Securitisation 2024 Comparisons

Credit Asset Securitisation

In China, asset securitisation can be roughly divided into two types based on the nature of the originator. One is called “credit asset securitisation” originated by licensed financial institutions (mainly credit institutions) and issued in the China Interbank Bond Market (CIBM) where the underlying assets of securitisation are limited to credit assets, including corporate loans, small and micro-enterprise (SME) loans, personal residential mortgage loans, personal consumer loans, auto loans, credit card assets, financial leasing debt claims and non-performing loans.

Business Asset Securitisation

The other type of securitisation is called “business asset securitisation” (issued in the CIBM or listed on the stock exchanges), where the originators are mostly non-financial institutions, and the commonly known underlying assets include petty loans, financial lease debt claims, factoring financing claims, supply chain payables, rights of returns related to infrastructure and public utilities, various kinds of account receivables, commercial mortgage loans, securities margin financing claims, trust beneficial rights and intellectual property. In recent years, consumer loans and SME loans extended by trust companies on popular internet platforms have become a growing part of the field of business asset securitisation. As trust companies are not qualified as originators of credit asset securitisations, these assets can only be structured through business asset securitisations.

Credit Asset Securitisation

Credit asset securitisation adopts a special purpose trust (SPT) as the issuance vehicle, and the trustee shall be a trust company which has got a special permission for such business. The basic structure is as follows:

• the originator, as the settlor, entrusts its legally owned credit assets (underlying assets) as trust property to a trustee, in order to establish an SPT;
• the trustee (as issuer) issues asset-backed securities (ABS) representing the beneficial rights in the trust to the investors, and pays the principal, interests or yields of securities from the cash flows generated by the trust property;
• the lead underwriter shall assemble an underwriter syndicate to underwrite the securities;
• the trustee engages a servicer (usually the originator) to provide daily collection, management and other services for underlying assets;
• the trustee engages a fund custodian to provide the fund custody services in respect of the collections generated by the trust property; and
• the trustee engages the China Central Depository & Clearing Co, Ltd. (CCDC) as securities depository and paying agent for the securities.

Exchange Market Securitisation

Business asset securitisation listed on stock exchanges (“exchange market securitisation”) adopts an asset-backed special plan (ABSP) as the issuance vehicle, and its basic structure is as follows:

• the investors sign subscription agreements with the plan manager and make subscription payments to the plan manager to set up an ABSP;
• the plan manager (henceforth representing the ABSP) purchases underlying assets from an originator with the raised funds by signing an underlying asset purchasing agreement with the originator;
• the plan manager engages a servicer to be responsible for the recovery and collection of underlying assets, the disposal of defaulted assets and other management work relating to underlying assets, by signing a servicing agreement with the servicer (usually the originator);
• the plan manager engages a fund custodian bank to safeguard the ABSP account opened in the name of the plan manager, and there is often an account supervision arrangement over the collection account of the servicer; and
• the plan manager engages the China Securities Depository and Clearing Corporation Limited (CSDC) for the registration and depository of the securities and the payments of principal and interest on the securities.

CIBM Business Asset Securitisation

Business asset securitisations carried out in the CIBM (“CIBM business asset securitisation) adopt a structure different to exchange market securitisations but similar to credit asset securitisations. The products of a CIBM business asset securitisation include asset-backed notes (ABNs) and asset-backed commercial paper (ABCPs); the later are issued on rolling basis and with a maturity of less than one year. The specific structure is as below:

• the originator entrusts the underlying assets to a trust company (as trustee and issuing vehicle manager) to establish an SPT;
• the SPT (represented by the trustee), as the issuing vehicle, issues notes (often through an underwriting syndicate) to investors in the CIBM;
• the trustee pays the principal and interest of the notes with the cash flows generated from the trust property, and cash from rolling issuance or liquidity provider in the case of ABCP;
• the trustee engages a servicer to provide management and collection services in connection with the underlying assets, and engages a funds custodian to provide fund custody services for the SPT;
• the Shanghai Clearing House, as the notes depository, provides the registration and depository services for the notes and agency services in relation to the payments of the notes.

Credit Asset Securitisation

The laws and regulations that have a material effect on the transaction structure of credit asset securitisations include the Civil Code, the Trust Law, the Administrative Measures for the Securitisation of Credit Assets (Announcement of the People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBRC) [2005] No 7), the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions (Order of CBRC [2005] No 3), and the Announcement on Further Regulating the Risk Retention of Originator in Credit Asset Securitisation (Announcement of the PBOC and CBRC [2013] No 21).

Exchange Market Securitisation

The laws and regulations that have a material effect on the transaction structure of exchange market securitisation include the Civil Code, the Securities Law, the Securities Investment Fund Law, the Administrative Provisions on Asset Securitisation by the CSRC, and the list condition confirmation guidelines for securitisation issued by the Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE).

CIBM Business Asset Securitisation

The laws and regulations that have a material effect on the transaction structure of CIBM business asset securitisation include the Civil Code, the Trust Law, the Measures for Administration of Debt Financing Instruments Issued by Non-Financial Enterprises in the Interbank Bond Market (Order of PBOC [2008] No 1), and the Rules on CIBM Business Asset Securitisation and Information Disclosure Guidelines on CIBM Business Asset Securitisation (Announcement of the National Association of Financial Market Institutional Investors (NAFMII) [2023] No 3).

In most (if not all) circumstances, the SPV will be set up in China and governed by PRC laws. For foreign exchange policy reasons, the transfer of underlying assets to a foreign SPV can hardly be achieved, as there is no explicit rule regarding such cross-border transfer of financial assets except for non-performing loans.

Credit enhancement in the securitisation market can be divided into internal credit enhancement and external credit enhancement. Forms of internal credit enhancement commonly used include subordination, over-collateralisation, cash deposits, cash reserve accounts, etc. Forms of external credit enhancement include shortfall supplement commitments, guarantees, external liquidity support, credit risk mitigation instruments, etc. In particular, shortfall supplement commitments are only used in business asset securitisations, where the cash flow projection of the underlying assets is not persuasive enough or is highly dependent on the continuous operation of the originator; therefore, the commitments are usually made by the originators, the ultimate financing parties, or their related parties.

Role of the Issuer

In credit asset securitisation, the issuer is the trustee of the SPT, which shall have an SPT trustee qualification approved by the National Administration of Financial Regulation (abbreviated as NAFR, formerly as CBIRC or CBRC).

In exchange market securitisation, the issuer is the manager of the ABSP, which can be a securities company or its subsidiary, a subsidiary of a fund management company, a trust company, or an insurance asset management company.

For CIBM business asset securitisation, the issuer shall be the special purpose vehicle (SPV) or its manager. Currently, the issuers are all trust companies with the SPT trustee qualification, but the National Association of Financial Market Institutional Investors (hereinafter referred to as NAFMII) is considering expanding the scope of SPV manager to other asset management companies, to keep in line with the practice of exchange market securitisation.

Issuer’s Responsibilities

As the issuer is also the trustee or plan manager of the SPV, who stands in a trust relationship or agency relationship with the investors, its role is a combination of issuer and bond trustee. Its basic responsibilities include:

• handling the approval, registration and record-filing regarding the securities issuance;
• handling information disclosure during the issuance phase and life of the securities;
• holding and managing asset pools;
• distributing SPV assets to investors or creditors of the SPV;
• convening a security holders’ meeting, if necessary;
• supervising other institutions providing services to the SPV; and
• taking measures to protect the interests of investors.

In credit asset securitisation, the underlying assets are often originated by the originator itself, although there is no restriction on purchased assets in the regulations. In contrast, the role of sponsor has emerged in recent years for business asset securitisation. For example, factoring companies often purchase account receivables in the form of factoring and securitise these assets in the markets. Another example is the trust company, which may be a sponsor of a securitisation where the asset pool is comprised of loans originated by itself or purchased from other trust companies, in either case the underlying assets are served by the same asset servicer and the same eligibility criteria apply.

The regulations set no special requirements on a sponsor, so a sponsor’s responsibilities are not different from that of an originator (for details please see 2.3 Originators/Sellers).

