China

Author: | Published: 9 Jul 2001
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Like 2000, 2001 promises to be an eventful and highly significant year for China. China's impending entry into the World Trade Organization (WTO) has already triggered ground-breaking changes in many of China's industry sectors (the banking sector being no exception), to anticipate and to prepare such sectors for WTO accession. Many sectors have seen a constant flow of new legislation and in the banking sector, the thought of WTO membership has injected much needed impetus into an industry that is ripe for reform.

Key regulatory bodies

The central bank – People's Bank of China (PBOC) – remains a key figure in banking sector reform, strengthening monetary policy and control over the financial sector. PBOC has been instrumental in enhancing Chinese banks' credit discipline, tightening credit supervision of industrial and commercial enterprises, and strengthening the supervision and management of banks. In the area of foreign exchange control, notably the conversion and repatriation of foreign currency, the State Administration of Foreign Exchange (SAFE) plays a pivotal role. Other key regulators affecting the banking industry are the State Administration of Industry and Commerce (SAIC), State Development Planning Commission (SDPC), State Economic and Trade Commission (SETC), Ministry of Finance (MOF) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC), as well as a whole host of industry- or infrastructure-specific regulators such as the Ministry of Information Industry, the State Bureau of the Power Industry, the Ministry of Transportation and the China Securities Regulatory Commission (CSRC). While always working with a view to improving the Chinese economy, these regulators have remained focused, among other things, on the issue of WTO entry and how Chinese industries could rise to the challenge.

Market trends

It is recognized within the Chinese regulatory authorities that China still has a long way to go to make its banking and other laws conform with international standards and practices, especially now that WTO entry is imminent and China wishes to take full advantage of WTO membership. While promulgation of actual legislation is required at many levels, updating and in many cases revolutionizing business and banking practices remain necessary. No doubt time will tell how successful this will be, but already regulators are working overtime to improve China's laws and regulations in a way never seen before.

In an effort to encourage competition within the banking industry, especially in light of WTO entry, the government is encouraging the listing of shares of domestic banking institutions. The Chinese stock market regulator, CSRC, has outlined new listing rules for financial institutions, which lift the restrictions on bank listing. So far, Huaxia Bank has been approved to issue A shares, which would make it the fourth bank to list on the domestic stock markets. Three of China's joint-stock banks, the Shanghai Pudong Development Bank, Shenzhen Development Bank and China Minsheng Bank, are already listed on domestic stock markets. Three of China's big four commercial banks – Bank of China, Industrial and Commercial Bank of China and China Construction Bank – have all indicated that they are seeking a stock market listing. Other banks pushing for a listing include China Merchants Bank and Bank of Communications.

The Chinese government plans to loosen its grip on interest rates in a deliberate and gradual manner. Since September 2000, interest rates on foreign currency loans extended by Chinese banks and large deposits have been marketized to bring these in line with foreign markets, so that banks could set their own hard-currency lending rates. Over the next three years, the renminbi lending and deposit rates will be eased – with the renminbi lending rate next in line and the renminbi deposit rates last to be liberalized. The gradual liberalization of interest rates is seen to help China's economy in its drive to be competitive.

China is expected to approve the establishment of 10 private commercial banks to prepare this sector for foreign competition after China joins the WTO. The new private banks will be wholly owned by private businesses and individual investors. Four of the banks have already completed the relevant feasibility studies and are awaiting final government approval. The establishment of these private banks has been hailed as a major breakthrough in China's banking reform, as this would help lower state shareholding in Chinese banks and improve bank efficiency. When set up, these private banks would also be aiming to list shares on China's stock exchanges.

PBOC continues to maintain a policy of encouraging more residential mortgage lending and with this, a workable and enforceable system of registration of mortgagee rights and interests. As a result, home mortgages have been on the increase while local property mortgage procedural rules are elaborated from time to time. The Real Property Mortgage Procedures (revised as of January 1 2000) promulgated by the Shanghai Municipality is a good example.

At the same time, PBOC is encouraging lending to farmers and small hi-tech and service businesses to help stimulate the economy. To echo this policy, the state banks have increased lending to rural credit cooperatives that would in turn provide loans to farmers, thereby helping to promote rural industrial restructuring and support the farming community's involvement in the processing of agricultural products.

As a sign of the direction lending into China may be heading, China observers will be aware of the state's efforts to open up and develop China's inner (especially western) regions. The May 2001 visit by top-level government officers and business leaders from Hong Kong to Xinjiang province is a prime instance. Already SDPC and MOFTEC have formulated (as of June 16 2000) a catalogue of industries in 20 interior provinces, municipalities and autonomous regions in which foreign investment (and with it, bank lending) is encouraged and given preferential treatment. This initiative was supplemented by a State Council Circular on Several Policy Measures for Opening Up Western China, effective January 2001. The catalogue of industries ranges from agricultural, forestry and mining to transportation and electronics, with a passing reference to environmental protection. While China has not traditionally been known for taking a proactive approach towards environmental protection, environmental risk issues are likely to become more pronounced and more important for both investors and banks lending to projects.

