APR 2 ò 1993 

Our Ref. No. 92-S11-CC
 

custody of B Shares


Trading on the 

Shenzhen and Shanghai
 

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Securi ties Exchanges
 

DIVISION OF INVESTMENT MAAGEMENT File No. 132-3
 

Your letters of August 31, 1992 and March 10, 1993, request
 

our assurance that we would not recommend enforcement action to
 

the Commiss ion under section 17 (f) of the Investment Company Act
 

of 1940 ("1940 Act") and Rule 17f-S thereunder if registered
 

investment companies maintain custody of "B" shares listed on the
 

Shenzhen Stock Exchange ("Shenzhen Exchange") and the Shanghai
 

Securities Exchange ("Shanghai Exchange") through the facilities
 

of one or more of ten financial institutions 1/ that act as
 

custodians or subcustodians for the assets of registered
 

investment companies. ~I
 

In Jardine Fleming China Region Fund, Inc. ("Fund") (pub.
 

avail. Apr. 26, 1993), the staff assured the Fund that it would
 

II Bankers Trust Company, The Bank of New York, Boston Safe


Deposit and Trust Company, Chase Manhattan Bank NA, Chemical
 

Bank, citibank NA, Hongkong and Shanghai Banking Corporation
 

Limi ted, Morgan Guaranty Trust Company of New York, Standard
 

Chartered Bank, and State Street Bank and Trust Company.
 

~I Section 17(f) of the 1940 Act provides that every registered


management investment company shall maintain its securities
 

and similar investments in the custody of (1) a bank meeting
 

certain requirements, (2) a member of a national securities
 

exchange, (3) the company itself, in accordance with
 

Commission rules, or (4) a system for the central handling
 

of securities pursuant to which all securities of any
 

particular class or series of any issuer deposited wi thin
 

the system are treated as fungible and may be transferred or
 

pledged by bookkeeping entry without physical delivery of
 

such securities, in accordance with Commission rules. Rule
 

17f-S provides an exemption from Section 17(f) to allow a
 

registered management investment company to deposit foreign
 

securities in the custody of an "eligible foreign
 custodian." Rule 17f-S(c) (2) (i) defines the term "eligible 

foreign custodian" to include "a banking institution or
 

trust company, incorporated or organized under the laws of a
 

country other than the United States, that is regulated as
 

such by that country's government or an agency thereof and
 

that has shareholders' equity in excess of $2 00, 000, 000. "
 

Rule 17f-5(c) 
 (2)(iii) defines the term "eligible foreign
 

custodian" to include "a securities depository or clearing
 

agency, incorporated or organized under the laws of a
 

country other than the United States, which operates the
 

central system for handling of securities or equivalent
 

book-entries in that country."
 
not recommend enforcement action to the Commission under Section
 

17(f) or Rule 17f-S(c) (2) (i) if the Fund, through its global
 

custodian, held "B" shares listed on the Shenzhen Exchange on the
 

books of a Shenzhen branch of aU. S. bank and on the books of
 

Shenzhen branches of foreign banks (together, "Agent Banks").
 

Our position was based, in part, on the Fund's representations
 

that 1) each of the Agent Banks is either a foreign branch of a
 

U. S. bank that has shareholders' equity in excess of
 

$100,000,000, or a branch of a foreign bank that has
 

shareholders' equity in excess of $200 million; and 2) each of
 

the Agent Banks acts as the sole registration institution for a
 

particular issue of "B" shares, maintains a computerized book-


entry system, and issues a share registration receipt in


connection with each trade. 

The staff also assured the Fund that it would not recommend
 enforcement action to the Commission under Rule 17f-5(c) 
 (2) (iii) if the Fund, through its global custodian, held liB" shares listed
 

on the Shanghai Exchange in an account in the book-entry system
 

of the Shanghai Exchange. Our position was based, in part, on
 

the Fund's representations that the Shanghai Exchange is the
 

central book-entry depository and sole clearing agent, transfer
 

agent, and registrar of all "B" shares traded on that


Exchange. 1.1 

Accordingly, on the basis of our response to the Fund and on
 

the facts and representations in your letters, but without
 

necessarily agreeing with your legal argumentsL we would not
 

recommend enforcement action to the Commission if registered
 

investment companies maintain custody of "B" shares listed on the
 

Shenzhen Exchange and the Shangha i Exchange through the
 

facil i ties of one or more of the ten financial institutions named
 

in your letter that act as custodians or subcustodians for the
 

assets of registered investment companies, in the manner
 

described in the staff's letter to the Fund.
 

This enforcement position is further based on your
 

representation that each of the ten financial institutions agrees
 

that if it is the custodian for a registered investment company,
 

it will forward a "B" shares confirmation request received from
 

that company to the appropriate subcustodian, and if it is a
 

subcustodian for a registered investment company, it will forward
 

such a request received from the primary custodian (or from a
 

higher-tier subcustodian) to either the appropriate next-tier
 

1./ In Hong Kong Securities Clearing Co. Ltd. (pub. avail. Sept.
 

8, 1992), the staff granted no-action relief under Rule 17f­ 5(c) (2) (iii) to an entity that operated the only central 

system for the handling of book-entry securities traded on
 

the Hong Kong Stock Exchange.
 

- 2 ­
subcustodian or to the appropriate "B" shares book-entry system.
 

This position is based on the facts and representations in
 

your letter; any different facts or representations may require a
 

different conclusion. This letter expresses the Division's
 

position on enforcement action only and does not purport to
 

express any legal conclusions on the issues presented.
 

~~p~~ Senior Counsel
 

- 3 ­
BAKER & MÇKE~zlE
 

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ArJ (LA G- I CJ L/ (: 

SECTON 

RULE i'(-Ç - s:

PUBLIC L-( l' I 0, ~ VIA MESSENGER
 A VAILABIl _ LG. (. :-_ 

Gene r.. Goh lke
 

Associate Direct:)~

Division of Investrrent !'~è. ~ a 9 e:7.e:-:. 

Secur i ties anè Exchange CC:7..-:,issic:-. 

450 Fifth Street, N. K.
 

Kashington, D.C. 205";9
 

Robert B. Carrell 

Senior Special Counsel
 

Di vision of Investment ~anage~e~t
 

Securities and Exchange CC7.~lss:e~
 

450 Fifth Street, N.w.
 

Kashington, D.C. 20549
 

Re: Custody Pursuant to Investment Company Act
 

Rule 17f-S of B Shares Trading on the Shenzhen
 

and Shanghai stock Exchanges/Supplement to
 

No-Action Request dated Auqust 31, 1992
 

Dear Messrs. Gohlke and Carroll: 

This is in response to our recent telephone conversations
 

concerning Baker & McKenz ie's pending no-action letter request
 

regarding the application of Investment Company Act Rule 17f-S te
 

custody of B shares trading on the Shenzhen and Shanghai stock
 

exchanges in the People's Republic of China. In those
 

conversations, you have indicated that, in the context of a
 

Commission inspection of a registered fund which held B shares, the
 

staff might wish to review documents conf irming the fund's B shares
 

posi tion. Accordingly, you asked that I supplement the no-action


request with information concerning this issue. 
BAKER &. ~lÇKE~ZlE 

Gene A. Gohlke
 Robert B. Carroll 

Division of Investment
 

Management 

Page 2
 

As you are aware, Rule 17f-S provides that investment company
 

assets may be held in custody pursuant to the rule only if a
 

majority of the investment company's directors have approved a
 

wri tten contract which requires, among other things, that -­

"(D) Adequate records will be maintained identifying the

assets as belonging to the company;
 

II (E) The company's independent public accountants will be

gi ven access to those records or coni irmation of the contents of those records ¡and 

i' (F) The company ~ill receive periodic reports ~ith respect
 

to the safekeeping of the company's assets, including, but not
 1 ir.,i ted to, not i fica t i on of any transfer to or fro;: the

cor.ipany's account." Rule 17f-5(a) (1) (iii) (D)-(F). 