Role of the Originator

Originators transfer underlying assets to an SPV by means of sale or trust. In credit asset securitisations, the sponsor is a financial institution that originates credit assets and transfers them through the establishment of an SPT. Only financial institutions approved by the NAFR can act as originators. These include commercial banks, policy banks, automobile finance companies, consumer finance companies, financial leasing companies and financial asset management companies.

In business asset securitisations, the originators are basically non-financial enterprises from a range of industries, with limited exceptions for financial institutions.

Originator’s Responsibilities

The responsibilities of an originator mainly include:

• providing underlying assets that meet the eligibility criteria;
• redeeming or replacing the ineligible underlying assets;
• co-ordinating and supporting the issuer and related intermediaries in performing their duties;
• maintaining a risk retention of the underlying assets (exemptions are given to qualified business asset securitisation);
• providing relevant disclosure information to the issuer and related intermediaries in a timely manner; and
• ensuring that the information provided is true, accurate and complete.

If the cash flows of the underlying assets depend on the continued operation of the originator, then the originator shall commit to maintaining normal operation throughout the life cycle of the securitisation, and to supplement the shortfalls in the cash flow of the underlying assets.

Role of the Underwriter

An underwriter or placement agent is an institution responsible for the promotion and sale of the ABS. It will preside or participate in the bookbuilding or bidding procedure for issuance of the securities; and before that, it will do market investigations and road shows, to form an accurate opinion regarding the margin for price. The lead underwriter normally acts as the transaction arranger or financial adviser, taking the lead in the design of the transaction structure, the co-ordination of the progress of the project participants, filing with the regulatory authorities and other matters.

The underwriters are generally domestic financial institutions, mainly banks and securities companies, as well as foreign banks registered in China. Regarding CIBM business asset securitisation, in addition to banks and securities firms, trust companies can also act as underwriters.

Necessity of the Underwriter

In credit asset securitisation and CIBM business asset securitisation, an underwriter is required. The regulations on credit asset securitisation even require the issuer to organise an underwriting syndicate. In contrast, an underwriter or placement agent is not a requirement for an exchange market securitisation, as the issuers are often capable of placing the securities by themselves.

A servicer is often engaged by the issuer to provide services in relation to the underlying assets. Servicers are usually the originators of the underlying assets, or their affiliates. The issuer may also engage more servicers besides the originator; these are often technical servicers or professional institutions with expertise in the underlying assets. The general responsibilities of the servicers include collecting the cash flow from the underlying assets and transferring it to the SPV, managing the underlying assets and keeping related records, safeguarding the legal documents and records, disposing of the defaulted assets and providing regular service reports to the SPV manager or trustee.

In respect of credit asset securitisation, the servicer shall be a financial institution established in China and qualified to extend loans. For other types of securitisations, there is no specific permission requirement for a servicer, except for authorisation conferred in the servicing agreement.

Investors in ABS generally do not actively participate in the management of the SPV, but passively receive payments on the securities. The investors can only attend the security holders’ meeting and vote in situations where the investors’ rights might be affected. The main obligations and responsibilities of the investors include paying the subscription price in accordance with the terms of the subscription agreement, complying with the trading limits set in the relevant laws, regulations, and transaction documents, complying with the provisions on the exercise of rights, and maintaining confidentiality regarding trade secrets. The business types of investors are introduced under 4.13 Entities Investing in Securitisation.

Article 92 of the Securities Law requires that a bond trustee shall be appointed for a public offering of corporate bonds. Since securitisation in China has not adopted the corporate form of special purpose company (SPC), there’s no requirement of a bond/note trustee: as the SPV for a securitisation is often a trust or agency relationship, and the trustee or plan manager stands in a fiduciary relationship with the investors, a separate bond/note trustee is not necessary. The plan manager or trustee’s role often overlaps with the issuer, the main responsibilities of which can be found in 2.1 Issuers.

A security trustee/agent is not necessary in China’s securitisation practices because, legally, the trustee/plan manager (on behalf of the investors) holds legal title to the underlying assets and makes payments using the cash flows generated from the underlying assets; the underlying assets are not designed as collateral for the securities. The trustee/plan manager itself plays the role of a security trustee/agent. When necessary, it has the power to liquidate the underlying assets without authorisation or consent of the originator, but in most circumstances it needs the approval of a meeting of the security holders.

Trust Agreement

In credit asset securitisations and CIBM business asset securitisations, the bankruptcy-remote transfer of financial assets is achieved through the provisions of the “trust agreement”. The trust property is independent and will not be affected by the bankruptcy of the settlor and the trustee, which meets the requirement of risk isolation in securitisation. Meanwhile, the trust can achieve limited recourse – both the settlor’s and the trustee’s liabilities to the beneficiaries are limited to the trust property. The trust agreement is one of the core transaction documents, and its main provisions include the following:

• the scope, type, standard and status of the trust property;
• the delivery of the trust property;
• the conditions for the establishment of the trust;
• the redemption of ineligible assets;
• the rights perfection mechanism;
• the rights and obligations of the trust parties;
• the types and characteristics of the securities;
• the cash flow allocation order;
• the trust termination and liquidation;
• the organisational form and power of the security holders; and
• the liability for defaults and indemnities.

Asset Transfer Agreement

In exchange market securitisations, the transfer of assets while maintaining bankruptcy remoteness is realised through the “asset transfer agreement”. This agreement is signed between the originator and the plan manager of the ABSP. The originator transfers the ownership of the underlying assets to the plan manager to ensure the true sale of the underlying assets, in order to achieve bankruptcy remoteness. The main contents of the asset transfer agreement include the following:

• the status of the underlying assets;
• the purchase and delivery methods of the underlying assets;
• the purchase price and payment;
• the redemption of the ineligible assets;
• the repurchase option of the asset pool;
• the covenants and warranties of the buyer and the seller;
• defaults and liabilities; and

• the effectiveness and termination of the agreements.

“Asset warranties” refer to the representations and warranties of the originator regarding the underlying assets of the securitisation as of a specific date or time (such as the cut-off date and the trust property delivery date). The contents of asset warranties may differ depending on the different types of underlying assets, but customarily include the following:

• the underlying assets meet the eligibility criteria;
• all relevant information and information disclosure of the underlying assets is true, accurate and complete;
• the originator has sole and legally valid ownership of the underlying assets;
• the underlying assets are not encumbered by pledges or other kinds of burdens, nor restrictions on transfer;
• the conditions precedent for the obligor’s obligations to perform on contracts concerning the underlying assets have been satisfied;
• the provisions of the contracts concerning the underlying assets are legally valid and binding on the relevant obligors; and
• the originator has not given a third party any option affecting the recoverability of the underlying assets.

If the underlying assets do not satisfy the requirements of the asset warranties at the time of entering the asset pool or transfer, the underlying assets will be recognised as ineligible assets and must be redeemed by the transferor or originator according to the transaction documents.

Currently, the prevailing right perfection measures include two kinds: (i) sending right perfection notice to the debtor and the guarantor, and (ii) conducting the transfer registration for the related mortgage or pledge. Since the notice and the transfer registration need to be conducted separately, for the purposes of facilitating the collection of the assets and reducing the transaction costs, such measures are not normally required to be taken at the delivery of the underlying assets, but only required upon the occurrence of right perfection events provided in the transaction documents.

Right perfection events usually include but are not limited to situations where:

• the servicer is terminated due to the occurrence of servicer termination events;
• the servicer loses a certain credit rating; and/or
• the originator loses a certain credit rating or solvency.

After the occurrence of a right perfection event, the asset seller or the settlor will send a right perfection notice to the debtor or the guarantor (referred to collectively as the obligor):

• informing the obligor of the transfer of the underlying assets or the establishment of the trust; and
• instructing the corresponding obligor to repay directly to the ABSP account or the trust account from the date of receipt of the right perfection notice.

If the underlying assets are secured by a mortgage or pledge that requires a registration, the asset seller or originator must conduct the transfer registration of the mortgage or pledge promptly upon the occurrence of a right perfection event, to ensure that the mortgage or pledge held by the plan manager or the trustee will be valid against any bona fide third party.

In addition, based on new changes brought by the Civil Code and the Interpretation of the Security System (see 6.3 Transfer of Financial Assets), more securitisation transactions will consider registering the transfer of account receivables in the Registration and Public Notice System of the PBOC’s Credit Reference Centre. However, the actual time of conducting such registration (immediately after the transfer or after the occurrence of an agreed trigger event) may be decided based on the credit status of the settlor or the asset seller.

