On June 29, 2018, the China Banking and Insurance Regulatory Commission promulgated the Measures for the Administration of Financial Assets Investment Companies (Trial Implementation) (the “Measures”) in order to promote the healthy and orderly development of market-oriented and legalized Swaps (“Swaps”) of banks and to provide a legal basis for regulating banks’ business operations involving such Swaps.
The Measures consist of 6 chapters and 67 articles. The first chapter defines the legislative basis, scope of application, basic principles, and supervisory duties. The second chapter stipulates the establishment, amendment and termination of financial asset investment companies. The third chapter provides for the business scope and business operation rules of a financial asset investment company and encourages the implementation of Swaps in the form of “debt-to-equity transfer”, with a strong emphasis at the same time on strict compliance with clean transfer principles and actual transactions, while strongly guarding against conflicts of interest and tunneling. The fourth and fifth chapters respectively stipulate the requirements for risk management and supervision. The sixth chapter provides for matters such as the right of interpretation, the time the Measures shall enter into effect, etc. Specifically, the Measures cover the followings:
I. Scope of application
According to the Measures, the main purpose of the Measures is to regulate banks in conducting Swaps-related business. The applicable financial asset investment companies primarily refer to non-banking financial institutions which are approved by the supervisory authority for banks under the State Council, set up within the territories of the People’s Republic of China, and primarily engage in Swaps and supporting businesses.
For banks implementing Swaps through financial asset investment companies, the Measures provide that creditor claims shall be carried out through financial asset investment companies by converting the claims into the equity of the target enterprises. Unless otherwise stipulated by the state, a bank shall not directly convert creditor claims into equity.
The Measures also provide that other banking financial institutions, such as financial asset management companies or trust companies and commercial banks (through other qualified subsidiary bodies) participating in the development of market-oriented Swaps are also required to refer and apply the business rules and risk management requirements under the Measures unless the law or the regulations from the financial supervisory authorities stipulate otherwise. Financial asset investment companies implementing Swaps for claims from non-banking financial institutions are also governed by the Measures unless the law or the regulations from the financial supervisory authorities stipulate otherwise.
II. Establishment of a financial asset investment company
The Measures first require the following conditions for the establishment of a financial asset investment company: (1) articles of incorporation that comply with the Company Law of the People’s Republic of China and the regulations of the banking supervisory authority under the State Council; (2) shareholders and registered capital in compliance with the requirements of the Measures; (3) qualified directors and senior management and staff familiar with the business; (4) effective corporate governance, internal control and risk management systems with an information technology system appropriate to its business operations; (5) a physical place of business with the security and precautionary measures and other facilities appropriate to its business operations; and (6) compliance with any other prudential conditions stipulated by the banking supervisory authority of the State Council.
The Measures further provide that a financial asset investment company shall be found and established by commercial banks incorporated within the territories of the People’s Republic of China, who shall be its major shareholders. The establishment process has two stages, namely, preparation and opening.
In addition, the Measures also contain specific requirements for the shareholder qualifications of commercial banks and other legal persons, detailed procedures regarding the preparation and opening stages, and amendments after the establishment of the financial asset investment company.
III. Business scope and business operation rules of financial asset investment companies
With respect to the business scope of financial asset investment companies, the Measures stipulate that a financial asset investment company may operate the following types of business in whole or in part with the approval of the banking supervisory authority under the State Council: (1) purchasing a bank’s corporate creditor claims for converting the claims into equity, and managing such equity; (2) reorganizing, transferring and disposing of other corporate creditor claims which cannot be converted into equity; (3) investing in the equity of invested enterprises for Swaps where the enterprises will use their entire equity investment to satisfy existing claims; (4) raising funds from qualified investors pursuant to law and issuing private equity asset management products to support the implementation of Swaps; (5) issuing financial debentures; (6) obtaining funds through bond repurchase, inter-bank lending, inter-bank borrowing, etc.; (7) carrying out the necessary investment management for self-operated funds and raised funds, where self-operated funds can be used toward businesses such as deposits at other banks, call loans to banks, purchase state debts or other fixed income securities, and raised funds should be used in manners consistent with the agreed-upon purposes; (8) providing financial consultation and advisory businesses relating to Swaps; and (9) conducting other businesses approved by the banking supervisory authority under the State Council.
The Measures require Subparagraphs (1), (2), (3) and (4) to be the main businesses of a financial asset investment company, and those four together, or the revenue from those four businesses, shall make up no less than 50% of the total business or total revenue.
On this basis, the Measures regulate the operation of various types of businesses. For example, if a financial asset investment company applies to issue financial debentures in the interbank market and the exchange market, the following conditions should be met: (1) a good corporate governance mechanism, a comprehensive internal control system and a sound risk management system; (2) adequate capital for prudential supervision requirements; (3) adequate risk monitoring indicators in line with prudential supervision requirements; and (4) compliance with other prudential conditions as promulgated the banking supervisory authority under the State Council.
IV. Risk management and supervision Requirements
As far as risk management is concerned, the Measures require financial asset investment companies to establish an effective risk management framework that matches their business scale, complexity level, and risk profile, formulate clear risk management strategies with specific risk preferences and risk limits, set comprehensive risk management policies and procedures, and identify, measure, evaluate, monitor, control or mitigate all major risks in a timely and effective manner.
For supervision, the Measures stipulate that the banking supervisory authority under the State Council and its designated agencies shall continuously supervise financial asset investment companies and their affiliates (subsidiary bodies) through both off-site and on-site inspection. Financial asset investment companies and their affiliates (subsidiary bodies) shall submit regulatory information to the banking supervisory authority under the State Council and their designated agencies in accordance with applicable requirements. Such information primarily includes: (1) business operation and risk management systems; (2) information about the organizational structure and major managerial personnel; (3) financial statements and regulatory statistical reports; (4) information disclosure materials; (5) major incident reports; (6) other information deemed necessary by the banking supervisory authority under the State Council and its designated agencies.
In general, while the Measures follow the principles of market orientation and rule of law throughout the text, it is hoped that through sound and prudent supervision rules, reasonable pricing, clean transfer, and real transactions, the risks associated with the company in question may be prevented from being transferred to banks, financial institutions and the public and to avoid conflicts of interest, tunneling and relevant moral hazards. On the other hand, the Measures encourage financial asset investment companies to develop their business by “buying debt before converting it into equity,” encourage banks to use the write-off provision to write off asset transfer losses in a timely manner. The creation of reasonable loss sharing mechanisms among interested parties such as banks, financial asset investment companies, the target enterprises for the Swaps and the original shareholders through the use of Swaps, introduction of new investors and capital write-down of their original shareholders. This shall realize true debt-to-equity swaps promote quality economic development, and achieve the objective of actively creating a robust debt-to-equity swap market environment. For investors interested in investing in the Swaps business, the promulgation of the Measures provides them with the operating guidelines conducive to further development of the industry.