Our no-action reques~ does not seek rel ief from, or modif ication 

of, these requirements. Accordingly, if our request is granteà,
 

these requirements will remain fully applicable to any custoày
 

agreement under which our clients hold B shares for the account of
 

a reg istered investment company.
 

We believe that these provisions should largely satisfy the
 

staff's concerns regaràing its ability to obtain confirmation, in
 

the context of an inspection, of a fund's B shares position. The
 

staff would routinely have access to the periodic reports which
 

such a fund had received from its custodian regarding the fund's B
 

shares. Moreover, if the staff wished to obtain and revie~ a
 

specific confirmation of a fund's B shares position as of a given
 

date, it could request that the fund instruct its accountants to
 

obtain such a confirmation, as contemplated by Rule 17f­ 5(a) (1) (iii) (E). B shares custodians and subcustodians will 

necessarily base their records, confirmations, and periodic reports
 

on the data supplied to them by the B shares clearing banks which,
 

as set forth in our no-action request, reconcile their records to
 

those of the Registrars Co. (in Shenzhen) or of the exchange itself
 

(in Shangha i) . 
B.-lR &. ~j:çKE~ZIE
 

Gene A. Gohlke
 

Robert B. Carroll
 

Division of Investment
 

Management 

Page 3
 

You have, however, also asked that, as an element of their no-


action request, our clients represent to the staff that, if so
 

instructed by aU. S. -registered investment company for which they
 

act as custodian or subcustodian, they would apply to the relevant
 

B shares book entry system for confirmation of that fund's B shares
 

position. As explained in our August 31 letter, in Shenzhen this
 

system consists of the three registration banks and the Registrars
 

Company ¡ in Shanghai, the exchange itself maintains the book entry
 system. Our clients have each individually authorized us to 

respond to the staff's concern by representing that, where one of
 

them is the U. S. custodian for a fund , it will forward a B shares


conf irmation request recei ved fr~m that fund to the appropriate 

sUbcustodian¡ ~here one of them is a subcustodian, it will for~ard
 

such a request received from the primary custodian (or from a
 

higher-t ier subcustodia:-) to either the appropriate next-tier
 subcustodian or to the õppropriate B shares book entry syste~.: 

Please contact Daniel L. Goelzer or Simon Zornoza of Baker &
 

McKenzie (Washington) at 202/452-7013 if you have further questio~s
 

concerning this matter. As I know you are aware, there is great
 

interest in B shares investment among registered funds, and ~e look
 for~ard to final actic~ on our no-action request as soor. as possible. 