In order to ensure a smooth transaction, the originator usually makes the following covenants in the transaction documents:

• the originator will continue to fulfil its obligations under the contracts concerning the underlying assets in a comprehensive, complete and timely manner, and not relinquish or delay the exercise of its rights;
• after the transfer of the underlying assets or the establishment of the trust, the underlying assets will not be transferred to or disposed of for the benefit of any third party, nor will any security interests be established regarding the underlying assets;
• any defect in assets or the transaction that might hinder the transfer of the underlying assets shall be remedied with due diligence to facilitate the smooth and lawful execution of the transaction;
• the contract concerning the underlying assets shall not be arbitrarily modified, nor shall any obligations or liabilities of the obligor on the underlying assets be waived, so that material adverse effects on the underlying assets are avoided;
• the originator will provide protection for the underlying assets and related interests to prevent such rights and interests from being infringed upon by third parties;
• the originator will not lose solvency in the foreseeable future due to the establishment of the trust; and
• the originator will not engage in any act that might result in the corresponding debtor exercising a right of set-off or right of defence regarding the underlying assets.

The originator will be deemed to be in default of the contract and liable for indemnities and other liabilities upon breach of any covenant.

The contents and conditions of the services provided by the servicer are stipulated in the servicing agreement and may vary according to the types of the underlying assets. However, the main services can be summarised as the following:

• collecting the receivables on the underlying assets and transferring collections thereof to the SPV;
• managing the underlying assets and monitoring their conditions;
• risk management, recovery and disposal of the underlying assets;
• recording the status of the collection of funds in an accurate and timely manner;
• safekeeping of the data and records concerning the underlying assets;
• assisting the trustee/plan manager in replenishing eligible underlying assets when a revolving pool is involved; and
• reporting the conditions of the asset pool on a regular basis.

A servicer generally would not provide any guarantee or assurance on the return of the underlying assets. If the servicer fails to perform its obligations under the servicing agreement, or if any of its representations, warranties and commitments under the servicing agreement is materially false, inaccurate or misleading, the servicer is deemed to be in default and becomes liable for the breach of contract.

In securitisation transactions, the principal default events include accelerated payment events, events of default and termination events. Both accelerated payment events and events of default will result in changes of cash flow distribution order and early amortisation of securities, but accelerated payment events are generally less severe than events of default.

Accelerated Payment Events

Accelerated payment events generally include:

• insolvency of the originator;
• occurrence of a servicer termination event;
• breach of the servicer’s main obligations under the transaction documents such as the transfer of collections;
• the accumulative default rate of the underlying assets exceeding a certain threshold; and
• failure to appoint a qualified successor within a certain period of time when it is necessary to replace the trustee or the servicer pursuant to the transaction documents.

Some accelerated payment events are not caused by default of participants in the transaction, but rather circumstances that may have a detrimental impact on the project.

Events of Defaults

Events of default generally include:

• failure to fully pay interest on the highest class of securities within the agreed time;
• failure to pay the full principal amount of the securities within the agreed time after the final maturity date; and
• failure to legally and effectively deliver collections to the trustee/plan manager or to defend against the claims of third parties.

Termination Events

Termination events of the trustee/plan manager, the servicer and the fund custodian usually include:

• loss of corresponding qualifications;
• material breach of contract;
• insolvency; or
• failure to maintain any required rating.

Upon occurrence of any termination event, the meeting of security holders has the power to replace the corresponding institution.

Typical indemnification provisions in securitisations include indemnification for breach of contract by the servicer, the fund custodian and other securitisation service providers; and indemnification for the trustee/plan manager’s failure to manage the assets of the SPV in accordance with relevant laws and the transaction documents. Specifically, in terms of the originator and the trustee/plan manager, it is generally specified in the transaction documents that the securities are not liabilities of the originator or the trustee/plan manager, and the investors’ right of recourse is only limited to the assets of the SPV; however, the liability for compensation of the originator or the trustee/plan manager in the event of default under the transaction documents is not limited by the aforementioned provisions.

The terms and conditions of the securities/notes are customarily included in the trust agreement/asset management contract as well as the offering circular. The trust agreement/asset management contract is like a charter for the SPV and provides basic terms and conditions of the SPV, such as purpose of trust, parties relating to the SPV, establishment of the SPV, entrustment/purchase of the underlying assets, distribution of the SPV assets, articles for the meeting of security holders, costs and services fees relating to the SPV, information disclosure, etc.

The offering circular often includes risk disclosure, introduction to participating institutions, description of transaction structure (such as distribution of cash flows, credit enhancement measures, meeting of security holders, and a summary of rights and obligations of the transaction parties), information on the underlying assets, information on securities, intermediary opinions, and information on PRC law factors.

Derivatives such as interest rate swaps, currency swaps, and credit risk mitigation/protection instruments could be used in securitisation transactions. However, most transactions will avoid using derivatives, so as to simplify the transaction structure and to save transaction costs.

Interest Rate Swap

The coupon rates of securities/notes are often designed to cope with the characteristics (fixed/floating) of the asset pool, so there is rarely the need for an interest rate swap. For instance, coupon rates of RMBS are often floating rate and will be adjusted simultaneously with the underlying assets, because most underlying mortgages are floating rate; and the interest rate mismatch risk is almost negligible.

Currency Swap

Currency swaps are also rarely used because the majority of cross-border issuances are in Chinese yuan and are in line with the currency of the underlying assets. Nevertheless, if the securities/notes are issued in other currencies, a currency swap would be required to hedge exchange rate risk.

Credit Risk Mitigation/Protection Instruments

Credit risk mitigation/protection instruments can be used to hedge credit risks in connection with a reference entity or a target debt in a securitisation. These instruments can be roughly divided into two types: agreement and warranty. The former is a financial agreement between the buyer and seller for the purchase of credit protection, while the latter is a security of value created by the warranty issuer (often a qualified underwriter or guarantee company). However, as the credit derivative market in China is overall less developed, credit instruments are not commonly used in securitisations.

Offering memoranda are customarily required in a securitisation, often in the form of an offering circular.

For credit asset securitisation, the Administrative Measures for the Securitisation of Credit Assets provides the framework of contents and the release time for an offering circular. The Announcement of Matters Regarding Information Disclosure of Credit Asset Securitisations’ Underlying Asset Pool (Announcement of PBOC [2007] No 16) and the disclosure guidelines published by NAFMII for various kinds of underlying assets provide detailed requirements on the contents and forms of an offering circular.

With regard to CIBM business asset securitisation, the Information Disclosure Guidelines on CIBM Business Asset Securitisation sets the basic framework and some specific disclosure requirements such as disclosures pertaining to important obligors and credit enhancement providers. The Registration Documents and Forms for the Public Offerings of Asset Backed Notes by Non-Financial Enterprises (Announcement of NAFMII [2017] No 27) includes Form ZM which provides specific disclosure requirements for an offering circular.

As for exchange market securitisation, the Disclosure Guidelines for the Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of CSRC [2014] No 49) provides the content framework and some basic disclosure requirements regarding underlying assets for an offering circular. Schedule 5 of Circular [2014] No 459 by the Asset Management Association of China (AMAC) provides particular contents and forms for the offering circular of an ABSP.

Credit Asset Securitisation

Information disclosure regarding credit asset securitisation mainly follows the rules published by the People’s Bank of China (PBOC), including the Rules for the Information Disclosure of Asset-Backed Securities (Announcement of PBOC [2005] No 14) and the Announcement of Matters Regarding Information Disclosure of Credit Asset Securitisations’ Underlying Asset Pool (Announcement of PBOC [2007] No 16), and the disclosure guidelines for various kinds of underlying assets published by NAFMII, which include SME loans, retail auto loans, personal mortgage loans, redevelopment of shanty towns loans, personal consumer loans, and non-performing loans.

