A Q&A guide to structured finance and securitisation law in China.
This Q&A provides an overview of, among others, the markets and legal regimes, issues relating to the SPV and the securities issued, transferring the receivables, dealing with security and risk, cash flow, ratings, tax issues, variations to the securitisation structure and reform proposals.
To compare answers across multiple jurisdictions, visit the Structured lending and securitisation Country Q&A tool.
This Q&A is part of the PLC multi-jurisdictional guide to structured finance and securitisation. For a full list of contents visit www.practicallaw.com/securitisation-mjg.
How active and/or developed is the market and what notable transactions and new structures have taken place recently?
To what extent have central bank liquidity schemes assisted the securitisation market in your jurisdiction? Were retained securitisations common in the last 12 months?
Is securitisation particularly concentrated in certain industry sectors?
In China, there are two main methods of conducting a securitisation transaction:
Credit assets securitisations using trusts as special purpose vehicles (SPVs) (special purpose trusts (SPTs)), which are regulated by the People's Bank of China (PBOC) and the China Banking Regulatory Commission (CBRC).
Corporate assets securitisations using customer asset management plans as SPVs, which are regulated by the China Securities Regulatory Commission (CSRC).
Residential mortgage-backed securitisations (RMBS), collateralised loan obligation (CLO) transactions, non-performing loan (NPL) securitisations, commercial mortgage-backed securitisations (CMBS) and car loan securitisations have been conducted under pilot programmes but have not evolved into anything resembling the recurring and liquid securitisation markets of the West before the financial crisis. Most of the above transactions are retained securitisations, where the originator retains the junior tranche asset backed securities (ABS) notes. There is no central bank liquidity scheme in the People's Republic of China (PRC) that would enable the originator to fund itself through central bank borrowing secured by these junior notes. In addition, the underlying assets must be credit assets of the CBRC-approved financial institutions.
In December 2005, China's financial institutions made their successful start in two pilot credit assets securitisation transactions. One transaction was an RMBS pass-through deal initiated by the China Construction Bank (CCB). The other was a static cash flow CLO transaction initiated by the China Development Bank (CDB). Other notable transactions include the following:
In April 2006, the CDB launched another CLO transaction with a similar structure.
In December 2006, China Cinda Asset Management Corporation and China Orient Asset Management Corporation sponsored two NPL securitisations and respectively placed CNY3 billion (as at 1 May 2011, US$1 was about CNY6.5) and CNY0.7 billion senior trust certificates through the inter-bank market.
In the second round of securitisation pilots, more commercial banks successfully initiated credit assets securitisations (for example, the Industrial and Commercial Bank of China and the Merchant Bank). In addition to traditional transaction structures such as CLO and RMBS, some commercial banks have designed new transaction structures. For example:
The China Zheshang Bank initiated a CNY696 million ABS deal, which was the first small loan securitisation in China.
The China Minsheng Bank attempted to originate China's first CMBS deal.
GMAC-SAIC, as the originator, initiated an ABS deal (2008) worth about CNY2 billion, which was the first car loan securitisation in China.
However, the CBRC and PBOC have not approved any credit assets securitisation during the past 12 months.
In August 2005, China Unicom pioneered the corporate assets securitisation transaction, with offering proceeds of CNY9.36 billion, under the collective asset management plan (CAMP) model. After that transaction, the CAMP model began to attract other corporate originators, which resulted in the launch of eight more CAMPs on the market. These securitisation transactions occured in various business sectors, such as telecommunication, infrastructure, communication and financial leases.
However, the CSRC has put the CAMP issuance approvals on hold in September 2006, and has shifted its focus from approving new issuances to evaluating the existing transactions, through addressing the structural and legal issues that have surfaced, and formulating more detailed administrative guidelines.
An informal securitisation market started in 2008 and peaked in 2009. In informal securitisations, banks package loans into investment products and then sell them to retail investors.
However, the following features make the informal securitisations riskier and more opaque as compared to the conventional structures:
Transferred assets generally remain on the originator's balance sheet.
The asset pools lack diversification.
Disclosure is minimal to non-existent.
Lack of a secondary market means investors typically must hold positions until maturity.
Typically there are no tranching arrangements based on credit risk.
The roles of the originator, product distributor, custodian, and loan manager are vested in one person (or affiliated persons).
In July 2010, the CBRC required trust companies, which play a vital role in these transactions, to temporarily halt all informal securitisations with banks and issued other restrictive notices.
What are the main laws governing securitisations?