Sincerely i 

~~~~'o~z~)) 5\ 

Our August 3 i, 1992 no-action request was submi tted o~
 behalf of the ten financial institutions listed therein. In a 

given case, one or more of these institutions may act as custodia~
 

or subcustodian for a particular registered investment company.
 

Our clients make no representation concerning the procedures and
 

practices of the Shenzhen or Shanghai book entry systems for


responding to conf irmation requests. 

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Z _0= :­ August 31, 1992 

ICA section 17 (f)

ICA Rule 17f-5 

DELIVERED BY HAND
 

Office of the Chief Counsel
 

Division of Investment Management
 

Secur i ties and Exchange Commi ss ion
 

450 Fifth street, N.W.
 

Washington, D.C. 20549
 

Re: Custody of B Shares Trading on the
 

Shenzhen and Shangha i Securities Exchanqes
 

Ladies and Gentlemen:
 

We are counsel to the following ten financial institutions
 

that act as custodians or subcustodians for the assets of
 

registered investment companies:
 

Bankers Trust Company
 

The Bank of New York
 

Boston Safe Deposit and Trust Company
 

Chase Manhattan Bank NA
 

Chemical Bank
 

ci tibank NA
 

Hongkong and Shanghai Banking Corporation Limited
 

Morgan Guaranty Trust Company of New York
 

Standard Chartered Bank
 

State Street Bank and Trust Company
 

On behalf of these institutions, we request the assurance of the
 

Staff of the Division of Investment Management that it will not
 

recommend enforcement action under section 17 (f) of the Investment
 

Company Act Df 1940 against any registered investment company that
 

maintains cùstody of B shares traded on the Shenzhen or Shanghai
 

securi ties exchanges through the facilities of one or more of our
 

clients. As set forth belm.,', we believe that the book-entry


systems establ ished for each of these exchanges as the excl usi ve 
B.-\KER o. ~ll\E::ZIE
 

Off ice of the Chief Counsel
 

Di vision of Investment Management
 

Securities and Exchange Commission
 

Page 2
 

method of share ownership are consistent with the requirements of
 

Rule 1 7f-S. We ask that 
 the Staff concur in this conclusion.
 

As you are aware, trading commenced earlier this year in so-


called liB shares" on the Shenzhen Securities Exchange and the
 

Shanghai Securities Exchange in the People's Republic of China
 

("PRC") . B shares are avai lable for purchase by non-Chinese


investors, and there is considerable interest on the part of
 

certain u.S. investment companies in acquiring these securities.
 

Currently, however, most registered funds have refrained from
 

making such purchases because of uncertainty concerning the custody
 

requirements appl icable to B shares. We do not believe that the
 

Commission's custody rules were intended to operate as a
 prohibi tion against investment company purchases of particular secur i ties, much less to prohibit the purchase of all securities 

publ icly traded in a particular country. Yet, in the case of the
 

PRC, there is a risk that U. S. custody requirements could be
 

interpreted to have this effect. Unlike the situation in which an
 

investment company has the theoretical ability to opt out of a


depos i tory or book -entry system and cause its custodian to take 

possession of the fund's securities, participation in the Shenzhen
 

and Shanghai book-entry systems is the only means of ownership
 

available to foreign investors acquiring B shares.
 

We believe that U. S. investment companies that purchase B
 

shares through the facilities of our clients will be fully
 

protected against the risks with which Section 17(f) and Rule 17f-5
 

are concerned, and that the custody requirements should not,
 

therefore, pose an obstacle to investment company B share
 

purchases. Our analysis is set out below.
 

I. operation of the PRe Securities Markets!
 

In December, 1991, companies in the PRC were authorized to
 

issue B shares, a special class of securities that can only be
 

purchased by and traded among foreign investors. The Shenzhen
 

Securities Exchange and the Shanghai Securities Exchange, which
 

The factual material set forth in this letter is based on
 

published information concerning the operations of the Shenzhen and
 

Shanghai markets, descriptions received from certain of our
 

cl ients, and the experience of knowledgeable persons in our Hong
 

Kong and Shanghai offices. However, practices in the Shenzhen and
 

the Shanghai markets are evolving. In the event that we learn
 

addi tional information during the pendency of this request, we will
 of course inform the Staff. 
:B_-\KER 6. ~l'KE:\zi:E
 

Office of the Chief Counsel
 

Di vision of Investment Management
 

Securities and Exchange Commission
 

Page 3
 

handle primarily non-B share transactions involving domestic
 

investors, also provide a trading market for B shares. Each
 

issuer's shares may trade on only one of these two exchanges. B
 

shares are denominated in Renminbi2 and are uncertificated¡ that
 

is, ownership of B shares is reflected by book-entry in a system
 

maintained, in Shenzhen, by three "registration banks" on behalf of
 

the Shenzhen Securities Registrars Co., Ltd. (the "Registrars Co.")
 and, in Shanghai, by the exchange itself. 3 

A. Legal Framework4
 

The People's Bank of China (the "PBOC"), the central bank of
 

the PRC, is the government agency charged with overall regulation
 

of the securities markets. The PBOC has delegated day-to-day
 

supervision and management of share issuance and trading to its
 

local branches. In addition to national supervision, the Shenzhen
 

and Shanghai markets operate under an array of measures promulgated
 

by the municipal authorities in their respective cities. These
 

measures were adopted either jointly with, or with the approval of,
 

the PBOC. The PBOC branches have, in turn, issued rules to
 

implement the municipal measures, and the securities exchanges have
 

adopted corresponding operating rules. In Shenzhen, the Registrars
 

Co. also has adopted rules of operation (with the approval of the
 

PBOC-Shenzhen) . 

The municipal ordinances in question provide, among other
 

things, for the establishment of an exchange in each of the two
 

cities for the trading of B shares, subject to the approval of the
 

Al though shares are pr iced in Renminbi on both exchanges, 

B share settlement occurs in Hong Kong dollars in Shenzhen and in
 

U.S. dollars in Shanghai. The Securities Trading Automated
 

Quotation system (STAQ), operated by Reuters, displays B shares
 quotations. STAQ converts Renminbi prices to Hong Kong dollars
 before disseminating quotations. 

3 The Registrars Co. (in Shenzhen) and the exchange (in Shangha i) perform functions comparable to those of a transfer agent. 

4 English versions of the key measures and rules applicable
 

to the Shenzhen and Shanghai markets have been published by Baker
 

& McKenzie in a booklet entitled Selected Securities Requlations of
 

the People's Republic of China (hereinafter "SSR"). A copy of this
 

booklet is attached. Relevant provisions of these measures and
 

rules are cited herein.
 
l:L\J\:EH &: ~1"KE::ZIE 

Office of the Chipf Counsel
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 4
 

PBOC. The measures designate the PBOC branches as being the 

"Authority in Charge" and regulate:
 

organization of the exchanges, including their
 

management and membership;
 

types of entities that may issue B shares and the
 

approval process for such issuances;
 

condi tions required for listing B shares on the
 

exchanges and the approval process for listing;
 

qualifications of local brokers eligible to execute
 

transactions in B shares;
 

qualifications of foreign brokers to place trades
 

with local brokers; 

clearing and settlement procedures and the 

appointment of clearing banks; 

share transfer and registration procedures. 

The local resolution, violations. 

measures 

foreign also dea 1 with such matters as dispute 

exchange, tax liability, and penalties for 

Of signif icance to this request, the legal framework 

established jointly by the PBOC and municipal authorities requires 

that B share custody strictly conform to the rules of each 

exchange. In particular, there is no opportunity to take physical 

custody of shares or to otherwise opt out of the mandatory book 

entry system.5 B shares listed on a given exchange must trade 