CIBM Business Asset Securitisation

Information disclosure regarding CIBM business asset securitisation mainly follows the Administrative Measures for Debt Financing Instruments of Non-financial Enterprises in the Interbank Bond Market (Order of PBOC [2008] No 1) published by the PBOC, and the rules published by NAFMII in relation to information disclosure, such as the Rules on CIBM Business Asset Securitisation and the Information Disclosure Guidelines on CIBM Business Asset Securitisation, the Registration Documents and Forms for the Public Offerings of Asset Backed Notes by Non-Financial Enterprises, the Rules for Information Disclosure on CIBM Debt Financing Instruments of Non-Financial Enterprises (2021), and the Duration Information Disclosure Forms for CIBM Debt Financing Instruments by Non-Financial Enterprises (2021) (Announcement of NAFMII [2021] No 10).

Exchange Market Securitisation

Information disclosure regarding exchange market securitisation primarily follows the Administrative Provisions on Asset Securitisation by the CSRC and the Disclosure Guidelines for the Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies. Based on these provisions, the SSE and the SZSE have respectively published disclosure guidelines for different types of underlying assets, including the Disclosure Guidelines on Financial Lease Claim Asset-Backed Securities, the Disclosure Guidelines on Public-Private Partnership (PPP) Project Asset-Backed Securities, the Disclosure Guidelines on Account Receivable Asset-Backed Securities and the Disclosure Guidelines on Infrastructure Asset-Backed Securities. At the end of 2022, the SSE and SZSE respectively issued a series of Guidelines on the Application of the Recognition Rules for the Listing Conditions for Asset-Backed Securities, which stipulate the information disclosure requirements in the listing periods of the exchange market securitisations.

As the Securities Law amended in 2019 clearly extends to ABS, some stipulations under Chapter 5 of the Securities Law “Information Disclosure” also apply to securitisation. Article 85 of the Securities Law lays foundation for misrepresentation liabilities of issuers and related parties thereof, underwriters, and intermediaries.

Laws and Regulations on Credit Risk Retention

For credit asset securitisation, the Announcement of PBOC and CBRC [2013] No 21 requires an originator to retain no less than 5% of the total issuance amount of the securitisation, and in the meantime no less than 5% of the lowest class of securities. The originator may choose either horizontal retention or vertical retention, as long as it meets the minimum requirements.

As far as exchange market securitisation is concerned, the SSE and SZSE have respectively issued a series of Guidelines on the Application of the Recognition Rules for the Listing Conditions for Asset-Backed Securities, which clearly stipulate the requirements on risk retention. However, the applicable rules may vary based on the types of underlying assets. The risk retention ratio is normally 5% by the originator or its affiliates where the underlying assets are creditor’s claims or future operation income. But if the originator is in good credit condition and the ABSP has credit enhancement mechanisms such as guaranty or shortfall supplements, the risk retention requirements can be exempted.

With respect to CIBM business asset securitisation, in the Rules on CIBM Business Asset Securitisation published in 2023, NAFMII has added risk retention requirements for originators. The proportions of risk retention are basically consistent with those of credit asset securitisation, but exemptions are given to securitisations where the originator or debtor is in good credit condition and the SPV has credit enhancement mechanisms such as guaranty, shortfall supplements, or debt accessions.

Regulation and Enforcement

The risk retention rules for credit asset securitisation are formulated by the PBOC and the NAFR, and the NAFR authorises the China Credit Assets Registry & Exchange Centre to perform part of its supervisory responsibilities on securitisation. The risk retention rules for CIBM business asset securitisation are formulated by NAFMII and authorised by the PBOC. The risk retention rules for exchange market securitisations are formulated by the SSE and SZSE, authorised by the CSRC. The supervisory authorities will review the risk retention arrangements in the documentation, non-compliant applications will not be able to obtain the pre-issuance approval/registration or confirmation of listing.

Penalties for Non-compliance

Currently, there are no explicit rules relating to penalties for violations of the risk retention requirements, but the relevant regulatory authorities can take regulatory measures such as issuing an order to correct, a warning letter, or an order for public explanation.

Requirements Regarding Periodic Reporting

The disclosure regulations for each type of securitisation (see 4.1 Specific Disclosure Laws or Regulations) include particular requirements for periodic reporting. Generally speaking, the trustee/plan manager shall provide reports to investors at a frequency that matches that of the payment of the securities, and shall disclose an audited annual report for the life cycle of the securities. These reports often include the status of the underlying asset pool, information on the principal and interest payments of each class of the securities, statistics on the asset pool, reinvestment of the assets (if a revolving structure is involved), the disposal of defaulted loans, etc. The rating agencies shall also disclose an annual monitoring report to the investors, which must include information on the changes in the underlying asset pool and credit risk analysis.

The SSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities and the SZSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities stipulate the compilation of an annual asset management report and annual fund custodian report, as well as the disclosure requirements for these reports. This is intended to make information disclosure more targeted and effective, thus helping investors to make better investment decisions.

Regulators and Penalties for Non-compliance

The disclosure activities in the CIBM are subject to self-regulatory management by NAFMII and supervision by the PBOC. The disclosure activities in exchange market securitisations are subject to self-regulatory management by the securities exchanges, the Securities Association of China (SAC) and the AMAC, and supervision by the CSRC and its local agencies.

In relation to securitisations in the CIBM, NAFMII may impose sanctions on non-compliant information disclosers. These include public denouncements, orders to correct misconduct, orders to attend mandatory training, and suspension of relevant business. If the non-compliant act is suspected of violating the laws and regulations, NAFMII shall hand the matter over to the relevant authorities, including the PBOC.

For misconduct in the disclosure of information regarding exchange market securitisations, the CSRC and its local agencies may impose regulatory measures such as orders to correct, warning letters, orders for public explanation and orders to make periodic reports. It also has the power to impose administrative penalties on responsible persons. AMAC may conduct regular or ad hoc on-site and off-site investigations into the SPV managers, and may impose disciplinary sanctions such as written warnings, orders to correct, public condemnations, suspensions of record-filing and cancellation of membership, etc, depending on the seriousness of the case. In addition, the SSE and SZSE have the power to impose disciplinary measures on disclosure violations, and may prudently process subsequent applications by the relevant parties.

Regulations about the RAs’ Activities

Rating services provided by rating agencies (RAs) are regulated by the regulatory authorities of the respective markets and the professional self-regulatory organisations (SROs). The substantive regulations may be divided into the following three categories:

• market entry regulations, including rules for the entrance of different markets and different products;
• requirements relating to business processes, methods and prevention of conflicts of interest; and
• requirements on the disclosure of rating reports.

The rules vary depending on the rated product and market concerned. RAs that meet the relevant requirements to provide credit rating services in the CIBM shall apply to NAFMII for registration of the type of bond rating services to be carried out. In addition, the Chinese regulators have started to permit foreign RAs to provide rating services via their local branches or subsidiaries. S&P Ratings (China) Co, Ltd. and Fitch (China) Bohua Credit Ratings Limited have been officially admitted to provide credit rating services in the CIBM.

Regulators and Penalties for Non-compliance

Regulators of RAs include the credit rating industry regulating authority and the credit rating business administration authorities, such as the PBOC, which is responsible for the supervision of credit rating business across the country and has the authority to formulate the market entry principles and fundamental rules; and the CSRC, which regulates the credit rating business in its corresponding jurisdiction. RAs are also subject to the disciplines of SROs in the corresponding markets. If RAs are found to be violating any law, regulation or rule, then the regulators may impose administrative sanctions such as fines, suspension of business, revocation of business approval, or impose regulatory measures such as issuing a directive to correct, a warning letter, a directive to make public explanation, or a directive to make regular reports.

Applicable Capital and Liquidity Rules

The volume of risk-weighted assets (RWA) will affect a commercial bank’s capital adequacy ratios, and the securitisations that a commercial bank engages in will affect the measurement of its risk-weighted assets. On 1 November 2023, NAFR published the renewed Measures for Administration of Capital of Commercial Banks, which came into force on 1 January 2024. As long as a financial institution incurs securitisation risk exposure because of its business of asset securitisation, the institution shall set aside corresponding capital reserves according to the risk-weighted asset calculation rules.

In terms of liquidity risk regulatory indicators, engaging in securitisation or investing in ABS will affect a commercial bank’s liquidity coverage ratio or high-quality liquid asset adequacy ratio, net stable funding ratio and liquidity gap ratio. Different from Basel III, the Measures for Administration of Liquidity Risk of Commercial Banks do not include RMBS as high-quality liquid assets (HQLA).

