exploitations that allowed them to circumvent rules meant to enforce stability.

In effect, this means that no matter how many shares a major shareholder lends out via Zhuanrongtong, as long as they still hold a combined total of over 5% when accounting for lent shares, they remain subject to the same regulations regarding selling and short-term trading as before

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For instance, they cannot arbitrage by simultaneously lending shares while also engaging in new positions for financing or selling on margin.

Historically, the absence of specific clauses in securities law outlining improper reduction of holdings created numerous opportunities for questionable behaviors among shareholdersThis new rule not only standardizes these practices, but it also aims to fill in regulatory gaps that have previously been exploitedUltimately, these changes seek to enhance protections for minority investors, who often find that their interests are compromised when major shareholders engage in unsupervised stock sales.

For instance, previous scenarios have seen major shareholders conducting low-price sales while collaborating with market manipulators, leading to the unjust exit of unwitting retail investors from the marketBy introducing stringent regulations on how major shareholders manage their stakes, the exchanges hope to elevate the standards of equity trading, prizing the principles of transparency and fairness