solely on that exchange. 6 The application of these laws to B share

ownership and trading is discussed in detai 1 below. 

5 See Articles 3 and 7, Provisional Rules of Shenzhen
 

Municipali ty for Registration of Special Renminbi-Denominated
 

Shares (SSR at 55). Article 30, Detailed Implementing Rules for
 

the Measure of Shanghai Municipality for Administration of Special
 

Renminbi-Denominated Shares (SSR at 22).
 

6 Article 16, Provisional Measures of Shenzhen Municipali ty
 

for Administration of Special Renminbi-Denominated Shares (SSR 

at 47). Article 18, Measures of Shanghai Municipality for

Administration of Special Renminbi-Denominated Shares (SSR at i 7) . 
B.,\l~ER &. ~l'-i~E::ZIE 

Office of the Chief Counsel
 

Division of Investment Management


Secur i ties and Exchange Commission 

Page 5
 

B. The Shenzhen Securities Exchange
 

In order to execute B share transactions on the Shenzhen
 Secur i ties Exchange, investors must route their orders through one 

of a limited number of international brokers approved by the PBOC­ Shenzhen.7 These international brokers, which are primarily 

located in Hong Kong, are not members of the Exchange and must, in
 

turn, place client orders through local brokers. Each foreign
 

broker must have executed detailed agency agreements with the


var ious loca 1 brokers, and these agreements must be approved by the

PBOC-Shenzhen.8 

Clear ing, settlement, and share ownership registration are
 

accomplished through one of three banks (referred to herein as the


"reg istrat ion banks"). The registration banks, which were selected 

by the Exchange subj ect to the approval of the PBOC-Shenzhen, 9 are:
 

(i) standard Chartered Bank (Shenzhen Branch); (ii) Hongkong and


Shanghai Banking Corporation Ltd. (Shenzhen Branch); and (iii)
 

Ci tibank NA (Shenzhen Branch). All trades for a given issuer are
 cleared through one, and only one, of the three registration 

banks.10 The relevant bank opens a share registration account in
 

the name of each investor, and this account is assigned a unique
 

., See Article 15, Provisional Measures of Shenzhen 

Municipali ty for Administration of Special Renminbi-Denominated 

Shares (SSR at 47); Articles 4 and 13, Detailed Implementing Rules 

for the Provisional Measures of Shenzhen Municipality for 

Administration of Specia 1 Renminbi -Denominated Shares (SSR at 50, 

52). There are currently 13 approved foreign brokers. 

See Article 47, Provisional Measures of Shenzhen
 

Municipality for Administration of the Issue and Trading of Shares
 

(SSR at 37); Article 9, Provisional Measures of Shenzhen


Municipality for Administration of Special Renminbi-Denominated
 

Shares (SSR at 47); Articles 2 and 14, Detai led Implementing Rules
 

for the Provisional Measures of Shenzhen Municipality for
 

Administration of Special Renminbi-Denominated Shares (SSR at 50,
 

52); and Article 11, Operating Rules of the Shenzhen Securities
 

Exchange for Trading and Clearing of B Shares (SSR at 60).
 

9 See Article 20, Detailed Implementing Rules for the
 

Provisional Measures of Shenzhen Municipality for Administration of
 

Special Renminbi-Denominated Shares (SSR at 53).
 

10 Article 5(5), Operating Rules of the Shenzhen Securities
 

Exchange for Trading and Clearing of B Shares (SSR at 59).
 
:SAnER &. ~1' l\:E::ZIE 

Off ice of the Chief Counsel
 

Division of Investment Management
 

Securities and Exchange Commission
 

Page 6
 

number. Where the investor acts through an intermediary, such as
 

its custodian or subcustodian, the account will include the name of


the intermediary. ii 

The registration banks maintain the computerized book-entry
 

system reflecting the ownership of B shares. 12 The registration
 

banks process securities transactions by effecting debit and credit
 

entr ies to participants' stock accounts held at the banks, and by
 

corresponding entries in the share registration account. The
 

registration bank responsible for a given transaction also issues
 

a share registration receipt in connection with the trade.13 This
 

document is a statement of account which evidences the fact that
 

specific B shares have been registered in the name of the investor,
 

but is not itself negotiable and does not confer rights in the
 

underlying security. 1~
 

All trades are reported da i ly by the registration banks to the 

Registrars Co., the official share registrar for B shares traded on
 

the Shenzhen Securities Exchange. 15 However, the Registrars Co.,
 

a state-owned corporation, has largely delegated its registry
 

functions to the registration banks. 16 The Registrars Co., like
 

the registration banks, maintains its own computerized share
 

ownership records for B shares traded on the Exchange. The
 

ii See Articles 6 and 8, Provisional Rules of the Shenzhen
 

Municipali ty for Registration of Special Renminbi-Denominated


Shares (SSR at 55). 

12 Id. at Article 3, (SSR at 55). 

13 Id. at Articles 3 and 4 i (SSR at 55). 

14 Id. at Article 5, (SSR at 55). 

15 See Article 67, Provisional Measures of Shenzhen
 

Municipali ty for Administration of the Issue and Trading of Shares
 

(SSR at 39); Article 18, Provisional Measures of Shenzhen


Municipal i ty for Administration of Special Renminbi-Denominated
 

Shares (SSR at 47); and Article 2, Provisional Rules of the
 

Shenzhen Municipality for Registration of Special Renminbi-


Denominated Shares (SSR at 55).
 

16 The Registrars Co. 's authority to delegate its functions 

appears in Article 2 i, Detailed Implementing Rules for the
 

Provisional Measures of Shenzhen Municipality for Administration of
 

Specia 1 Renminbi-Denominated Shares (SSR at 53).
 
B_-\:KER &: ~1"i\:E::ZlI= 

Office of the Chief Counsel
 

Division of Investment Management
 

Securities and Exchange Commission
 

Page 7
 

function of the Registrars Co. is limited, however, to providing a
 

back-up for the records of the registration banks. After the
 

registration banks electronically report share transfers to the
 

Registrars Co. , it cross-checks the information against trade
 

reports received from the Exchange. 17 If discrepancies are
 

discovered, the Registrars Co. contacts the relevant registration
 bank to resolve the problem. Once the accounts tally, the

Registrars Co. and the registration bank sign the cross-checked
 

accounts which then become the official record of ownership. The
 

Registrars Co., through the registration banks, also performs the
 

functions of a dividend paying agent for the issuer companies,
 

wi thholds the appropriate taxes, and forwards shareholder


communications. i' 

C. The Shangha i Securities Exchange
 

Each investor in B shares on the Shanghai Securities Exchange
 

has an account with the Exchange. 19 An intermediary, such as an
 

investment company's custodian or subcustodian, may open such an
 

account in its own name for the account of its investor client,
 

e.g. XYZ Bank alc ABC Fund. The investor's (or its intermediary'S)
 

account with the Exchange must be opened through a PBOC-Shanghai
 

approved foreign broker. 20 Trades are initiated through one of the
 

foreign brokers, which in turn effects the trade through a PBOC­ " approved local broker.-I 

(

1- Ar-ticle 17, Provisional Rules of Shenzhen Municipality
 

for Registration of Special Renminbi-Denominated Shares (SSR at


57) . 

n Id. at Articles 19-21 (SSR at 57).
 

19 See Articles 25 and 26, Detailed Implementing Rules for
 

the Measures of Shanghai Municipality for Administration of Special
 

Renminbi -Denominated Shares (SSR at 22).
 

20 See id. Articles 12-15 (SSR at 21).
 

21 See Article 41, Measures of Shanghai Municipality for
 

Administration of the Trading of Securities (SSR at 9) ; Article 21, 

Measures of Shanghai Municipality for Administration of Special
 

Renminbi-Denominated Shares (SSR at 18); Article 8, Detailed
 

Implementing Rules for the Measures of Shanghai Municipality for
 

Administration of Special Renminbi-Denominated Shares (SSR at 20) ;
 

and Article 7, Supplementary Operating Rules for the Trading Market
 

(Specia 1 Renminbi -Denominated Shares) of the Shanghai Securities
 
B_-\EEH c: ~l"EE:'ziE
 

Office of the Chief Counsel
 

Di v ision of Investment Management 

Securities and Exchange Commission
 

Page 8
 

Both the local and foreign brokers send clearing and
 

settlement instructions to an entity authorized to act as a
 

clearing bank.22 The only authorized clearing bank is Citibank
 