According to the Administrative Measures for Risk Control Indicators of Securities Companies (2020 Revision) and the Provisions on the Calculation Standard for Risk Control Indicators of Securities Companies (2020), securities companies shall calculate the risk control indicators such as net capital, risk coverage ratio, capital leverage ratio, liquidity coverage ratio, net stable funding ratio, etc, in line with the principles of prudence and substance over form. Securities companies shall set aside capital reserves for ABS held according to the measurement standard provided by the CSRC.

One important regulatory indicator for insurance companies is the solvency ratio. According to the Administrative Provisions on the Solvency of Insurance Companies (2021 Revised), the comprehensive solvency ratio of an insurance company (ie, the ratio of the actual capital to the minimum capital) shall not be lower than 100%. The actual capital of an insurance company refers to the difference between the recognised assets and the recognised liabilities. In calculating recognised assets, different recognised values will be assigned to the securitisation in which an insurance company has invested, depending on the external ratings of the products in question.

Regulation of Capital for Securitisation

In respect of traditional securitisation transactions, the originator may deduct the securitised assets from the calculation of RWA only if:

• the material credit risk related to the transferred asset has been transferred to an independent third party;
• the originator does not retain actual or indirect control over the transferred assets;
• the originator does not bear payment obligations or responsibilities towards the investors of the ABS, the investors only have recourse to the limit of underlying assets;
• the underlying assets has been transferred to the SPV, and the holders of beneficial rights in the SPV have the right to pledge or trade the beneficial rights;
• the trust agreement and other legal documents related to the securitisation do not contain certain specific provisions, such as requiring the originator to change the assets in the asset pool, so as to enhance the quality of the asset pool, or allowing the originator to provide additional credit enhancement after assignment of the underlying assets;
• the procedures for a clean-up call are compliant with the regulatory requirements of the Rules on the Calculation of Risk-Weighted Assets in Securitisation; and
• except for a termination arising from a clean-up call, taxes, certain regulatory changes or early amortisation that meets the regulatory requirements, there are no other triggers or conditions where the originator has the right to terminate the SPV in advance.

Schedule 11 of the Measures for Administration of Capital of Commercial Banks – Rules on the Calculation of Risk-Weighted Assets in Securitisation provides three approaches for capital calculation of securitisations: internal ratings-based approach (IRBA), external ratings-based approach (ERBA) and standardised approach (SA). Securitisation exposures where none of the aforementioned approaches can be applied must be assigned a 1,250% risk weight to calculate the RWA. The minimum risk weight of the securitisation risk exposures is 15%. For a securitisation which meets the Simple, Transparent, Comparable (STC) standard, the minimum risk weight of the senior class is 10%, in contrast to 15% for the other classes.

Regulations of Use of Derivatives

Currently, there are no specific laws or regulations on the use of derivatives in securitisations; however, relevant parties (including the plan manager, trustee and investors) shall comply with the general rules applicable to derivatives transactions.

In respect of credit derivatives, the trading of such instruments is mainly subject to a series of rules published by NAFMII, the SAC, AMAC, the SSE and the SZSE, such as the Guidelines for the Credit Risk Mitigation Agreement and the Guidelines for the Credit Risk Mitigation Warrants issued by NAFMII, and the Guidelines for the Investment of Publicly Offered Securities Investment Funds in Credit Derivatives issued by AMAC.

As for interest rate swaps and foreign currency swaps, a body of rules promulgated by the PBOC, the China Foreign Exchange Trade System (CFETS) and the National Interbank Funding Centre will apply, such as the Notice of the People’s Bank of China on Issues Concerned in Operating RMB Interest Rate Swap Business, the Notice by the China Foreign Exchange Trade System on Issuing the Trading Rules of Interbank RMB Foreign Exchange Market, etc.

Before entering into any derivatives trading, the SPV manager or trustee needs to obtain qualifications for derivatives trading from the corresponding supervisory authorities. According to the PBOC’s applicable rules, participants in the interbank market engaging in derivatives trading shall also be enrolled with NAFMII as members of the interbank market and must execute the master agreement prepared and published by NAFMII.

Regulators and Penalties for Non-compliance

The PBOC has the power to supervise the derivatives trades in the national interbank market, while the State Administration of Foreign Exchange (SAFE), under the authorisation of the PBOC, supervises and manages the forward exchange market. Other than that, NAFMII is authorised by the PBOC to conduct self-regulatory administration over members of the interbank market and the transactions carried out therein; the CFETS provides services related to transactions carried out by members of the interbank market and conducts day-to-day monitoring of transactions under the authorisation of the PBOC.

Banking financial institutions engaging in derivatives trading activities without approval will be subject to administrative sanctions including confiscation, fine, suspension of business and revocation of business licence, etc, by the NAFR. For banking financial institutions that have failed to effectively implement derivatives trading risk management and internal control systems, the NAFR has the power to suspend or revoke their licence to engage in derivative trading and impose monetary sanctions. Meanwhile, SROs including NAFMII and the CFETS have the power to impose sanctions, based on the seriousness of the violation.

Regulatory Mechanisms

Investor protection is provided for in some basic laws, including the Securities Law and the Securities Investment Fund Law, as well as various securitisation regulations. Chapter VI of the Securities Law provides general rules for protection of securities investors, covering placement agencies’ duties in placement activities, issuers’ fraudulent issue and misrepresentation liabilities, representative litigations, etc. Other laws and regulations cover matters such as investor qualifications and limits on the number of investors (see 4.13 Entities Investing in Securitisation), due diligence, credit risk retention (see 4.3 Credit Risk Retention) market trading rules, as well as information disclosure (see 4.1 Specific Disclosure Laws or Regulations and 4.2 General Disclosure Laws or Regulations), the duration standard operational responsibilities and many other aspects.

One of the mechanisms for investors protection is the meeting of security holders. Securitisation regulations customarily require the issuer to establish a meeting of security holders as the governing organ of the issuing vehicle, to make decisions on important matters pertaining to the issuing SPV. In particular, for CIBM business asset securitisations, NAFMII has promulgated the Procedures of the Meeting of Holders of Non-Financial Enterprises Debt Financing Instruments in the CIBM, which provides for the conditions of convening a meeting, the procedures of the meeting, the voting rights of instrument holders, etc.

Another mechanism for investor protection is the due diligence requirements for the relevant intermediaries. In November 2014, the CSRC issued the Guidelines for Securities Companies and Subsidiaries of Fund Management Companies on Due Diligence for Asset Securitisation, specifying the plan manager as the overall responsible party for due diligence, and proposing the relevant due diligence requirements. In June 2019, AMAC promulgated three detailed guidelines to specify the requirements for due diligence on the securitisation of financial leases, PPP projects and account receivables. The due diligence requirements on related parties in CIBM Business Asset Securitisation are provided in the Guidelines for Due Diligence on the Asset-Backed Notes by Non-Financial Enterprises (Trial Implementation 2021) and Guidelines for Due Diligence on Debt Financing Instruments by Non-Financial Enterprises (2023), both released by NAFMII.

Regulatory Authorities

Two kinds of authorities are in charge of the implementation of investor protection mechanisms.

Authorities such as the NAFR, PBOC and CSRC, may impose a number of administrative penalties or regulatory measures on the trustee or plan manager for failure to fulfil the duties of honesty and diligence, including orders to rectify, warning letters, orders to make public statement, etc. Administrative penalties include fines, suspension of business for rectification or revocation of business licence.

The most important self-regulatory organisations are AMAC, the SSE and SZSE (for exchange market securitisations), and NAFMII (for securitisations in the CIBM). AMAC, for example, according to the Measures for the Administration of the Record Filing of ABSP published by it, may respond to behaviours that violate the self-regulatory structures by imposing written warnings, orders to correct, public condemnations, suspensions of filing, revocations of membership and/or other actions based on the type and seriousness of the violation.

Commercial banks as originators will be subject to the same regulatory measures as any other originator on credit asset securitisations, along with other financial institutions under the supervision of the NAFR; however, commercial banks investing in credit asset securitisation products are subject to certain specific rules, including the following:

• a commercial bank as the originator shall not invest in securitisation products originated by itself, except for the part retained by itself according to the credit risk retention rule;
• the wealth management products offered by a commercial bank shall not directly or indirectly invest in the subordinated class of ABS issued by itself;
• the wealth management products offered by a commercial bank to non-institutional investors shall not invest in any subordinated class of ABS, or any non-performing asset securitisation products;
• a single commercial bank’s holding in the ABS from a single issuance as a proportion of the total volume of the issuance, in principle, shall not exceed 40%; and
• a commercial bank’s wealth management product shall also abide by certain concentration limits when investing in ABS.