Is there a regulatory authority?
The CBRC and the PBOC regulate different aspects of the credit assets securitisation process:
The CBRC is concerned with monitoring financial institutions.
The PBOC regulates the issuance and trading on the inter-bank bond market.
The PRC Trust Law (Trust Law) is the principal law governing credit assets securitisations. In addition, on 20 April 2005, the PBOC and the CBRC jointly issued the Administrative Measures for Pilot Credit Asset Securitisation Projects (Administrative Measures for CAS) and on 7 November 2005, the CBRC issued the Administrative Measures for Supervision of Pilot Projects for Securitisation of Financial Institutions' Credit Assets (Administrative Measures for Supervision). These administrative regulations form the legal framework governing the credit asset securitisation process, in addition to the Trust Law.
The CSRC issued the Tentative Measures for the Client Assets Management Business of Securities Companies (Tentative Measures) on 1 February 2004. Although the Tentative Measures were not specifically designed to create a vehicle for securitisation, in practice, market participants find that the CAMP is a suitable vehicle to carry out corporate assets securitisations. The CSRC adopted the CAMP structure, and, as the securities industry regulator, regulates securities companies in their asset management business, including their corporate assets securitisation business.
In addition, parties to a CAMP securitisation define their respective rights and obligations through contractual agreements under the PRC Contract Law (Contract Law).
Accounting practices in your jurisdiction, such as application of the International Financial Reporting Standards (IFRS)?
National or supra-national rules concerning capital adequacy (such as the Basel International Convergence of Capital Measurement and Capital Standards: a Revised Framework (Basel II Accord) or the Capital Requirements Directive)? What authority in your jurisdiction regulates capital adequacy requirements?
Credit assets securitisations are carried out for all the reasons listed in the Model Guide.
The two main reasons for doing a corporate assets securitisation are:
Cheaper borrowing and credit arbitrage.
Alternative source of funding.
The Ministry of Finance, as the regulatory authority for accounting practices in the PRC, issued the Accounting Standard for Enterprise and a series of implementation rules, which together constitute the PRC generally accepted accounting principles (GAAP). The PRC GAAP heavily rely on and adopt international accounting standards (IAS) and, in line with IAS 39, the Ministry of Finance published Accounting Provisions of Credit Assets Securitisation (Caikuai [2005] No. 5) regarding the de-recognition of financial assets in securitisation transactions.
The CBRC is the authority regulating the capital adequacy of banks. It issued the Administrative Measures for Capital Adequacy Ratio of Commercial Banks in 2004, and amended them in 2007.
In addition, the CBRC issued the Circular on Printing and Distributing the Instructions concerning Implementation of the New Capital Accord by China Banking Industry and a series of detailed rules to implement the Basel II in Chinese commercial banks. In particular, the CBRC issued Guidance on Determining Regulatory Capital Requirements on Exposures Arising from Securitisation (Guidance), which became effective on 1 January 2010.
On 3 May 2011, the CBRC issued the Instructions concerning Implementation of the Basel III Capital Accord by China Banking Industry to implement the new Basel III.
Together GAAP and the CBRC's rules provide guidance and incentives for banks and other originators to achieve de-recognition of assets on their balance sheets through securitisations.
What form does the SPV usually take and how is it set up?
What is the legal status of the SPV?
How is the SPV usually owned?
Are there any particular regulatory requirements that apply to the SPVs?
An SPT is used in credit assets securitisations (see Question 1). Trust is not considered a separate legal entity under the PRC law. Under the Trust Law, the originator, as a settlor, entrusts certain assets to the trustee and the trustee manages or dispose of those assets in its own name and for the benefit of the ABS noteholders.
Similarly, a CAMP has no separate legal status from its originator. Parties to a CAMP securitisation define their respective rights and obligations through contractual agreements under the Contract Law, particularly the provisions related to the entrustment relationship.
A CAMP transaction involves two stages:
The investors entrust their funds to the securities company to establish a CAMP.
The securities company, on behalf of the investors, uses the entrusted funds to purchase certain assets, such as receivables over a certain period of time, from the settlor.
Under the current pilot regulatory regime, the securitisation pilot is limited to domestic deals and is not applicable to cross-border securitisation. While there are no statutory prohibitions relating to cross-border securitisation under the PRC law, in practice it is difficult to obtain State Administration of Foreign Exchange (SAFE) approval to convert Chinese yuan renminbi into hard currency for remittance to service cross-border debt.