N.A. 's Shanghai Branch ("Citibank Shanghai"). citibank Shanghai
 

matches trades, and debits and credits the accounts which the local
 

and foreign brokers maintain with it. On the settlement date,
 

ci tibank Shangha i confirms the net settlement amount of each local
 

broker to the Bank of Communications of China ("BCC"), a state-


owned institution. Ci tibank Shanghai will then debit and credit
 

the account maintained by the BCC and the local brokers. BCC
 

reports to the Exchange the pr imary settlement between the local
 broker and the Exchange. Specif ical ly, settlement occurs in the

fol low ing manner: 

Cash. Cash clearing for B share transactions takes place at two levels -- (1) between the buying and selling local
 

brokers and (2) between these local brokers and the foreign
 brokers representing the buyer and the seller. 23 ci tibank 

Shanghai handles the clearance of cash accounts between the
 

foreign and local brokers. BCC handles clearance as between
 

the local brokers. The purchaser transfers funds to its
 

foreign broker's clear ing account at ci tibank Shanghai via
 ci tibank' s New York Branch. Both the foreign and local brokers send cash clearing and settlement instructions to

Ci tibank Shanghai. ci tibank Shanghai matches the
 

instructions, debits and credits the cash accounts which the
 

foreign and local brokers maintain wi th it, and transfers the
 

sale proceeds to the local broker's account at the BCC. On
 

the settlement date, the BCC clears accounts between the
 

buying and selling local brokers and transfers payment to
 

Citibank Shanghai, for the account of the seller's foreign


broker. 

Securi ties. BCC reports the settlement to the Exchange.
 The Exchange makes the appropriate securities account 

Exchange (SSR at 26).
 

22 Article 4 0, Detai led Implementing Rules for the Measures
 

of Shanghai Municipality for Administration of Special Renminbi-


Denominated Shares (SSR at 24).
 

23 The first-level and second-level clearance procedures are
 

set forth in Articles 34-39, Detailed Implementing Rules for the
 

Measures of Shanghai Municipality for Administration of Special
 

Renminbi -Denominated Shares (SSR at 23).
 
B_-\l~ER &. :\l'EE:\ZII:
 

Off ice of the Chief Counse 1
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 9
 

transfers and credits the securities to the purchaser's
 

account. Shares are registered either in the name of the
 

investor or its intermediary, as described above, by the
 

Exchange's computer at the close of business on the settlement
 

date. The Exchange also generates a confirmation which is
 

sent to the foreign broker for delivery to the investor or its


intermediary. 

As noted above, the Shan~hai Securities Exchange acts as its
 

own registrar for B shares. 4 The Exchange also handles all
 

di vidends and shareholder communications. 25 To assist investors'
 intermediar ies (i. e. custodians) in performing their tasks, the 

Shanghai Securities Exchange recently commenced issuing "B Share
 

Custodian Services Confirmation Letters" to banks acting in a
 

custodian capacity. 26 The letter entitles the custodian to receive
 

a copy of the Exchange's transaction report on the trade date and
 

the confirmation of registration following settlement. It also
 

permi ts the custodian to access the Exchange's computer (strictly
 

for informational purposes only) to monitor the flow of securities
 

in and out of the investor's account.
 

II. Custody Requirements Under the Investment Company Act
 

A. Section 17(f) 

Section 17 (f) of the Investment Company Act of 1940 requires
 

that registered investment companies maintain their portfolio
 

securi ties in the custody of ei ther aU. S. bank (with aggregate
 

capital in excess of $500,000), a member of a national securities
 

exchange, or in self-custOdy. The Commission has, by rule,
 

24 The Exchange's registrar functions are referred to id. at Article 47, (SSR at 24) ¡ and Articles 16 and 17 of the

Supplementary Operating Rules for the Trading Market (Special
 

Renminbi-Denominated Shares) of the Shanghai Securities Exchange
 

(SSR at 27).
 

25 Dividend payments are made by an issuing company to the
 

Exchange, which channels payment via the local and foreign brokers'
 

accounts to the investor or its intermediary. The Exchange
 

simi larly transmits corporate communications via the brokers.
 

26 See Article 47, Detailed Implementing Rules for the
 

Measures of Shanghai Municipality for Administration of Special
 

Renminbi -Denominated Shares (SSR at 24). Article 47 refers to
 

these documents as liB share deposit certificates."
 
BAKER &: ~rKE::ZIE 

Off ice of the Chief Counsel
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 1 a 

expanded the category of custodians in various respects. In
 

particular, Rule 17f-5 creates an exemption from Section 17 (f) to
 

permi t investment companies to maintain their foreign securities
 

and related cash and cash equivalents in the custody of an eligible
 

foreign custodian, as defined in the rule, subject to various
 conditions. As relevant here, Rule 17f-5 defines an eligible 

foreign custodian to include -­

(1) a foreign bank that is regulated as such in
 

the foreign country and which has in excess of
 

$200 million in shareholders' equity; or
 

(2) a foreign securities depository or clearing


agency which operates the central system for
 

handling of securities or equivalent book-


entries in that country.
 

B. Custodians in Certif icateless Environments
 

Section 17(f) and Rule 17f-5 generally contemplate that
 

investment company portfolio securities will exist in the form of
 

physical certificates, and that the holder of such a certificate is
 

a custodian. However, with the increasing use of pure book-entry
 

systems and the corresponding dematerialization of securities in
 

the United States and other parts of the world, the question arises
 

as to who must be viewed as the custodian of a certificateless
 

securi ty, and who must therefore comply with Section 17 (f) or one 

of the exemp~i ve rules thereunder. The Commission has not squarely
 

considered this question, and the Staff has touched upon it only in
 

the domestic context, through various no-action requests under Rule
 

1 7 f - 4 . 27
 

27 Investment Company Act Rule 17f-4 authorizes an
 

investment company or its custodian, in accordance with certain
 

procedures set forth therein, to deposit securities owned by the
 

fund in a clearing agency which is registered under Section 17A of
 

the Securities Exchange Act of 1934 and which acts as a securities
 depository. Rule 17f-4(a) defines a securities depository as a 

system for the central handling of securities where all deposited
 

securi ties of any particular class are treated as fungible and may
 

be transferred or pledged by bookkeeping entry. In proposing Rule
 

1 7f-4, the Commission distinguished investment company
 

participation in such a depository from investment company
 

ownership of securities issued only in book-entry form, and
 

indicated that such ownership was outside of the scope of proposed
 

Rule 1 7f-4. See Use of Depository Systems by Reqistered Management
 
HA.nER 6: ~lE:E="ZIE 

Office of the Chief Counsel
 

Di v ision of Investment Management 

Securi ties and Exchange Commission
 

Page 11
 

Thus, in Institutional Equity Fund (Feb. 27, 1984), an
 

investment company's bank custodian wished to maintain stock index
 

options owned by the fund at the Options Clearing Corporation
 

("OCC"). The stock index options were uncertif icated and ownership


was reflected in the records of the OCC, a registered clearing
 

agency. The fund argued that the OCC should be treated as a
 securi ties depository for the purposes of Rule 17f-4 to permit it to act as custodian. The Staff granted the no-action relief, 

wi thout expressing any views as to the fund's legal conclusions.
 

Similarly, in American Pension Investors Trust (Feb. 1, 1991) and
 

FundVest (Nov. 21, 1984), the Staff also granted no-action relief
 

in situations where the investment company's custodian maintained
 

shares in the bOOk-entry systems maintained by the issuer's
 

transfer agents. The appl icants argued that the transfer agents
 

were the functional equivalent of a depository under Rule 1 7f-4.
 

It might be concluded from these letters that book-entry
 

systems, whether maintained by a clearing agency or a transfer