Additionally, according to the Measures for the Administration of the Large Exposures of Commercial Banks published by the CBIRC in 2018, in principle, a commercial bank’s investment in securitisation shall be treated by a “look-through approach”, according to which the ultimate obligor of the underlying assets of the securitisation shall be identified as the bank’s counterparty and the risk exposure of the underlying assets will be counted towards the risk exposure of the ultimate obligor. Meanwhile, the same measures provide several safe harbours. For example, for underlying assets whose risk exposure is less than 0.15% of the tier 1 net capital of a commercial bank, if the commercial bank can prove that there is no deliberate division of underlying assets, then the investment can be exempted from the look-through approach, in which case the securitisation product itself shall be identified as a counterparty and deemed a non-interbank single client.

The regulations relating to SPVs are different for each type of securitisation. Among them, the Administrative Measures for the Securitisation of Credit Assets stipulates that the SPV for credit asset securitisations shall be an SPT. The Rules for CIBM Business Asset Securitisation stipulates that the SPV shall be an SPT, an SPC or other SPV forms approved by NAFMII. In regard to exchange market securitisations, the Administrative Provisions on Asset Securitisation by the CSRC stipulates that the SPV shall be an ABSP or other SPV approved by the CSRC.

In the case that an SPT is adopted as the issuance vehicle, the establishment and operation of the trust shall be governed by the provisions of the Trust Law. A recent judicial trend tends to regard the relationship of an ABSP as a trust and shall apply the Trust Law as well. On the contrary, SPC and special purpose limited partnership (SPLP), which are common forms of SPE in international securitisation practices, have not been adopted in China’s securitisation market, because the Company Law, the Bankruptcy Law and the Partnership Enterprise Law do not contain any specific rules on SPC or SPLP.

Non-financial companies can choose to conduct business asset securitisation either in the CIBM or on the exchange market. The choices of market are mainly affected by the issuance costs and the efficiency of the approval/registration procedure. Many enterprises will apply shelf-registration both in the CIBM and the exchange market, to best satisfy their needs for financing efficiency and flexibility. At least so far, neither the trust structure nor the ABSP has any obvious advantages or disadvantages over the other in terms of tax treatment or bankruptcy remoteness.

SPVs are established for the purpose of securitisation; therefore, their activities are limited to the needs of carrying out securitisation business, which are generally agreed and stated in the transaction documents. At the same time, relevant laws or regulatory provisions stipulate the prohibited activities of the trustee or the manager. For example, in credit asset securitisation and CIBM business asset securitisation, trust companies shall avoid misappropriating trust property for any non-trust purpose, promising the trust property will suffer no loss or guaranteeing a minimum return, or creating security rights over trust property. In exchange market securitisation, the plan manager shall not embezzle or encroach on the assets of the ABSP, or provide guaranty for a third party with the assets of the ABSP.

State-invested or state-controlled enterprises (referred to collectively as state-owned enterprises, or SOEs) constitute an important part of the market economy of China and therefore participate in all kinds of securitisation practices. However, SOEs in the Chinese market need to be differentiated from the government-sponsored entities (GSEs)– such as Ginnie Mae, Freddie Mac or Fannie Mae – in the US market. SOEs in the Chinese market participate in the securitisation business equally with other market participants and are not entitled to special treatment or exemptions under the laws and regulations applicable to securitisation. The products issued by SOEs do not contain any explicit or implicit guaranty by the government.

Entity Types of Investor

Only institutional investors are qualified to invest in securitisation. At present, the main institutional investors are financial institutions and asset management products thereof, securities investment funds (public or private), enterprise annuities, and insurance funds.

In addition, foreign investment entities in the CIBM currently include:

• foreign central banks or monetary authorities, sovereign wealth funds and international financial organisations;
• qualified foreign investors, including qualified foreign institutional investors (QFII) and CNY-qualified foreign institutional investors (RQFII); and
• foreign financial institutions (such as commercial banks, insurance companies, securities companies, fund management companies), investment products issued by such financial institutions, and other medium and long-term institutional investors recognised by PBOC, such as pension funds, charity funds and endowment funds.

The aforementioned foreign investors may conduct transactions and settlements in the CIBM through settlement agents, or may conduct cash bond transactions via third-party platform with domestic market-making institutions by requesting a quote. Foreign investors compliant with the requirements of the PBOC can also invest in the CIBM through the mechanism of arrangement that mutually connects the infrastructure institutions between Hong Kong and the mainland Chinese bond market (“Bond Connect”).

According to Announcement No 4 [2022] of the PBOC, CSRC and the State Administration of Foreign Exchange, foreign institutional investors that are admitted to the CIBM may invest in the exchange bond market directly or through the connect scheme between the CIBM and the exchange bond market, which greatly enlarges the scope of foreign investors for securitisation products in the exchange market.

Additional Restrictions of Investment

In addition to the restrictions on commercial banks’ investment in securitisation products discussed in 4.9 Banks Securitising Financial Assets, the restrictions on investments by different types of investors also include the following:

• A trustee in a credit asset securitisation may not use its own funds or trust funds to invest in the securities issued by it, except for the early redemption by the trustee in accordance with relevant regulations or contracts.
• A trust company may invest in ABS with its own funds or with trust funds whose settlor is not a natural person, but the investment balance of ABS under its owner’s equity shall not exceed 50% of its net assets.
• A single banking financial institution shall not purchase and hold a single securitisation product exceeding 40% of its issuance scale.
• For insurance institutions, the credit rating of invested product shall not be lower than A, and the pooled credit assets are limited to loans classified as pass or special mention.
• In the case of pension funds, total investment in the securities as a percentage of the net asset shall not exceed 135%.
• Cash management-based products of commercial banks and its wealth management subsidiaries shall not invest in ABS with credit rating lower than AA+, and they are also subject to certain concentration limits relating to the originator of ABS.
• Wealth management products offered by a commercial bank’s wealth management subsidiary shall not invest in any subordinated class of ABS originated by its major shareholder, and products offered to non-institutional investors shall not invest in any non-performing asset-backed securities.
• A single securities investment fund shall not hold the same credit tranche of one ABS product exceeding 10% of its issuance scale; the percentage of investment in various ABS of the same originator shall not exceed 10% of the net value of the fund asset.
• Money market funds shall not invest in the bonds and debt financing instruments of non-financial enterprises with a credit rating under AA+, and investment in the bonds, debt financing instruments of non-financial enterprises and ABS of the same originator/issuer shall not exceed 10% of the net value of such fund’s asset.

Please refer to 1.3 Applicable Laws and Regulations.

According to the Notice of the People’s Bank of China, China Banking Regulatory Commission and Ministry of Finance on Further Expanding the Pilot Programme on Credit Asset Securitisation (Yin fa [2012] No 127), resecuritisation and synthetic securitisation are currently explicitly prohibited. In terms of business asset securitisation, although there is no explicit prohibition, resecuritisation and synthetic securitisation are also not allowed in practice.

Insolvency Laws and Securitisation

Insolvency laws are crucial for securitisation, because a primary legal objective for most securitisation transactions is the isolation of the underlying assets from the originator’s bankruptcy risks. “True sale” is a precondition for the bankruptcy remoteness of financial assets depends on the type and structure of the transaction. For credit asset securitisation or CIBM business asset securitisation (the structure of which is elaborated in 1.2 Structures Relating to Financial Assets) in the CIBM, the underlying assets are entrusted by an originator into an SPT, and the underlying assets’ bankruptcy remoteness is provided under Article 15 of the Trust Law, meaning that true sale is not an issue for such transactions. However, in the case of exchange market securitisation, where the underlying assets are transferred from an originator to an ABSP, the question of whether the transfer of the underlying assets constitutes a true sale or a financing guarantee is a decisive factor in determining the underlying assets’ remoteness from the originator’s bankruptcy risks.

