China

Author: | Published: 10 Oct 2001
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There has been more and more coverage of securitization in the Chinese financial newspapers. The governor of the People's Bank of China (PBOC), China's central bank, expressed the interest of the PBOC in securitization in a speech he made on March 26 2001. According to his speech, the PBOC will encourage securitization of certain bank assets as a kind of experiments to facilitate the development of mortgage loan markets. Meanwhile, China Hua Rong Asset Management Company has issued a press release recently in which it was mentioned that the company would issue a kind of asset-backed securities upon the approval by the relevant governmental authority in the foreseeable future. Coinciding with this news, which sent out very optimistic messages in terms of the launch of securitization in the domestic debt market, the newly promulgated PRC Trust Law may have a very significant impact on securitizations in the PRC.

THE NEW TRUST LAW

The new Trust Law will come into effect on October 1 2001. The lack of a trust mechanism in the PRC legal framework prior to the new Trust Law has been one of the main hurdles preventing securitization transactions. Now the Trust Law recognizes the trust being established for business purposes, as well as for civil and charity purposes (Article 3), which may enable securitization transactions to use a trust structure. However, whether a trust can act as a special purpose vehicle (SPV) in a securitization remains unclear.

According to the Trust Law, the trust assets must be separated from the assets of the trustee and must not fall within the bankruptcy assets of the trustee in the case of the trustee's bankruptcy (Article 16). Meanwhile, the debts owned by the trustee cannot be offset by the rights arising out from the trust assets managed and operated by the trustee (Article 18). It is obvious that a securitization transaction may take advantage of the principles set out by the aforesaid provisions of the Trust Law in achieving bankruptcy remoteness.

Although a trust is still not able to satisfy the legal requirements for a bond issuer, according to the PRC Company Law and certain regulations and rules issued by the PBOC, an SPV formed by way of a trust may raise funds by way of private placement. Under such a structure, the SPV in the form of a trust can borrow money from targeted financial institutions and the service of the repayment of such loans can be backed up by the receivables that the SPV purchased from the originator.

Notwithstanding the positive sides of the Trust Law, there are still some uncertainties related to certain clauses in the Trust Law. One of them is whether the receivables can become the trust assets. Under the Trust Law, the trust contract may be deemed to be void if the trust assets cannot be determined (Article 11). It is ambiguous, judging from the wording of this clause, whether the account receivables can be deemed as determined or not. PRC laws tend not to recognize the future receivables as assets of a determined nature due to the uncertainty behind such future receivables. If the future receivables are not deemed to be determined assets under the Trust Law, it will not be a good news for the optimistic market since the account receivables are not eligible to become the trust assets.

ANTICIPATION OF A SPECIAL REGULATION ON SECURITIZATION

Like other civil law countries, the strong influence of the civil law in the history of the PRC legal system is often perceived as an obstacle to financial innovations. Although the development of legislation in the past two years (including the enactment of the new Trust Law and the new Contract Law, effective on October 1 1999, which provides that a mere notice to the counter-parties is sufficient to transfer the contractual rights) has to some extent paved the way for the accommodation of securitization transactions in the domestic market, there are still some legal hurdles to be cleared. Such hurdles now mainly include:

Access to the public debt securities market. The SPV formed in whatever structure may be unlikely to satisfy the legal requirements, such as the three-year profit record for the issuer, for the issue of public debt securities in the PRC.

Security over future receivables. It is questionable whether the security created over future receivables will be recognized by PRC laws. It is noted that the recent explanation of the PRC Supreme Court established the principle that the security created over the receivables associated with real estates in the form of pledge is legal and valid. In other words, the security could be sought by the lenders over the future income from, at least, toll road, tunnel, bridge and other real estate projects. However, it does not touch on the question of whether the security over other contractual rights is recognized as well.

Tax neutrality. Although the value added tax does not apply to the sale and purchase of the receivables, it is not clear if the business tax will be levied on the SPV. The confirmation of the non-levy of any tax on the SPV or the transfer of the receivables is also essential.

The development of the legislation by piecemeal may not resolve all the problems identified above in the short term. The experience of other civil law countries shows the importance of special legislation in clearing the legal hurdles existing in the entire civil law background. It is the common belief of Chinese professionals that such a special regulation on securitization is requisite to launching securitization transactions in the domestic market. Given the positive message sent out by the head of the PBOC, we anticipate that such a special regulation may come in the forseeable future.


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