 agent, are the "custodians" of the uncertificated securities 

reflected on their records for Section 17 (f) purposes. As far as
 

we are aware, however, the Staff has not considered this issue in


the context of any non-U. S., government-mandated, certi f icateless system, such as the one established in the PRC. Similarly, neither 

the Commission nor the Staff appear to have addressed the
 

application of Rule 17f-5 to such a system.2~ The issue is
 

Companies, Investment Company Act Release No. 10053 at note 2
 

(Dec. 8, 1977), 42 Fed. Reg. 63272, 63273 (1977).
 

Rule 17f-5 contains no definition of the phrase
 "secur i ties depository." Thus, it is unclear whether the reference 

in Rule 17f-5(c) (2) (iii) to a "securities depository" includes a
 

book-entry issuance system of the sort described in Release No.


10053. 

28 In proposing Rule 1 7f-5, the Commission stated that the
 

type of securities depository intended to be covered by the rule
 

included the Canadian Depository for Securities, Ltd. , the
 

Frankfurter Kassenverein, and SICOVAM. See Exemption for Custody
 

of Securities by Foreign Banks and Foreign Securities Deoosi tories,
 

Investment Company Act Release No. 12354 at note 51 (Apr. 5, 1982),
 47 Fed. Reg. 16341, 16346 (1982). Of these three depositories, 

only SICOVAM operates a fully scripless system. However, in 1984,
 

the reference to these depositories was omitted from the amended
 proposing release and from the adopting release. Al though it is 

therefore not clear whether the Commission regarded SICOVAM as a
 
B_-\KER & )'lE.E:\zii:
 

Off ice of the Chief Counsel
 

Di vision of Investment Management
 

Securities and Exchange Commission
 

Page 12
 

particularly troublesome because, as the no-action letters
 

discussed above demonstrate, domestic book-entry systems can bring
 

themselves within the ambit of Rule 17f-4, as long as they
 

consti tute the central system for the particular security involved.
 

An identical book-entry system, when transplanted to a foreign
 

jurisdiction, however, would not qualify as an eligible foreign
 

custodian under Rule 17f-5 unless it satisfied the standards for
 

the central system for the country involved.
 

C. Foreign "Central Systems" as Custodians
 

As noted above, under Rule 17f-5, the term "eligible foreign
 

custodian" includes a depository or clearing agency which operates
 

"the central system for handling securities or equivalent book-


entries in that country." In order to qualify as the central
 

system, it is not necessary that the system handle all or even most
 

of the securities traded in the country in question, ~ nor is it
 

necessary that the system be the only depository in that country.
 

However, where more than one depository handles the same
 secur i ties, the Commission has required that the various 

deposi tories be sufficiently integrated so as to constitute a
 

single central system. In making this" integration" determination,
 

the staff has looked for common operating procedures, compatible
 

computer systems, the capacity of component entities to hold
 

secur i ties for each other, and even common ownership where


appropriate.30 

custodian when it adopted Rule 1 7f-5, SICOVAM would in any event
 

presumably be an "eligible foreign custodian" under the rule
 

because it operates the central system in France. However, in
 

1985, one of the other two depositories named in Release No. 12354,
 

the Frankfurter Kassenverein, was the subject of an exemptive
 

application filed by State Street Bank and Trust Company. In
 

granting the exemptive order, the Commission made no reference to
 

its original characterization of the Kassenverein as an eligible
 foreign custodian. See infra note 3 o. 

29 See,~, The Central Depositorv (PTE) Ltd. SEC No-


Action Letter (Mar. 27, 1990) (the central depository in Singapore
 

handled only securities traded on the Stock Exchange of Singapore


Dealing and Automated Quotations system). 

30 In 1985, the Commission issued an order permitting the
 

Frankfurter Kassenverein, one of seven regional depositories in
 

Germany, to act as a securities depository under Rule 1 7f-5. State
 

Street Bank and Trust Company, Investment Company Act Release No.
 
BAKER 6. ~YKE::ZIE 

Office of the Chief Counsel
 

Division of Investment Management
 

Securi ties and Exchange Commission
 

Page 13
 

In contrast, where there is more than one facility in a
 

particular country, but the various facilities do not handle the
 

same securities, the Staff has not required integration as a
 

condition to qualification of the facility as "the central system."
 Thus, in S.D. IndevaL. S.A. de C.V. (Oct. 19, 1990), the Staff 

accepted that Indeval operates the central system for handling
 

securities traded on the Mexican Stock Exchange, while also
 

recognizing that the Mexican Central Bank handles certain Mexican
 

Government securities not cleared by Indeval. Obviously, where a
 

number of depositories exist in a country, each handling the same
 or partial ly the same secur i ties, 3J the integration requirement is an appropriate safeguard. However, where two facilities, handle 

whol ly different securities, integration in the sense employed in


Investment Company Insti tute'è would be meaningless. 

III. Discussion
 

A. Overview of Issues
 

The application of Section 17(f) and Rule 17f-5 to the book-


entry systems operated in the Shenzhen and Shanghai markets raises
 

14698 (Aug. 28, 1985). Based on this order, the Staff subsequently
 

articulated standards by which to determine whether multiple
 

deposi tor ies in the same country are suff iciently integrated to be
 

considered as operating the central system in that country.
 

Investment Cómpany Institute, SEC No-Action Letter (Nov. 4, 1987).
 

In particulay, the Staff noted that the seven German depositories,
 

although independent, operated under the same procedural
 

guidelines, held securities for each other to reduce the need for
 

physical transfers, and were closely linked by computer. The
 

integration test was later also applied to the various Dutch
 

depositories, where the several entities comprising the central
 

system shared computer systems, operating procedures, and common


ownership. KAS-Associatie, N. V., SEC No-Action Letter (May 15,

1989) . 

31 See,~, Reserve Bank of Australia, SEe No-Action
 

Letter (request denied) (May 8, 1991), in which the Staff appeared
 

to be concerned that the Reserve Bank might be independently
 

performing 9verlapping depository functions with Austraclear
 

without the requisite level of integration. Austraclear had
 

previously been the recipient of no-action relief (SEC No-Action
 

Letter (Jan. 17, 1990).
 

3è Supra note 3 o. 
BAKEI~ &. \l'EE:"ZIL
 

Off iCQ of the Chief Counsel
 

Division of Investment Management
 

Securi ties and Exchange Commission
 

Page 14
 

several issues. We believe, however, that an investment company
 

which holds B shares through the facilities of its u.s. custodian,
 

or through an institution which is an eligible foreign custodian as
 

defined in Rule 1 7f-5, satisfies the requirements of the Section
 and the Rule. In particular -­

1. Gi ven that B shares have no physical existence
 

and that ownership is reflected solely through
 

book-entries, the book-entry system need not
 

itself be regarded as a custodian. Whi le we
 

recogni ze that, in the domestic context, the
 

Staff has impl ici tly treated book-entry
 systems for dematerialized securities as 

deposi tories and therefore custodians, the


Shenzhen and Shanghai systems can be
 

distinguished from those situations and need
 

not be viewed as custodians.
 

2. Al ternati vely, the Shenzhen and Shanghai book-


entry systems may act as investment company
 

custodians by virtue of the fact that both
 

systems are operated in fact by branches of
 

banks which each individually qualify either
 

as a u.S. bank under Section 17(f) or as an
 

eligible foreign custodian under Rule 17f­ 5(c) (2) (i). Since the book-entry function in

Shenzhen is operated by banks which


individually are eligible to serve as
 

investment company custodians, we believe that
 

the shares handled through this system are, as
 

a practical matter, in the custody of an
 

enti ty which satisf ies the Commission's
 

custody requirements. Similarly, in Shanghai,
 