To stimulate new sources of financing for China's hi-tech industries, and to plug the gaps left by traditional bank lending and project sponsors, various regulators (including PBOC, SPDC, SETC and CSRC) jointly issued opinions relating to the establishment of a venture investment mechanism in November 1999, basically laying down a conceptual framework to develop China's hi-tech industries with venture capital funding from various sources. As banks diversify their businesses to compete in newer or as yet unexplored markets, they may well regard the setting up of venture capital subsidiaries and venture capital funds as described in these opinions as being a good source of future business.

Renminbi business

According to the WTO agreement signed with the US and subsequently with other WTO member states, China promised that foreign banks would be allowed to carry out renminbi business two years after China becomes a WTO member, with territorial restrictions on renminbi business lifted within five years. So far, over 32 foreign banks have been licensed to carry on renminbi business, although their scope of activity is limited to certain localities and to certain categories of customers (such as foreign investment enterprises and foreign individuals). The last 12 months have not seen the issuance of any substantive relevant new legislation in anticipation of WTO entry. China observers have commented that new regulations should be promulgated soon, under which licensed foreign banks will be allowed to pursue renminbi/foreign exchange services for both foreign invested enterprises and local enterprises, although licensed foreign banks will need to comply with the same criteria imposed on domestic banks in respect of such renminbi business.

E-banking business

It is estimated that more than 200 branches and subsidiaries of some 20 banks have their own websites and homepages, with more than 50 of them providing substantial online services to an estimated 400,000 customers. Yet there are no specific e-banking guidelines for banks. PBOC is still drafting regulations concerning e-banking and guidelines for e-banking risk management – these are expected to be promulgated shortly. No doubt much consideration will be geared towards security and other risk management measures, and consumer protection.

A successful e-banking business depends on good telecommunications infrastructure, and it is in this area that China has to date seen or drafted substantial pieces of legislation geared to smooth the way for WTO entry, while at the same time attempting to improve the telecommunications backbone to enable the internet to be more accessible to the masses. The potential the internet offers to banks (such as the ability of banks to market products and services to a much wider customer base in light of tough competition after WTO entry) is vast. Banks should keep a close watch on the new pieces of telecommunications legislation not only from a compliance perspective, but also from the point of view that such legislation may well offer new business potential in the form of cooperation with foreign internet content providers, or telecommunications, technology or internet concerns. As a provider of content and news items on their own websites, banks should be wary of their liability under recent content provider legislation.

Credit card business

Credit card business for banks remains a gateway to profit. In June 2000, the China financial certification centre, which is sponsored by PBOC and formed under the auspices of 12 commercial banks, opened its doors. It is hoped that the centre will speed up national credit card integration, it being anticipated that such integration will be completed among large and medium-sized cities by 2003 so that credit cards issued in one locality can be used throughout most of China.

Securities dealings

According to the Law of the People's Republic of China on Commercial Banks effective as of July 1995, commercial banks are not permitted to carry on the business of trust investment and securities dealing. In March 2000, China Everbright Group, with CSRC's blessing, formally accepted the transfer of 240 million shares representing 18.6% of the total share capital of Shenyin Wanguo Securities Company, from its previous owner, the Shanghai Municipal Ministry of Finance. This made China Everbright the largest shareholder of a bank as well as a securities house. This development is perhaps an indication of future reforms regulating the control of securities businesses by banks.

PBOC supervision

In an effort to continually improve the qualifications of senior management, as well as the administration of financial institutions, there were a number of directives issued by PBOC. Among these was the Administration of the Qualifications for Office of Senior Management Personnel of Financial Institutions Procedures (March 2000), which covered the qualifications of the senior management of banks as well as conditions leading to disqualification, such as convictions for corruption and bribery.

Another PBOC directive was directed at leasing companies solely. The Administration of Lease Financing Companies Procedures (June 2000) dealt with the procedures as well as the requirements for establishing leasing companies in China. The Procedures state that the minimum registered capital of a leasing company should be no less than Rmb500 million ($60.4 million) and for those dealing in foreign currency business, $50 million or equivalent. Asset-liability ratios must also be maintained in accordance with the Procedures, such as total long-term investments not exceeding 30% of registered capital, and the balance of foreign guarantees not exceeding twice that of total capital.

July 2000 also saw PBOC issue guidelines regarding the issuance of bankers' drafts, in addition to procedures on payment and settlement agency that were applicable to all banks within China. In November 2000, PBOC issued guidelines relating to the administration of off-book business risk. These apply equally to both domestic banks and branches of foreign banks. The guidelines seek to control how banks should assess, monitor and regulate the risk imposed by off-balance sheet transactions.