There have been a few precedents, such as Dynasty 2006-1 CMBS, GZI Real Estate Investment Trust and CapitaRetail China Trust, where the underlying assets were in the PRC, and the assets generated hard currency revenues or the debt was serviced by hard currency dividends (which are permitted) paid to offshore issuers. However, these are exceptional cases.
In a credit assets securitisation, to ensure the bankruptcy remoteness of the SPT, the trust agreement always provides that both:
The trust is not allowed to incur any other debt except for the ABS notes.
All the relevant transactional parties promise not to seek to dissolve the trust before the legal maturity date.
In a corporate assets securitisation, under the Contract Law, the settlor or agent can rescind the entrustment contract at any time. An entrusted contract shall also be terminated by death, loss of civil capacity or bankruptcy of the settlor or the agent, unless the parties have agreed otherwise or it is inappropriate to terminate the contract given the nature of the entrusted matter(s).
To mitigate the risks relating to the entrustment relationship, the asset management contract between the investors and the securities company usually provides that:
The CAMP shall not terminate due to the bankruptcy of the investors or the bankruptcy or resignation of the securities company.
The securities company will perform all the duties and obligations under the agreement before the nomination of the successor.
After the successor is nominated, it will bear all the duties and obligations of the original CAMP manager.
The heir or beneficiary of the settlor will enjoy all the rights and bear all the liabilities under the CAMP agreement.
The parties' most critical concern regarding bankruptcy remoteness is whether the transferred assets are deemed to be separate from the originator's other assets. In a credit assets securitisation, it is easy to achieve bankruptcy remoteness from the originator when the trust structure is used. After the trust is legally created, if the settlor dies or is dissolved in accordance with the law, or is cancelled or declared bankrupt in accordance with the law (Trust Law):
If the settlor is not the only beneficiary, the trust shall continue to exist and the trust property shall not be deemed his heritage or liquidation property.
If the settler is the only beneficiary, the trust shall terminate and the trust property shall be deemed his heritage or liquidation property.
In a corporate assets securitisation, it is difficult to achieve bankruptcy remoteness due to lack of the trust structure. Whether the transferred assets can be separated from the originator's other assets will depend on a true sale analysis (see Question 16).
In a credit assets securitisation, the ABS notes are issued publicly on the inter-bank bond market. In a corporate assets securitisation, CAMP units can only be issued to the existing clients of the securities company (Tentative Measures). In addition, any public solicitation is prohibited on a CAMP issuance.
Are the securities usually listed on a regulated exchange in your jurisdiction or in another jurisdiction?
If in your jurisdiction, please briefly summarise the main documents required to make an application to list debt securities on the main regulated exchange in your jurisdiction. Are there any share capital requirements?
If a particular exchange (domestic or foreign) is usually chosen for listing the securities, please briefly summarise the main reasons for this.
To make an application to list the ABS notes on the inter-bank bond market, at least the following documents must be submitted:
Application report.
Transactional documents, such as the trust agreement, the servicing agreement and the custodian agreement, underwriting agreement and so on.
Prospectus.
The approval letter of the CBRC.
Legal opinion.
Accounting opinion.
Credit rating report.
The trust concept is recognised.
The underlying assets for credit assets securitisations include various types of loans, such as the residential mortgage loans, car loans, NPLs, commercial loans and small loans.
For corporate assets securitisations, the scope of underlying assets includes various accrued or future receivables in connection with toll roads, equipment leases, electricity sales, build-transfer (BT) projects, wastewater disposal and even instalments of share purchase price.
However, the securitisation transactions are not market-driven in the PRC. The securitisation pilots are tightly controlled by the regulatory authorities and subject to their changing policies. For example, the types of underlying assets to be securitised and the originator to carry out the pilot are always chosen by the CBRC, PBOC or the CSRC.
In a credit assets securitisation, the receivables are transferred through a declaration of trust. The originator and the trustee enter into a trust agreement. If the laws and regulations require trust assets to be registered, such registration should be effected according to the requirements under the specific laws and regulations (Trust Law). Subject to the registration requirements regarding the transfer of attached security (see Question 13), there are no special requirements for the transfer of loan assets under the PRC law.
In a corporate assets securitisation, the securities company, as the manager of a CAMP, and the originator will enter into an asset transfer agreement. There are no special perfection requirements for the transfer of general receivables. Generally, the transfer is deemed to be completed on the execution of the asset transfer agreement. However, the legal effect of the transfer will be subject to:
The true sale analysis (see Question 16).