ci tibank is the sole nexus between foreign
 

investors and the share registrar.
 

3. If the book-entry system in each market must
 

be deemed a custodian and if it is not an
 

eligible foreign custodian notwithstanding the
 

eligibili ty of the banks which perform the
 

essential functions, the Shenzhen and Shanghai
 systems nonetheless qualify as el igible 

foreign custodians under the "central system"
 

element of Rule 1 7f-5. The key fact is that
 

each is the sole bOOk-entry system for the
 

securi ties it handles.
 
B_-\KER &. ~l-KE:\ZIE
 

Office of the Chief Counsel
 

Di vision of Investment Management


Secur i ties and Exchange Commission 

Page 15
 

Each of these al ternati ve approaches to no-action relief is
 

outlined in more detail below.
 

B. Analysis
 

1. The Nominal Owners as Custodians
 

In the type of book-entry system employed in the PRC, an
 

argument can be made that the first-tier custodian of the B shares
 

is the entity whose name appears as share owner in the book-entry
 

system, not the system itself. Provided this entity is the fund's
 

u. s. custodian or one of its foreign sUbcustodians, 33 and the
 

entity is a qualified u.s. bank or an eligible foreign custodian,
 

the requirements of Section 17 (f) or Rule 17f-5 would be met.
 

Thus, the book-entry systems in Shenzhen and Shanghai would not


need to be ana lyzed as custodians under Section 17 (f) and Rule

17f-5. 

First, the book-entry systems established in Shenzhen and
 

Shanghai are not "custodians" in the literal sense of the word. No
 

share certificates are physically deposited, since none exist. The
 

systems are therefore unlike depositories in which share
 

certificates are immobilized and subsequent share transactions are
 

ref lected only as book-entr ies on the depository's records. ~
 

While we recognize that the Staff has implicitly treated the
 

transfer agents of certain domestic uncertificated securities as
 

custodians for Rule 17f-4 purposes, 35 neither the Commission nor
 

the Staff has had occasion to consider whether the same
 

interpretation should apply to a government-mandated foreign book-


entry system for uncertif icated securities. Where the investment
 

33 Of course, a security held by a u.s. investment company
 

may have several custodians. For example, a depository's records
 

may reflect that the security is owned by a depository participant¡
 

the participant's records, in turn, may show that it is held for
 

the account of a local bank ¡ and the bank's records may indicate
 

that it is held for the customers of the mutual fund's prime u.s.
 

custodian. Each of these entities would be viewed as in custody of
 

the security in question and would be required to satisfy Section
 

17 (f) or one of the rules thereunder.
 

~ Such a depository is, of course, a custodian of the securities it holds.
 

35 See American Pension Investors Trust and FundVest, supra


page 11. 
B_-\KER &: :\ll\.E::ZIE
 

Office of the Chief Counsel
 

Di vision of Investment Management


Secur i ties and Exchange Commission 

Page 16
 

company enj oys the protection resulting from the fact that the
 

nominal owner of its securities is an eligible foreign custodian
 

acting in compliance with Rule 1 7f-5, we believe that no added
 

purpose is served by concluding that the foreign book-entry system
 

is also a custodian.
 

Second, the objectives of the custody requirements are
 satisfied by treating the nominal owner as the first-tier 

custodian. The purpose of Section 17 (f) is to protect investment
 

company assets from loss or defalcation. ~ In the case of physical
 

share certificates, these assets are at the risk of the entity
 

which holds or has access to the certificates. In a book-entry
 

system in which no such certificates exist, there is no risk of
 

physical loss. Rather, the primary risk is that the entity in
 

whose name the secur i ty is held may, by virtue of its nominal
 

ownership, expose the security to loss, such as by subjecting it to
 

the claims of the nominal owner's creditors. This suggests that
 

the nominal owner should be treated as the first-tier custodian
 

subject to the requirements of Section 17(f) or Rule 17f-5, and
 

that the entity which maintains the share ownership records need
 not be so treated. 

Finally, in determining what entity is a custodian of B
 

shares, we believe that it is significant that the nominal owner
 

will be issued an instrument which can be viewed as a partial
 

surrogate for a physical certificate. In Shenzhen, the "share
 

registration receipt" issued by the registration bank, while not
 

i tself negot~able, constitutes a statement of account and serves as
 

evidence of the fact that the holder has B shares registered in its
 

name.37 In the event that any dispute might arise between the
 

investment company's custodian and registration bank (or the
 

Reg istrars Co.) concerning whether the custodian owns shares on
 

36 It is relevant to note that the Commission historically
 

has viewed Section 17 (f) as designed to protect the assets of
 

investment companies against theft and misappropriation by the fund
 

or its affiliated persons, not by third parties appointed to handle
 

certain fund activities. 7 SEC Annual Report 15 (1940); 10 SEC
 

Annual Report 169 (1944). The legislative history of the Act is to
 

the same effect. See Hearings on S. 3580 before the Senate
 

Committee on, Banking and Currency, 76th Cong., 2d Sess., Part I at
 57-70, 264 (1940); Senate Report on S. 4108 at 6. 

37 See Articles 3-5, Provisional Rules of Shenzhen 

Municipality for Registration of Special Renminbi -Denominated 

Shares (SSR at 55). 
BAEER i. ~l'KE::ZIE 

Office of the Chief Counsel
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 17
 

behalf of its client, the custodian's possession of the share
 receipt could be used to establish such ownership. Accordingly, it 

is the holder of that receipt, not the issuer thereof, that is most
 

logically viewed as a custodian. Similarly, in Shanghai, the
 

Confirmation Letter issued by the Exchange performs a comparable


function.38 

2. The Registration Banks as Custodians
 

An al ternati ve approach to analyzing B share custody issues 

would be to focus on the role of the registration banks in Shenzhen
 

and the clearing bank -- ci tibank -- in Shanghai. Since the book-


entry system for each exchange is comprised of, or is dependent
 

upon, banks which are qualified to serve as investment company


custodians under either Section i 7 (f) or Rule 1 7f-5, the B shares 

maintained on the books of these facilities are necessarily in the
 

hands of a qualifying custodian. It would be anomalous to conclude
 

that the book-entry system is ineligible, even though its key
 

component banks are eligible; the whole cannot be less than the sum
 

of its parts. 34
 

~ Shenzhen
 

As explained in detail above, in Shenzhen, transactions in B
 

shares may only occur through a specif ied registration bank. That
 

3' See supra note 26 and accompanying text. 

By way of comparison, the Canadian securities authorities
 

have determined that domestic, foreign, and transnational "bookbased" (or book-entry) systems are not "custodians" or "subcustodians" subject to the custody provisions of Canadian National
 

Policy No. 39 applicable to Canadian mutual funds. The Policy
 

expressly cites as examples of such systems the Canadian Depository
 

for Securities Ltd. and the Depository Trust Company. See Section
 

7.01 (9), Canadian National Policy No. 39, issued by the Canadian
 

Securi ties Administrators , effective Jan. 1, 1988.
 

39 We recognize, of course, that it is conceivable that, in 

the future , additional registration banks (in Shenzhen) or clearing
 

banks (in Shanghai) could be appointed which are not qualified to
 

act as custodians for u.S. mutual funds under Section 17(f) or Rule
 

17f-5. Given the stringent criteria for such banks, this is, as a
 

practical matter, unlikely. Should it occur, however, the
 

consequence would merely be that u. S. mutual funds could not
 

utilize the facilities of the ineligible banks.
 
B.-\:EER & :\l-l\.E:\ZIE 

Off ice of the Chief Counsel
 

Di vision of Investment" Management
 

Securi ties and Exchange Commission
 

Page 18
 

bank issues a statement or "receipt" with respect to the

transaction, which evidences the share holding. The registration
 

bank also maintains share ownership records. The role of the
 

