Regulation of foreign investment in Chinese-owned commercial banks

Following a rush to attract capital that has lasted several years, the large state-owned banks and most joint stock commercial banks with nationwide operating licences have successfully attracted capital and listed. Foreign investors have increasingly trained their sights on city commercial banks and rural financial institutions as acquisition targets.

While the regulation of such acquisitions has remained largely unchanged, related policies and access conditions have become stricter.

Investment methods

Since the issue of the Foreign-Funded Banks Administrative Regulations in 2006, many multinational financial institutions have established wholly owned banks with legal personality in the PRC, or are preparing to do so.

However, it is clear that many financial institutions prefer to take equity stakes in existing Chinese-owned commercial banks.

By doing this, a foreign financial institution can largely circumvent stringent restrictions in respect of the total assets of the investor, representative offices and registered and operating capital that are contained in the Administrative Regulations and their implementing rules. Such an investor also has the freedom to cooperate in particular ventures with the bank in which it has taken an equity stake, including establishing a cooperative business entity or, when regulations permit in future, an equity joint venture company.

Examples of this are the credit card centre long established by HSBC and the Bank of Communications, and the private bank business entity recently established by CITIC Bank and BBVA. This can be a quick and effective way for foreign investors to establish a presence in particular business sectors.

Limits on equity stakes

In December 2003 the China Banking Regulatory Commission (CBRC) issued the Investment and Acquisition of Equity Stakes in Wholly Chinese-Owned Financial Institutions by Foreign Financial Institutions Administrative Measures. These set forth clear and detailed provisions on the criteria that investors must meet, the methods by which equity interests can be taken and the percentages, the conditions for taking an equity stake, and investment procedures. In particular, the restriction that foreign investors taking an equity stake in a wholly Chinese-owned bank may not exceed 20% in the case of a single investor, or 25% in the case of multiple investors, has been termed a “base line that must not be crossed” by the CBRC. To date, no revisions have been made to the Administrative Measures or the restrictions on equity percentages.

Stringent access review

Under the Administrative Measures, a foreign financial institution that applies to take an equity stake is required to satisfy seven conditions. These conditions relate to total assets, credit rating, capital adequacy ratio, continuous profitability, internal control systems, regulation in its place of registration, and the economic situation of its home country. The CBRC also lays down other prudential requirements (namely the eight conditions set out in the Wholly Chinese-Owned Commercial Banks Items That Require Administrative Permission Implementing Measures). The CBRC reserves the right to revise these conditions in the light of the risk situation of the financial industry, so as to ensure that the PRC banking industry attracts genuine, financially strong, technically competent and well reputed investors.

As well as conducting access reviews in accordance with the above conditions, the CBRC has gradually made investors aware of other prudential requirements, including a lock-up period of five years for foreign strategic investors that intend to take an equity stake of at least 5%; a written undertaking by the investor at the time it submits its application that it will abide by PRC laws; and a prohibition on a foreign investor taking a stake in more than two banking industry financial institutions of the same nature.

Since the financial crisis, access reviews have become more stringent. In the Strengthening the Review of the Qualifications of the Major Shareholders of Small and Medium-Sized Commercial Banks Notice, issued by the CBRC in April 2010, the regulator further clarified the prudential conditions that must be satisfied by shareholders that hold or control at least 5% of the shares of a commercial bank and are among its largest three shareholders, or that are not among its largest three shareholders but have been determined to be major shareholders that have a material influence on the bank. Thus, in addition to the seven conditions of the Administrative Measures outlined above, a foreign investor that intends to take an equity stake and/or increase its equity interest in a small or medium-sized commercial bank and become a major shareholder is required to satisfy the following conditions:

• a single shareholder may not take an equity stake in more than two banking industry financial institutions of the same nature, and if the stake taken gives it control, it can only take an equity stake in or retain one banking industry financial institution (i.e. two stakes or one control);
• at the time of application, it is required to provide proof of the source of its funds; and
• it is required to issue several formal undertakings, including undertakings that it will not interfere in the bank’s day-to-day operations, will not transfer the shares for five years, will supplement capital on an continuing basis, and will not impose improper target pressures on the bank.

In substance, the notice summarizes the regulator’s prudential requirements, as practised over many years of reviews. These requirements should not be an obstacle to the purchase or increase of an equity interest in a wholly Chinese-owned bank by a foreign institution.

In its review, the regulator will also focus on such matters as whether the foreign investor will bring an advanced and suitable management philosophy to the small or medium-sized bank, provide effective technical support services, provide product or business training, or jointly develop and introduce support or cooperation in respect of such matters as risk control and corporate governance.

Dorothy Xing is a partner at Concord & Partners in Beijing