Insolvency Laws for True Sale v Secured Loan

Pursuant to Article 30 of the Bankruptcy Law, if the underlying assets have already been legally transferred to others when a bankruptcy petition pertaining to a transferor (as the debtor) is accepted by a court, then the underlying assets will not be held as part of the bankruptcy estate of the transferor, unless the transfer falls within the scope of revocable transfers (including unrequited transfer and transaction at manifestly unreasonable price) within one year prior to the acceptance of the bankruptcy petition, as provided under Article 31 of the Bankruptcy Law.

If a debtor only creates security rights over certain assets, then, according to the applicable laws, when the debtor enters into a bankruptcy proceeding, these assets shall be part of the debtor’s bankruptcy estate, but the secured party has a priority claim on the assets. Under Article 19 of the Bankruptcy Law, after a court accepts a bankruptcy petition, preservation measures pertaining to the debtor’s estate shall be lifted and enforcement procedures over the estate shall be suspended, which means the secured party must delay the exercise of security rights over the estate. In bankruptcy liquidation and bankruptcy settlement proceedings, while a secured party may make a claim to the administrator at any time to exercise the priority of compensation with respect to the disposition and liquidation of the security property, the administrator may decide to dispose of the security property with the rest of the bankruptcy estate as a whole if the disposition of such security property alone would reduce the value of the rest of the bankruptcy estate, and the disposition and distribution plan of the bankruptcy estate shall be approved by the meeting of creditors, which makes the exact timing of the realisation of the security rights ultimately uncontrollable. In the bankruptcy reorganisation proceeding, if there is any evidence proving that the security property is necessary for the reorganisation, and the administrator or the debtor can provide a corresponding guarantee or compensation, the People’s Court may rule not to approve the resumption of the exercise of the security right. Thus, in a secured loan transaction, a creditor’s right over the collateral will be affected by the debtor’s bankruptcy procedure in various aspects; in a true sale situation, by contrast, a transferor’s bankruptcy will not have any impact on the transferee’s exercise of rights over the underlying assets.

SPE Characteristics

Currently, China’s Company Law, Securities Law, Bankruptcy Law and other laws and regulations fail to provide room for the development of SPVs in the form of SPCs and SPLPs. The Trust Law was enacted in 2001, wherein the principle of trust property independence provides a solid legal basis for bankruptcy remoteness pursued in securitisation. Therefore, in credit asset securitisations and CIBM Business Asset Securitisations where a trust company serves as an issuer/issuing vehicle manager, SPTs are adopted. As for exchange market securitisations, the initial issuers were limited to securities companies or their subsidiaries, and due to the separate operation principle of trust industry and securities industry under the current financial regulation framework, ABSPs instead of SPTs are used. However, a recent judicial trend tends to regard the relationship of an ABSP as a trust and shall apply the Trust Law as well.

Neither an SPT nor an ABSP constitutes a legal entity, but rather a set of contractual relationships, where the trustee or plan manager conducts transactions or administrative activities on behalf of the trust or the ABSP according to the contracts, and no operations or debts irrelevant to the securitisation are allowed. The trustee or plan manager may further engage a servicer, fund custodian and other institutions to provide services for the SPV.

Bankruptcy Remoteness

An ABSP is set up by a plan manager, who purchases the underlying assets from an originator on behalf of the investors. According to Article 5 of the Administrative Provisions on Asset Securitisation by Securities Companies and Subsidiaries of Fund Management Companies issued by the CSRC, the assets of ABSPs are independent from the inherent property of the originator, manager, custodian and other business participants, and if the above-mentioned entities are subject to liquidation due to dissolution, revocation or declaration of bankruptcy, the assets of the ABSP do not belong to the liquidation property. Naturally, whether the assets of the ABSP can achieve bankruptcy remoteness from the originator also depends on whether the transfer of the assets from the originator to the ABSP can be recognised by the court as a true sale.

As for an SPT, according to Article 15 and 16 of the Trust Law, the trust property is differentiated from other property which the settlor has not entrusted; after the establishment of the trust, when the settlor is dissolved, revoked or declares bankruptcy, and the settlor is not the only beneficiary, the trust survives and the trust property shall not be regarded as the estate or liquidation property of the settlor; meanwhile, the trust property is differentiated from the property owned by the trustee (inherent property), and if the trust is dissolved, revoked or declares bankruptcy, the trust property does not belong to its liquidation property. Based on the above provisions, in credit asset securitisations and CIBM business asset securitisations, the underlying assets will not generally be consolidated with the bankruptcy estate of the originator or the trustee.

True Sale v Secured Loan

In China, the typical form of property security is the statutory mortgage or pledge, with a clear security agreement between the guarantor and the creditor, which is different from a sales contract. In practice, there is an atypical kind of security called “security by transfer”, whereby the debtor or a third party enters into a contract with the creditor to superficially transfer a property under the creditor’s name; if the debtor pays off the matured debt, the creditor shall return such property to the debtor or the third party; if the debtor fails to pay off the matured debt, the creditor could auction or sell the collateral, or be paid off with the collateral based on its estimated price. Due to the similarity in form, such transactions are easily confused with true sales. If the court determines that the purpose of the property transfer is security rather than a true sale, it will decide following the security rules in the Civil Code.

China is a country with a statutory law system, where a judge’s discretion is relatively limited. Based on limited judicial cases, when deciding the nature of a deal, a court tends to respect party autonomy, taking an approach under which the text of the contract is closely analysed to determine whether its true meaning complies with the characteristics of a sales contract as defined under the Civil Code. The courts seldom use the equity principle to overturn the explicitly expressed will of the parties to a contract.

Therefore, to achieve the target of a true sale and bankruptcy remoteness, at least the following factors need to be ensured in a transaction:

• there is a true and explicit expression regarding the transfer of the ownership of the underlying assets in the relevant transaction documents; and
• the transferee shall pay a reasonable consideration to acquire the underlying assets – the fairness of the consideration is primarily to ensure the transaction will not be revoked by the aggrieved party or its creditors/bankruptcy administrator as manifestly unfair or prejudicial to the interests of the creditors.

A basic premise is implied in this type of transaction: the underlying assets can legally generate steady cash flows which can match the payment of the securitisation products.

In some securitisation transactions, the originator may commit to make up for a shortfall in cash flows of the underlying assets compared to the predicted value, or to repurchase the underlying assets under certain circumstances (such as the deterioration of the transferor’s business condition or a material breach of contract). No judicial case has yet indicated that these arrangements will affect the recognition of a true sale. However, with the increase in legal disputes related to securitisation, it remains to be seen how judicial practice will evolve in respect of the standards for true sale.

“Internal Effect” and “External Effect”

Under PRC laws, the transfer of a creditor’s claim can have both an “internal effect” and an “external effect”. The internal effect of the transfer refers to its effect in relation to the transferor and the transferee. In this regard, as long as the asset transfer agreement has come into effect and the preconditions of transfer provided in the transfer agreement have been met, the transfer of the assets will be effective against the transferor.

Generally, the external effect of the transfer of a creditor’s claim first refers to the effect of the transfer in relation to the debtor. According to Article 546 of the Civil Code, any transfer of a creditor’s claim is invalid against the debtor unless the debtor has been informed. This means if a debtor has not received notice of the transfer of the creditor’s claim, the transferee cannot, on its own, assert the right against the debtor.

The external effect of the transfer of a creditor’s claim also includes the effect on the creditors of the transferor and any third parties. Although it’s not a requirement, the transfer of account receivables can be registered in the Registration and Public Notice System of PBOC’s Credit Reference Centre. According to Article 768 of the Civil Code and Article 66 of the Interpretation of the Supreme People’s Court on the Application of the Security System of the Civil Code of the People’s Republic of China (the Interpretation of the Security System), when one account receivable is the underlying asset of a factoring, pledge, and transfer simultaneously, the People’s Court will determine the order of priority based on factors such as whether the registration of transfer has been completed, the time order of the registration, and the arrival time of the notice of the transfer to the debtor.

In addition, regarding the mortgage and pledge securing the creditor’s claim, although these security rights are transferred to the transferee along with the creditor’s claim, the transferee’s right may not be able to confront a bona fide third party if no change of mortgage/pledge registration has been made to put the transferee’s right on public notice.