The PRC Security Law (Security Law) and PRC Property Rights Law (Property Rights Law) in relation to the security interest attached to the transferred receivables, if any.
Future receivables are the most common underlying asset in corporate assets securitisation transactions in the PRC (for example, the future receivables of toll road, equipment financial lease and electricity sale). Currently, no law or regulation expressly provides procedures for the transfer of future receivables under the PRC law.
The PBOC has established a registration system for pledges of account receivables (including future receivables), although it is still uncertain whether the transfer of receivables can be registered on this system. Due to this uncertainty, in practice, the investors always ask a third party guarantee as an additional credit enhancement if the underlying assets are future receivables.
Under the Property Rights Law, a security interest cannot be transferred, or be used as a guarantee for a third party's rights, independently from the obligation secured. When the obligee's rights are transferred, the security interest attached to them must be transferred at the same time, unless otherwise agreed by the obligee.
In land mortgage securitisation transactions, the mortgage right is established under Article 42 of the Security Law. In car loan mortgage securitisations, the mortgage right is established under Article 43 of the Security Law.
Mortgages under Article 42 of the Security Law (covering specified properties including land use rights, urban real estate, buildings, forest trees, aircrafts, ships, vehicles, equipment and other moveable properties) are established on execution of a written mortgage contract and registration of the same at the registries designated for each type of specified property. Mortgagee rights can be transferred together with the secured debt only by re-registration of the mortgage in favour of the new mortgagee.
Mortgages under Article 43 of the Security Law (covering all other types of property) can be established on execution of a written mortgage contract but are not effective against third parties unless registered. The mortgagee can choose whether to register its rights voluntarily. Mortgagee rights can be transferred together with the secured debt by assignment. However, the transfer is not effective against third parties unless the mortgage is re-registered in favour of the transferee.
There are no special prohibitions on transferring the receivables or other issues restricting the transfer under the PRC law. However, there may be some contractual restrictions to prohibit and/or restrict the transfer of the receivables by one party.
In particular, there are no general laws and regulations regarding the confidentiality of customer information or the transfer, or the collection or processing of personally identifiable information in the PRC. However, the Contract Law requires parties to a contract to act in good faith and perform obligations such as maintaining confidentiality in accordance with the nature and purpose of the contract and/or trade usage. Parties to the contracts must comply with this general principle of confidentiality.
A negative pledge is enforceable under the PRC law. A contractual party cannot transfer the receivables without the counterparty's consent if there is a negative pledge clause.
In a credit assets securitisation, true sale is achieved by using the trust structure. Once the trust is legally established, the trust assets will be separate from the assets of the originator and the trustee by operation of law subject to any applicable registration requirements (see Question 7). The risks of re-characterisation are quite small.
In a corporate assets securitisation, the court will consider the economic characteristics of the transaction rather than simply relying on the parties' statements and intention. Therefore, a sale may be re-characterised by the court considering its economic characteristics. The economic characteristics of a secured loan, which may prevent the achievement of true sale status, include but are not limited to:
The existence of the originator credit risk.
An obligation to repurchase receivables for breach of representation or warranty.
Control of the collections of the receivables.
The bankruptcy administrator has a right to request the court to revoke any of the following acts relating to the originator's assets occurring within one year before the court's acceptance of the originator's bankruptcy petition (Article 31, PRC Enterprise Bankruptcy Law):
A transfer of any assets for no consideration.
A gratuitous provision of security.
A payment of debt not yet due.
A unilateral surrender of creditor's rights.
Other transactions made for unreasonably low value.
The bankruptcy administrator also has the right to request the court to revoke any preferential payments made by the debtor within the six-month period before the court's acceptance of the bankruptcy petition, unless those payments benefit the debtor's assets (Article 32, PRC Enterprise Bankruptcy Law).
Therefore, whether the transfer of underlying assets constitutes an arm's-length transaction is very important under the PRC law. To mitigate the risks that the bankruptcy administrator can unwind a transfer, the transfer price must be reasonable. In practice, the transfer price is decided through a transparent book-building/bidding procedure. Therefore, barring fraud or other grounds for invalidation under the Enterprise Bankruptcy Law, a transfer will not be deemed invalid on the seller's bankruptcy because the transfer price is determined by the market and is considered fair.
The transactional documents are governed by the PRC laws in the onshore securitisation deals and therefore there is no governing law issue. However, if the contract in question has a foreign element (that is, one of the parties is outside China, the subject matter is located outside China, or the legal relationship between the parties occurred outside China), Chinese courts will enforce the choice of a non-Chinese law as the governing law of the contract.
