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Financing Security Companies

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Victor Ho

Registered Foreign Lawyer, Cal

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Matthias Voss

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28 October 2010

Further to the promulgation of the Interim Measures for the Administration of Financing Security Companies by seven State-level regulators on and effective from 8 March 2010 (the Measures), the Ministry of Commerce (the MOC) issued a notice on 26 August 2010 (the MOC Notice) to regulate foreign-invested financing security companies (FSCs), and the Shanghai government and several provincial-level governments (eg Anhui, Guangdong, Jiangxi and Shandong) promulgated regulations to implement the Measures. This bulletin revisits the key features of FSCs.

Scope of business

"Financing security" (融资性担保) refers to the securing of financing debts of a secured party by a security provider. The Measures do not differentiate between onshore and offshore financing security, secured party or financing debts.

FSCs may provide security for loans, the acceptance of negotiable instruments, trade financing, project financing and letters of credit. FSCs may also (1) guarantee litigation outcomes, (2) issue performance bonds for contract performance, bids or advance payments, and final instalment payments, (3) provide financing, financial consulting, and other intermediary services related to the security business, (4) invest their own capital, and (5) provide security for the secured liabilities of other FSCs.

FSCs are expressly prohibited from accepting deposits, granting loans or entrusted loans, investing on an entrusted basis, or providing financing security to their parents or subsidiaries.

Foreign-invested FSCs

Foreign investors can establish (and acquire) FSCs in China. The MOC Notice requires the establishment of a foreign-invested FSC to be approved by the provincial-level MOC and FSC supervision authority, ie the Finance Office (金融办). This process should apply to the acquisition of FSCs. The MOC Notice does not differentiate the approval procedures based on the registered capital amount of or purchase consideration for foreign-invested FSCs. There are no express restrictions under the Measures regarding the extent of foreign ownership permitted in FSCs.

Establishing FSCs

Establishing FSCs is similar to establishing foreign-invested enterprises. Some notable differences are that, under the Measures, (1) shareholders of FSCs must demonstrate the ability to continue to contribute capital, (2) the registered capital must be paid in cash, (3) key personnel, such as directors and senior management, must meet the qualifications drawn up by the designated inter-ministerial committee, and (4) FSCs are subject to prudential requirements (see below).

The Measures specify the minimum registered capital of FSCs to be RMB 5 million, or RMB 100 million if the FSCs engage in "re-guarantee" business. This requirement can differ from province to province. For example, in Guangdong, the minimum registered capital amount of FSCs is RMB 100 million.

Prudential requirements

Under the Measures, FSCs must establish prudent security appraisal procedures, claims and handling systems, and risk forewarning and contingency response mechanisms. FSCs must strengthen the risk assessment and management of the projects for which security is given and they are also required under the Measures to maintain their customers' confidentiality and are prohibited from using information provided by a customer to engage in activities that are unrelated to FSCs' business or harmful to the customer's interests.

The liability secured under a financing security for a single secured party must not exceed 10% of an FSC's net assets, or 15% for such single secured party together with its related parties. For financing security related to bond issuance by a single secured party, the liability secured must not exceed 30% of an FSC's net assets. The total financing liabilities secured by an FSC must not exceed ten times its net assets. In addition, an FSC must allocate 50% of its security fee income for the year in question to its unrealised liability reserve and allocate 1% of the balance of the year-end financing security liabilities to its security indemnification reserve.

For investment with its own capital, an FSC should only invest in fixed-income financial products with relatively high credit rating such as treasury bonds and corporate and debt financing instrument bonds of large enterprises, and other investments that do not have a conflict of interest. The total amount invested must not exceed 20% of an FSC's net assets.

Supervision

FSCs are subject to the supervision of the designated regulator (ie the Finance Office). FSCs must provide the regulator with information on corporate governance, financial reporting, information on risk management, capital structure (and application) and creditors. FSCs must report the use of capital to the regulator on a quarterly basis. The regulator may set the appropriate capital adequacy ratio for the FSCs.

FSCs established before 8 March 2010 are required to comply with the Measures before 31 March 2011.

General observation

Although financing security is traditionally seen as the business of major financial institutions, there are many small-to-medium financing security companies in China that may not necessarily comply with the desired prudential control of the State Council as expressed under the Measures. The Measures and implementation rules create a regime for the establishment, governance and supervision of FSCs. Although there are some open issues to be resolved, the consolidating effect of this regime is likely to open doors to foreign and domestic players qualified to enter the financing security market in China. Since the Measures, there has been establishment of FSCs by some foreign investors and the development in this area will be closely monitored.