Registrars Co. is limited and primarily formal¡ as is authorized in
 

its governing ordinance, the Registrars Co. has largely delegated
 

its functions to the registration banks. Given that these banks
 

qualify as custodians, we believe that the Shenzhen book-entry
 

system which they operate likewise qualifies.
 

The Staff took an analogous approach in KAS40 and in Reserve
 

Bank of New Zea land. 41 In those letters, the Staff considered the
 

eligibility of depository facilities both under the foreign bank
 defini tion of eligible foreign custodian and under the central system def ini tion. In both cases, it was determined that the 

entities qualified as "central systems" even though they did not
 

have the requisite level of shareholders ' equity to qualify as
 

foreign banks. We believe that, in the reverse situation, where
 

the component banks of the book-entry system qualify as custodians
 

under either Section 17(f) or Rule 17f-5, the Staff's approach
 

should be identical. That is, each registration bank might be
 

viewed as a depository for the B shares it handles. Since these
 

banks are eligible to act as custodians, the Commission's custody


requirements are satisf ied. 

~ Shanqhai
 

Similar reasoning also supports the conclusion that the
 

Shanghai book entry system constitutes an eligible custodian
 

because of Ci tibank Shanghai's role in the administration of that
 system. Admi ttedly, Ci tibank Shanghai does not play the 

predominant role in the Shanghai system that the registration banks
 

play in Shenzhen. In particular, unlike the situation in Shenzhen,
 

the share registrar -- the Shanghai Exchange itself -- has not
 

delegated its functions to Ci tibank Shanghai. Moreover, in
 

Shanghai, the Bank of Communications of China -- which does not
 

appear to be an eligible foreign custodian as defined in Rule 17f-5
 

is also a participant in the cash clearing system and in
 

communicating information concerning transactions to the Shanghai
 

Securi ties Exchange. We believe, however, that these distinctions
 

are not fatal to concluding that, as in Shenzhen, the essential
 

component of the book entry system is an eligible foreign


custodian. 

40 Supra note 3 o. 

41 SEC No-Action Letters (May 25 and Nov. 15, 1990).
 
BA,KER &: ~l-KE:\zir: 

Off ice of the Chief Counsel
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 19
 

As described above, the Shanghai B share registration records
 

are derived solely and automatically from the clearing information
 

furnished to the Exchange by BCC. BCC, in turn, derives its
 

information concerning B share transactions from ci tibank Shanghai.
 

As a practical matter, Citibank Shanghai controls the input to the
 

registration records; the share registrar merely records
 

information it receives from Ci tibank Shanghai through BCC. Since
 

there are no physical certificates in the custody of any of the
 

participants, the relevant issue from the stand-point of
 

safeguarding an investment company investor's shares is the
 

reliability of this information. Section 17 (f) reflects a
 

determination that investment companies may rely on U. S. banks,
 

such as Ci tibank Shanghai, to safe-guard their assets. ci tibank


Shanghai's el igibil i ty as a custodian should suffice to establish

the el ig ibi 1 i ty of the Shangha i system. 

3. The Share Registry Systems as Custodians
 

Third, we believe that each exchange and its bOOk-entry system
 

is "central" for the securities it handles wi thin the meaning of
 

Rule i 7f-5. The PRC securities markets are different from many
 

others in that a particular securities issue trades only on one
 

exchange.42 Accordingly, the book-entry systems for Shenzhen and
 

Shanghai operate independently of each other without the need for
 

any inter-system transfers of securities. Each bOOk-entry system
 

can, therefore, be characterized as operating the central
 

indeed, the sole -- system for its exchange; for all B shares
 

traded on trat exchange; and for all trading in those B shares
 throughout the PRC. Under these circumstances, we believe that 

each bOOk-entry system satisfies the central system definition in
 

Ru 1 e 17 f - 5 (c) (2) (i i i) .
 

As discussed above, this approach is consistent with the
 

Staff's position in S.D. Indeval, S.A. de C.V.43 Indeval did not
 

operate the only central system in Mexico, since the Mexican
 

central bank also operated a system for certain Mexican Government
 

securities. Nonetheless, the Staff agreed that Indeval satisfied
 

the Rule 17f-5 central system requirement because it was the
 

central system for the securities it handled, which were different
 

from the securities handled by the Mexican central bank.
 

Similarly, in the PRC, Shenzhen and Shanghai are each the sole and
 

exclusive share registry systems for their markets and the B shares
 

42 See supra note 6 and accompanying text.
 

43 Supra page 13. 
BA.KER i: :\ll\:E:'ziE 

Office of the Chief Counsel
 

Di vision of Investment Management
 

Securi ties and Exchange Commission
 

Page 2 a 

traded therein. Unlike the situation in Reserve Bank of
 

Australia, ~ there is no overlap in the securities handled between
 

Shenzhen and Shanghai. For these reasons, both Shenzhen and
 

Shanghai are the central system in the sense relevant to their


respecti ve markets, 45 since a book-entry system need not handle all securi ties traded in a particular country, but need only be the 

exclusive system that handles particular securities.
 

For these reasons, we believe it is unnecessary to establish
 

that Shenzhen and Shanghai constitute an integrated system. Since
 

there is no possibility of any transfer of funds or securities
 between the two systems, integration would serve no function. 

Indeed, we are hard-pressed to understand how two self-contained
 

systems of this nature could be integrated. Both systems are, as
 , descr ibed above, subj ect to the oversight and control of the PRC 

Government through the PBOC. The PBOC has already established
 

certain common policies and procedures for both systems, such as
 

T+3 settlement, 46 and continuously monitors their activities.
 

Under the circumstances, further "integration" is unnecessary.
 

iv. Conclusion
 

For the reasons stated above, we request that the Staff confirm that it will not recommend enforcement action under Section
 

i 7 (f) of the Investment Company Act of 1940 against any registered 

investment company that, in reliance upon Section 17 (f) and Rule
 i 7f-5 thereunder, maintains assets through the custody facilities 

4- Supra note 32. 

45 This approach is consistent with the analogous domestic
 

requirements under Rule 1 7f-4. We note that, prior to the adoption


of Rule 1 7f-5, Rule 17f-4 was used as a bench mark for determining 

the acceptability of a foreign depository and the proposed custody /
 

arrangements. See, ~, State Street Bank and Trust Company SEC
 

No-Action Letter (Jan. 12, 1984). We note that this is also the
 

test established in Section 17A of the Securities Exchange Act of


1934, which is incorporated by reference into Rule 1 7f-4, and the 

test established for qualifying pension plans which maintain assets


overseas under ERISA Regulation 4 04b-1. 

46 See Article 24, Detailed Implementing Rules for the
 

Measures of Shanghai Municipality for Administration of Special


Renminbi-Denominated Shares (SSR at 23) ¡ . Article 60, Operating 

Rules of the Shenzhen Securities Exchange for Trading and Clearing
 

of B Shares (SSR at 66).
 
BAKER &. ~l-i~E:'ZIE 

Off ice of the Chief Counsel
 

Di vision of Investment Management
 

Securities and Exchange Commission
 

Page 21
 

of one or more of our clients in the book-entry systems of the
 

Shenzhen and Shanghai securities markets. In the event that the
 

Staff is not inclined to grant the relief requested herein, I would
 

respectfully request the opportunity to meet with you prior to any
 

final determination.
 

For the convenience of the Staff, seven copies of this letter
 

are enclosed. If you require further information, or wish to
 

discuss this request, please feel free to contact me, or Simon
 

Zornoza of this off ice, at (202) 452-7000.
 

Sincerely, ~'i ji,' ( G i

Daniel L. Goelzer ) ~ /Û!VJL L. ~ i¿ t')

Enclosure: 

Selected Securities Requlations of the Peoples Republic of


China 

I: \DATA \DLO\PUBL \41576,1