Securities association’s notice regulates co-operation between banks and companies

By Li Min, Zhonglun W&D Law Firm
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On 17 July 2013, the Securities Association of China issued the Notice on Matters Relevant to Regulating Co-operation Between Securities Companies and Banks in Engaging in Targeted Assets Management Business (Draft for Comments), triggering quite a reaction within the industry.

Main provisions

The objective of the notice is to regulate the co-operation between securities companies and banks in engaging in the channelling-type targeted assets management business. Its main provisions are set out below.

李敏 Li Min 中伦文德律师事务所 合伙人 Partner Zhonglun W&D Law Firm
Li Min
Zhonglun W&D Law Firm

The following circumstances may not apply to a securities company if it wishes to engage in targeted business in co-operation with a bank: i) having an entity, such as a branch, business or office that does not have assets management business qualifications independently engaging in a disguised manner in targeted assets management business; ii) engaging in fund pool business; iii) investing in an industry in which investment is prohibited by the state, such as one that is highly polluting or high energy consuming; iv) engaging in funnelling of benefits; or v) another prohibited circumstance.

The notice additionally requires securities companies to be prudent in their selection of co-operating banks. A co-operating bank is required to satisfy such conditions as having assets of not less than RMB30 billion (US$4.87 billion) as at the end of the last year, a capital adequacy ratio of not less than 10%, not having been subjected to administrative penalties or to major administrative regulatory measures for a major violation of laws or regulations in its operations or management during the past year, etc.

In addition, the notice sets out relatively strict requirements in respect of the internal risk controls of securities companies, and requires them to improve their internal management mechanisms in order to prevent operational risk, such as strictly prohibiting an employee of a securities company from taking official seals offsite to handle business or paying service fees to a third party that is not involved with the targeted assets management business.

Issuance of the notice

The notice is the first regulatory document addressing co-operation between banks and securities companies, and reflects the regulatory thinking of the China Banking Regulatory Commission (CBRC) in the first half of 2013 in tightening up the regulation of wealth management product fund pools and strengthening the controls on insider trading in the bond market. The background to the issuance of the notice is to be found in the ‘great leap forward’ in the assets management channelling business of brokerages and the accumulation of risks.

More specifically, after the Brokerage Innovation Conference in May 2012, the assets management business of brokerages took off, reaching assets under their management amounting to RMB3.5 trillion by the end of June 2013, exceeding that of publicly offered funds, and of that, 80-90% was derived from the channelling business.

However, the channelling business has not resulted in significant profits. According to statistics, the net return rate on the assets management business of brokerages in 2012 was a mere 0.155% and an even less than 0.08% or so in the first half of 2013.

Low returns do not, however, signify low risk. The solvency of clients and transaction counterparties has a direct bearing on the risk exposure of securities companies. In June 2013, the media reported that a certain brokerage in Shanghai was caught up in a scam in the amount of RMB1 billion, and although no actual loss was incurred, it shows the risks involved in such business.

Some securities companies have also revealed ethical risks in their assets management business, mainly involving the payment of intermediary fees and the funnelling of benefits.

Negative impact limited

The notice is an approval for the engagement by brokerages in channelling business in co-operation with banks, and protection for brokerages. We are of the opinion that the notice is not an “inhibitory magic spell” placed on the assets management channelling business of brokerages.

The policy direction remains “regulation” rather than “halt”. The notice does not call for a halt to channelling business, rather it exhorts securities companies to pay attention to risk control. The notice repeatedly emphasises that securities companies need to beef up internal management and control, which would be beneficial to the risk management of brokerages and the regulation of the industry.

The negative impact of the notice on the industry is limited. The unfavourable aspect of the notice lies in the possibility that it could slow down to a certain extent the speed of growth of this business, but on the whole, its impact on brokerages will be minimal, the reasons being that:

  • unlike the Notice on Issues Relevant to Regulating the Investment and Operations of the Wealth Management Business of Commercial Banks (document No. 8) issued by the CBRC, the notice does not offer any specific provisions on the speed or a ceiling on the size of the targeted business engaged in by banks in co-operation with securities companies;
  • the provision that prohibits the business offices and branches of brokerages from engaging in such business does not have a major impact on brokerages because, at present, the great majority of the business offices and branches of brokerages do not independently engage in such business;
  • “may not engage in fund pool business” was strictly restricted early in document No. 8 of the CBRC, and the provision this time has a very limited impact on brokerages;
  • the notice requires that investments not be made in highly polluting and high energy consuming industries, however in practice these types of projects are few in number; and
  • the requirements in respect of the co-operating banks are not overly burdensome, as the majority of banks can satisfy the RMB30 billion in capital threshold and the 10% capital adequacy ratio, not to mention that the main source of the funds for the channelling business comes from large banks. Accordingly, the substantive impact of this provision is limited.

The notice will light the way for innovation in the business of brokerages. We are of the opinion that the notice can effectively cause certain small and medium-sized brokerages to tighten up their pace, and more particularly it will guide brokerages in prudently developing the channelling business that invests in a roundabout way in high-risk sectors such as real estate and local financing platforms, and will be conducive to brokerages “correcting the bias” in the orientation of their assets management business.

Li Min is a partner at Zhonglun W&D Law Firm

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