On 6 April, the People’s Bank of China published the Financial Stability Law (Draft for Comment). As insurance is an essential part of the financial sector, relevant provisions of the draft will apply to the insurance industry. In this article, the authors navigate the draft’s impact on risk disposal in the insurance industry.
Imposing responsibilities on major shareholders and actual controllers of insurers. Articles 24, 28 and 32 of the draft reflect the regulatory orientation that reaffirms the responsibilities of major shareholders and actual controllers of insurers. These provisions are based on the risk disposal experience of China’s financial industry in recent years.
According to the draft, the practice of early disposal shows that corporate governance failures and extensive business models of certain small and medium-sized financial institutions, abuse of control rights and illegal occupation of financial institutions’ funds by certain shareholders and actual controllers are important causes of financial risks. Therefore, future risk disposal of insurers requires responsible major shareholders and actual controllers to take a more proactive stance.
Emphasis on market-oriented disposal methods to reduce disposal costs. Generally speaking, risk disposal of insurers can be carried out by market-oriented, administrative or judicial means. Conventional methods in China reflect the philosophy of administrative leadership and market supplementation. Although it is certainly forceful and effective, it requires frequent use of regulatory resources and industry guarantee funds, incurring higher disposal costs.
The draft, on the other hand, will help to further rationalise the administration and market’s roles. The idea is, as far as possible, to manage risks in a market-oriented manner and only consider resorting to industry guarantee funds, financial funds or financial stability guarantee funds to help troubled insurers when an effective market-oriented disposal cannot be identified. It should be noted that a priority of market-oriented disposal does not exclude the guiding or promoting role played by regulatory authorities.
DIVERSIFYING RISK DISPOSAL
Article 30 of the draft systematically provides for the risk disposal measures available for regulatory authorities, some of which are brand new in the insurance industry. For example, “setting up bridge banks and special purpose vehicles (SPVs) to undertake the business, assets and liabilities of the disposed financial institution” will enable the transfer of business, assets and liabilities of an insurer at risk to be transferred to the SPV.
Another new measure is the “implementation of equity and debt write-down and debt-to-equity swap when the disposed financial institution meets the requirements provided for by the financial management department of the State Council”. Although article 151 of the Insurance Law (amended 2015) provides that under certain circumstances regulatory authorities may order shareholders of insurers to transfer their held equity, the depth of such risk disposal efforts remains limited. Under the framework of the draft, regulatory authorities may write down the shareholders’ equity of troubled insurers according to the law, which is stricter than previous provisions.
FACILITATING RISK DISPOSAL
In addition to providing new measures for risk disposal, the draft also sets regulations to facilitate disposal. For example, article 31 states that whether the business, assets and liabilities of a troubled insurer are transferred to an insurer of the same type or an SPV, transfer in whole may be conducted by issuing an announcement, upon which it becomes effective.
Under article 35 – for SPVs set up to undertake the business, assets and liabilities of the disposed insurer – regulatory authorities may exempt or change certain requirements based on the risk disposal demands. Therefore, granting regulatory exemption to SPVs also will alleviate obstacles to undertaking the business, assets and liabilities of troubled insurers, thus facilitating risk disposal.
Establishing financial stability guarantee funds as reserve for risk disposal of insurers. One of the highlights of the draft is the addition of financial stability guarantee funds to provide reserve funds for the risk disposal of financial institutions, including insurers. Under article 28, if material financial risks endanger stability, financial stability guarantee funds may be used according to relevant provisions. This means the establishment of financial stability guarantee funds serves as a safety net to the operation of insurers.
According to its supplementary provisions, the draft applies to the financial risk disposal activities that have taken place before its implementation, as well as ongoing ones.
Therefore, insurers in the process of risk disposal will be governed by the officially implemented Financial Stability Law. However, it remains to be seen to what extent regulatory authorities will apply that law’s approach to insurers at risk.
Yao Xiaomin is a partner and Cai Min is an associate at Lantai Partners
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