Capital adequacy

China's banking industry is dominated by the four large state-run banks, which together own some 70% of the asset base of all banks. A key issue facing the state banks is their inadequate capital adequacy ratio that adopts the standards of the Basel Capital Accord. While a ratio of not less than 8% is acceptable, the capital adequacy ratio for the state banks is noticeably less than that, even though steps are being taken by PBOC in conjunction with the state banks to improve the ratio.

Foreign exchange control

As a country with tough foreign currency controls, especially in relation to capital accounts, China has had its fair share of having to deal with illegal currency trading. With such currency trading prevalent throughout many areas in China, SAFE has sought to crackdown on foreign exchange evasion and fraud, especially in black market trades, working in conjunction with the public security forces. It is anticipated that SAFE will focus on service sectors such as currency exchange services, bank services and credit card services, and unannounced inspections of state banks and their operations are likely.

At the same time, since SAFE maintains a strict regime when foreign currency is lent into China with or without Chinese collateral, the need to obtain the approval of SAFE for the loan (and the security), and to register the same with SAFE pursuant to Chinese foreign exchange and security laws must time and again be emphasized. Non-compliance with these laws imposes a real risk that the loan or the security will become unenforceable, a fact which regrettably foreign lenders in the unfortunate position of having to enforce their loan or security interests have had to come to terms with in the past few years.

It is perhaps noteworthy to mention in this connection that in December 2000, the effect of such non-compliance on security provided by a Chinese entity to a foreign lender was re-examined and clarified in a set of interpretations issued by the Supreme People's Court effective as of December 13 2000, aimed at clarifying some of the uncertainties left unanswered by the Security Law of 1995. The Interpretations regarding Several Issues Concerning the Application of the Security Law (Security Law Interpretations) – which are further discussed below – actually raise as many issues as they seek to address, but are nonetheless helpful for the points they answer. One interesting observation is that the Interpretation provides for civil liability in respect of a security provider for a certain portion of the undischarged debt of the debtor, if the security provider is at fault for the failure to obtain the SAFE approval or registration that triggered the security's invalidity.

It is anticipated that SAFE will continue to actively monitor the foreign exchange implications of inbound investments (whether by way of mergers and acquisitions, fund investments or asset transfers), and to continually promulgate regulations to control the flow of foreign currency and in the context of fulfilling Chinese policies relating to WTO entry.

Asset management companies and trust investment companies

A key problem for the four state banks is the level of their bad debts. The Chinese solution was to offload non-performing assets into four asset management companies each having capital funding of Rmb10 billion, one for each state bank – Great Wall Asset Management Company for the Agricultural Bank of China, Dongfang Asset Management Company for Bank of China, Cinda Asset Management Company for China Construction Bank, and Huarong Asset Management Company for Industrial and Commercial Bank of China, with the latter reportedly having the largest assets.

Under the Financial Asset Management Companies Regulations promulgated by the State Council in November 2000, such companies are under the supervision of PBOC, CSRC and MOF. For these asset management companies to manage (including enforce) non-performing debts against debtors, engage in debt-equity swaps, and achieve a certain measure of investor return would be a challenge in itself. It is known that pursuing debtors in China is filled with obstacles both legal and administrative, as well as geographical, and asset management companies have needed to resort to novel ways to recover debts. Recently, it was reported that one of the asset management companies is resorting to the internet as a channel to enable it to sell non-performing real property assets at low prices.

As asset management companies continue to pursue their given objectives, in January 2001 PBOC took another step towards restructuring China's state-owned enterprises and divesting state ownership in these enterprises by issuing the Trust Investment Company Administration Measures. It is hoped that the creation of investment funds and fund management companies under this new regime will play a key role in the much needed restructuring of state-owned enterprises. However, the success of these new measures will lie in the political will of the central government to ensure that the new investment funds and management companies have the support to carry out their stated objectives.

Insolvency and financial restructuring the Chinese way

Since the high-profile collapse of Guangdong International Trust and Investment Corporation (GITIC) and its declaration of insolvency on January 16 1999, numerous international trust and investment corporations have continued to struggle with foreign creditors to agree on debt restructuring packages that work. At the same time, Hong Kong window companies of Chinese provincial or municipal governments heavily indebted to foreign creditors have had their fair share of financial restructurings, or were otherwise wound up.