However, a PRC court will not enforce the parties' choice of non-PRC law to govern the contract if the court considers that:
Such law is contrary to the public interest of the PRC.
The application of such non-PRC law will circumvent the application of any PRC mandatory or prohibitive law.
The most common security interest over the underlying assets is a mortgage (see Question 14). The perfection requirements vary depending on the type of security.
In a credit assets securitisation, the security is held by the trustee on behalf of the SPT. In a corporate assets securitisation, the security is held by the manager on behalf of the CAMP.
To create a valid trust, the following requirements must be met:
A trust must serve a legitimate purpose.
There must be ascertained trust property and that property must be lawfully owned by the settler. See Question 12 for registration requirements.
A trust must be created in writing.
There are no PRC laws and regulations regarding the recognition of foreign trusts. In addition, PRC is not a party to the Hague Convention on the Law Applicable to Trusts and on their Recognition 1985 (Hague Trust Convention). Whether a foreign trust will be recognised by a PRC court is a factual matter decided on a case-by-case basis.
The following methods of credit enhancement set out in the Model Guide are commonly used:
Over-collateralisation.
Creation of retained spread.
Creation of subordinated tranches.
Cash reserve fund is the commonly used liquidity support measure in the securitisation transactions in the PRC. In addition, a loan facility from a third party is also used in some credit assets securitisations.
There are no substantial variations to the cash flow index accompanying Diagram 9 of the Model Guide. However, swap arrangements are not common in the PRC.
Servicing fee is the most common method of profit extraction by the originator. Typically, the originator does not provide a subordinated loan or inject equity capital in a securitisation transaction.
This is not applicable, as securitisation pilots can only be initiated onshore (see Question 5). For a rating in a PRC securitisation, the rating agency focuses on the underlying assets rather than any political issues.
What transfer taxes may apply to the transfer of the receivables? Please give the applicable tax rates and explain how transfer taxes are usually dealt with.
Is withholding tax payable in certain circumstances? Please give the applicable tax rates and explain how withholding taxes are usually dealt with.
Are there any other tax issues that apply to securitisations in your jurisdiction?
Value added tax (VAT) is imposed on the sales/imports of goods and the provision of processing, repairs and replacement services (VAT services) in the PRC territory. The VAT rate is generally 17%, with reduced rates applicable to certain goods.
Business tax is imposed on the provision of services (other than VAT services), the assignment of intangible assets and the sale of immovable properties in the PRC territory. The business tax rate ranges from 3% to 20%, with the 5% rate being the most common for commercial services. Examples of intangible assets are land use rights, trade marks, patents, copyrights, non-patented technology and goodwill. The receivables are not classified as intangible assets under the business tax rules, and therefore no business tax should be payable on the transfer of the receivables.
As long as the seller or the buyer is domestically incorporated, no withholding tax will apply to any part of the payments on the receivables. The issuer is not itself taxable, nor are its payments to investors, whose receipts are simply part of their overall taxable income.
Stamp duty is a tax levied on certain taxable documents executed or used in the PRC. The agreement for sale of the receivables does not fall within the scope of taxable documents. Therefore, no stamp duty should be payable on entering into these agreements.
In theory, the use of synthetic securitisations is possible under the current legal framework. However, in practice, this will depend on the development of the credit derivative market and the policy of the regulatory authorities in relation to securitisation and derivatives. There have been no synthetic securitisation transactions until recently in the PRC.
The various securitisation structures set out in the Model Guide are not yet available in the PRC.
Even after the successful recapitalisation of major commercial banks in China through the Central Huijin bond facility in 2010, the solvency problems faced by many commercial banks have not been fully alleviated. Therefore, off-balance sheet treatment of the securitised assets through true sale will attract more banks to engage in securitisation. After an initial period of market feedback, it is likely that the PBOC and CBRC will consider re-launching the securitisation pilots.
T +86 10 6505 4243
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E fredchang@fenxunlaw.com
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Qualified. New York, 1987
Areas of practice. Corporate finance.
Recent transactions
T +86 10 6505 4647
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E yangxusheng@fenxunlaw.com
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Qualified. New York, 1999
Areas of practice. Securities; securitisation; venture capital; derivatives.
Recent transactions
T +86 10 6505 9190
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E wangting@fenxunlaw.com
W www.fenxunlaw.com
Qualified. PRC, 2006; New York, 2010
Areas of practice. Securitisation; bond issuance.
Recent transactions
