Member Article

On 20 April 2005, the People’s Bank of China (“PBOC”) and China Banking Regulatory Commission (“CBRC”) promulgated the Administration of Pilot Projects for Securitisation of Credit Assets Procedures (“the Procedures”). The enactment of the Procedures has received widespread support since they reflect one of the first attempts at regulating securitisation in China. What is securitisation? Securitisation involves the process of transferring credit assets to a special purpose vehicle (“SPV”) by a banking financial institution (the originator). In turn, the SPV pays the originator an amount equal to the value of the credit assets. The SPV normally obtains funding for the purchase of the assets by issuing debt securities, and redemption of the securities is met with the pool of credit assets. Generally, securitisation facilitates the obtainment of funding at a low cost from the capital markets so that the originator will have capital for re-investment. Securitisation in the PRC The following are two possible securitisation structures which could be adopted in China: (1) Trust Interest Structure. Under this structure, the originator assigns a trustee to maintain the trust assets and will hold a beneficial interest in the assets. However, the interests of the originator will be subordinate to those of institutional investors. The trustee will manage the assets but a bank may not serve as trustee because the banking business does not usually include trust business. (2) Fund Trust Structure. Institutional investors entrust a fund to a trustee by signing a fund trust contract. The Trustee may be entrusted with up to 200 contracts and funds entrusted under each contract must be more than RMB50,000. The trustee will then pool the funds and use them to purchase the credit assets. The Procedures in the PRC provide a framework for the regulation of the trust interest structure. The trust interest structure is preferable amongst the two options because the originator will be able to take the first step in the transaction and there are less restrictions. Nonetheless, the structure of securitisation in the PRC is slightly different from the common structures of securitisation adopted in many parts of the world. According to the Procedures, the originator will first set up a special purpose trust (“SPT”) for the securitisation of a pool of credit assets. The credit assets will be transferred into the SPT, the trustee of which is usually a trust and investment company. A trust contract will be executed between the originator and the trustee, specifying the rights and obligations of both parties, the trust term, the method of managing the credit assets and the form and means whereby the beneficiaries are to receive the benefits from the trust. The trustee will offer asset-backed securities in the form of trust beneficiary certificates to institutional investors and the PBOC will determine whether the trustee may offer the asset-backed securities on the national inter-bank bond market. In turn, the income generated by the assets will be used to pay returns on the asset- backed securities. Save as described above, the CBRC will supervise securitisation activities. What are the advantages of the Procedures? Under the Procedures, the credit assets held by the trustee are separate from the assets of the originator, trustee and other service agents which are involved in the securitisation transaction. As a result, the credit assets will be insulated from the insolvency risks of each of the relevant institutions. Subsequently, the asset-backed securities will be able to secure a higher credit rating than that of the originator, implying that cheaper funding could be obtained. The Procedures provide that, instead of a specific notice needing to be served on each counter party, a public announcement in the national press constitutes sufficient deemed notice. What are the weaknesses of the Procedures? Although the Procedures affirm that the credit assets to be entrusted are independent from the assets of the originator, trustee and other relevant institutions, the effect of a ‘true sale’ of credit assets between an originator and a SPT remains in doubt. This is probably due to the under-developed bankruptcy law in China. The PRC Enterprise Bankruptcy Law (Trial Implementation) 1986 (“Bankruptcy Law”) is considered to be an unreliable framework for the regulation of bankruptcy and has only been followed in a few court judgments. Not surprisingly, certain ambiguous provisions of the Bankruptcy Law exist to pose problems for the effectiveness of credit assets transferral to a SPT if originators become insolvent. For instance, the Bankruptcy Law states that any sale of assets at an unusually low price by an institution entering bankruptcy, which is effected up to six months before the court’s acceptance of the bankruptcy petition and ending on the date of the bankruptcy declaration, shall be nullified and that such assets shall become part of the bankruptcy estate. However, implementing rules for this provision have so far been lacking. It is therefore believed that uncertainties with regard to the pricing of assets to be securitised will arise due to the shortfall in the Bankruptcy Law. Another problem with the Procedures is that they only envisage the securitisation of credit assets of banking financial institutions. Moreover, the term “credit assets” has not been clearly defined in the Procedures. Loans have generally been recognised as credit assets but it is unclear as to whether cashflows such as credit card receivables and lease receivables are included in the definition of credit assets under the Procedures. Matters relating to security are not covered in the Procedures, so the limitations of the PRC Security Law and related regulations remain as before. The Procedures also refer tax and accounting issues to further legislation. Hence, uncertainties remain since future law development has to be taken into account in the securitisation of credit assets. Conclusion Undoubtedly, the new Procedures represent a legislative breakthrough with regard to the securitisation market in the PRC. Nonetheless, it is also observed that ambiguities underlie several areas within the procedures. Whether the Procedures will lead to a more active securitisation market in the PRC will therefore require further observation in the longer run.