The GITIC liquidation has caused banks to reflect further on China's insolvency laws and procedures, especially the apparent insecurity for creditors as shown by the way the various creditors' claims were assessed and how the procedural steps were handled. The GITIC insolvency has generated dissatisfaction amongst creditors on the assessment of claims made by the liquidation committee. For instance, it was not clear why, in the absence of SAFE approval or registration, certain creditors' claims were admitted. In other cases, there was a mark-down in the claim admitted after a finding of fault in dubious circumstances. Even though the State Enterprise Insolvency Law (Trial Implementation) provisions allow creditors to submit unsecured claims in respect of default interest and fees (including legal fees) prior to the date of declaration of insolvency, such claims were rejected. The GITIC insolvency illustrates the importance of SAFE approval and registration for a foreign currency financial transaction on the one hand, while on the other there is always the risk of the haphazard and uncertain manner of the liquidation process, and the risk of the unavailability of sufficient foreign currency (after realizing assets in renminbi) to pay creditors in a large liquidation.

The Legislation Law

To generate investor confidence, it is necessary to have a strong and stable legal system. China recognizes this and has been attempting for years to upgrade its laws. The PRC Legislation Law adopted on March 15 2000 seeks to formalize the structure of the Chinese legal system and the legislative process, and set forth a basis for distinguishing rules from other normative documents of lower status while requiring such normative documents to be filed with the relevant people's congress before becoming effective. It also identifies state organs responsible for reviewing any illegality or inconsistency in legislative measures. The Legislation Law covers a number of topics: scope of lawmaking authority, legislative process of the National People's Congress, legislative process of the National People's Congress Standing Committee, interpretation of national law, scope of application and filing, and other miscellaneous matters. Among other things, this Law empowers the National People's Congress Standing Committee to interpret national law – one such case was the much-debated interpretation of Hong Kong's Basic Law in 2000 regarding the right of abode.

Judicial interpretation of the Security Law

The Security Law of the PRC came into effect on October 1 1995 to facilitate and regulate security transactions in mainland China. Since its promulgation, courts at different levels in mainland China have been confronted with a multitude of litigation, the result of which has seen courts adopting different interpretations of the Security Law. To make the interpretation uniform and afford certainty of results to litigants, the Supreme People's Court of China has been attempting to set interpretation guidelines since the second half year of 1996. Five drafts of guidelines were discussed and debated at all levels before the Security Law Interpretations were issued in December 2000, to serve as judicial guidelines to be followed by all levels of court in mainland China.

The Security Law Interpretations clarified various issues, such as:

  • when security (including a guarantee, charge, pledge and lien) given by a Chinese enterprise (the security provider) in favour of a foreign creditor will be considered void;
  • the provision and level of compensation to a foreign creditor enforcing its security against a security provider in scenarios where the principal contract is valid or void, as the case may be;
  • where the Security Law applies to the guarantee, a guarantee should specify a period during which the guarantee obligation is effective – a so-called "guarantee period". The creditor is further required under the Security Law to take appropriate steps against the debtor or the guarantor before the expiry of the guarantee period. Much uncertainty has surrounded the meaning of the "guarantee period" and the Security Law Interpretations have come to offer some guidelines. Notably, when the contracted guarantee period expires at the same time as or prior to the day when the debt falls due and payable under the principal contract, it is deemed the parties have not contracted for a guarantee period. In such a case, the guarantee period is deemed to be extended to a date six months from the date the debt falls due and payable under the principal contract. When the contracted guarantee period expires upon full repayment of overdue debt under the principal contract, it is deemed the parties have not clearly agreed to the length of the guarantee period. In such a case, the guarantee period is deemed to be extended to a date two years from the day the principal debt falls due and payable.

Another issue that often plagues banks but that has been settled by the Security Law Interpretations is the effect of the Security Law provision that provides that the debt secured by a mortgage may not exceed the value of the mortgaged property. Very often in practice, local land bureaux would, on the basis of this provision, refuse to register real property security the value of which was lower than the loan extended. The Security Law Interpretations now provide that where the secured debt exceeds the value of the mortgaged property, the excess will not have priority, which basically enunciates the obvious principle that the mortgage is only good to the extent of its value.

The Security Law Interpretations throw further light on the nature of a pledge over movables and a pledge over rights under Chinese law. Of note is the concept that a pledgor can create a pledge where it has indirect possession of the asset pledged and the person with actual possession of such asset will be bound by the terms of the pledge with notice. The Security Law Interpretations are particularly helpful in the way they clarify the use of certain security concepts under Chinese law, although many other issues are not addressed.

Year 2001 and beyond

This year will again see China's economy register steady growth. The World Bank estimates that China's share in world exports will almost double within five years of WTO accession, while its share in imports will be more than doubled after five years. This doubling of China's share will be complemented by the opening of various sectors of great potential that have long been closed to foreign investors. While the Chinese banking sector has its own reforms to tackle, the imminent opening up of the banking and other industries to foreign participation offers both Chinese and foreign banks an unprecedented potential to compete for business and revolutionize the way banking business is carried out in China.


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