General Requirements

As mentioned above, certain perfection measures are required to make a transfer of financial assets definitively enforceable against the debtors, the transferor’s creditors and bona fide third parties. These include registering the transfer of account receivables, notifying the debtors of the transfer, a change of mortgage/pledge registration, and the transfer of possession of the pledged movables, etc. For a more detailed analysis on right perfection measures, see 3.3 Principal Perfection Provisions.

Opinion of Counsel

In a securitisation transaction, a legal counsel is normally not required to issue an opinion on whether a transfer of the underlying assets constitutes a true sale. However, when legal counsel does issue an opinion on whether the underlying assets could achieve bankruptcy remoteness, it would consider the nature of such transaction and its effect on bankruptcy remoteness.

Since China has formulated specialised regulations for various types of securitisations, the transaction structures are relatively “fixed” under the relevant regulations. For now, bankruptcy remoteness can only be achieved through the two means outlined in 6.3 Transfer of Financial Assets.

Limited recourse and non-petition provisions are common in transaction documents where an SPT is adopted, to ensure bankruptcy remoteness. In the case of an ABSP, usually only limited recourse clauses would be stated in the transaction documents. This is probably because an ABSP is regarded as an agency relationship, and in civil law an agency can be rescinded at any time, even though rescission of a contract may cause heavy damages liabilities in practice.

Limited Recourse Provision

It is usually agreed that investors understand and recognise that the securities held by them only represent corresponding beneficial rights and shall not be regarded as liabilities of the trustee or plan manager. Except for wilful misconduct, bad faith, negligence or breach of its obligations under the transaction documents, investors’ recourse against the trustee/plan manager shall be limited to the SPV property and to the amounts available for use in accordance with the payment order stated in the agreement. The security holders shall have no claim or recourse against the SPV or the trustee/plan manager for the amounts that remain unsatisfied after the management and disposal of the SPV property and/or the realised proceeds thereof.

Non-petition Provision

Non-petition clauses protect the SPT against insolvency actions by transaction parties, especially the security holders. It is usually agreed that each of the parties undertakes that during the life of the SPT or for a period agreed by all parties, it shall bring no lawsuit or arbitration proceeding for the purpose of terminating the SPT. However, it would also be made clear that such non-petition clauses shall not be regarded as limiting the right of any party to bring a lawsuit or arbitration proceeding against any party in respect of any loss caused by such party as a result of its fraudulent or wilful misconduct.

Except for a transfer of the financial products stipulated in the Notice on Full Launch of the Pilot Scheme on Levying Value-Added Tax in Place of Business Tax (Ministry of Finance [2016] No 36), a transfer of financial assets is not currently subject to value-added tax (VAT). The transfer of underlying assets is not subject to stamp duty as well because a trust agreement or a purchase and sale agreement in asset securitisation transactions are not regarded as taxable documents listed in the Stamp Duty Law (2022).

A potential tax on the transfer of underlying assets is income tax. If the transfer price is greater than the tax basis of the transferred assets (ie, the historical cost or the actual amount of costs incurred in the acquisition of the assets), then enterprise income tax may be due on the taxable income. In practice, since the financial assets are usually transferred at parity or at a discount on their historical cost, usually no income tax is due on the transfer.

In securitisations, the transfer of underlying assets to the SPVs does not generally give rise to a tax burden for the SPVs. On the other hand, income derived from the underlying assets by the SPVs might be subject to enterprise income tax and VAT.

Income Tax

In regard to credit asset securitisations, according to Ministry of Finance [2006] No 5, if the trustee has allocated the income of the trust to institutional investors during the fiscal year, then the institutional investors shall pay the enterprise income tax on this income and, in order to avoid double taxation, no income tax needs to be paid by the trust. However, the unallocated trust income during the fiscal year shall be subject to enterprise income tax at the trust level. If the income allocated to the investors has already been taxed, then the investors do not need to pay the income tax thereon, to avoid double taxation.

According to the Enterprise Income Tax Law, “enterprises” and “other income-earning organisations” shall pay the enterprise income tax. For other types of asset securitisation business, whether the SPV is an SPT or an ABSP, neither constitutes an “organisation” under the law, and therefore neither is subject to enterprise income tax.

Value-Added Tax

If the underlying assets are interest-bearing assets such as loans or financial leases, then the SPV will acquire rights to such interest or income after the underlying assets are transferred to it. According to the Ministry of Finance [2016] No 140 and the Ministry of Finance [2017] No 56, etc, the manager of the asset management products shall pay VAT at a rate of 3% on its taxable activities occurred in the operation of the asset management products. This rule also applies to securitisation. Nevertheless, in the case of an on-balance sheet securitisation, the tax authority may require the originator to continue to pay a 6% VAT on the proceeds from the transferred underlying assets, which may result in the problem of double taxation. After unremitted communications with tax authorities, some local tax authorities have agreed to a tax on the SPV for interests of the securities issued to the investors instead of interests arising from the underlying asset pool, to alleviate the tax burden. There are also a very small number of local tax authorities that allow trustees not to pay taxes on any interest. But the State Taxation Administration has not yet provided any clear instruction on it, this issue has not been completely resolved.

Stamp Duty

The Ministry of Finance [2006] No 5 provides certain exemptions from stamp duties for credit asset securitisations. An originator or trustee is temporarily exempted from stamp duty arising from taxable agreements between the originator, the trustee and the fund custodian, the securities depository or other service providers in a securitisation transaction. The trustee’s sale and the investors’ purchase and sale of credit asset securities, as well as accounting books established for the trust, are temporarily exempted from stamp duty. So far, there are no special tax exemptions for exchange market securitisations.

The relevant parties in an overseas assets transfer shall follow the general tax regulations on the transfer of financial assets. Generally, if the transfer of assets constitutes a true sale, the foreign SPV has not acquired income as transferee during the transfer and the foreign investors have not acquired any income from China, then the transfer will not give rise to any withholding tax issues. However, if the transaction between an originator in China and an overseas SPV (or its investors) is deemed from a tax perspective to be a loan to the originator, then the payment of withholding tax will be an issue.

Additionally, a Chinese originator who sets up a conduit company for securitisation for tax avoidance purposes may be subject to an anti-tax avoidance investigation. The Enterprise Income Tax Law and the Measures for the Administration of General Anti-Tax Avoidance (Trial Implementation) (Order of State Administration of Taxation No 32) have established the general anti-tax avoidance system, according to which a conduit company may be subject to an anti-tax avoidance investigation by the tax authorities for suspected abusive use of the corporation form and tax havens in order to avoid taxes.

If the underlying assets in a securitisation transaction include real estate or equity interests, the transaction might also be subject to taxes related to real estate ownership and transactions, such as property tax, land value-added tax and title deed tax, or enterprise income tax. To alleviate the tax burden on the originator or their affiliates, direct transfers of real estate are generally avoided in favour of transfers of equity rights in the company that holds the real estate.

If necessary, transaction parties may ask accredited tax advisers for professional opinions concerning specific tax issues. Lawyers advising on a transaction do not usually provide opinions on specific tax issues.

The accountant’s determination regarding the consolidation of an SPV and a true sale is, to some extent, based on the economic essence of the transaction reflected in the terms of the transaction agreements. According to the Accounting Standards for Business Enterprises No 33 (ASBE No 33), published by the Ministry of Finance, the scope of financial statements consolidation shall be determined based on control. When determining control, the accountant may consider three factors: power, variable returns, and the relationship between power and returns.

For the assessment of the first factor, power, the originator’s power over the SPV as reflected in the transfer agreement and the servicing agreement is determinative. According to ASBE No 33, factors to be taken into consideration when determining whether the originator can de-recognise certain financial assets include whether or not the originator has transferred almost all the risks and rewards relating to the ownership of the financial assets to the transferee, including whether the originator has transferred the rights to collect the cash flow and, if not, whether it has undertaken to pass on the cash flow of the financial assets. In most securitisation transactions, before sending the notice of transfer to the debtors, the originator still bears the obligation to pass on the cash flows of the financial assets. Therefore, the accountant needs to conduct the “pass-through test” by examining whether the originator has complied with the “no-advance”, “no-misappropriation” and “no-delay” principles, which involves an inspection of the advance payment and reimbursement by the servicer, investment of idle funds, frequency of cash flow allocation, and other transaction arrangements.

For de-recognising financial assets, at the request of the accountant, the legal counsel may have to modify some specific provisions in the transaction documents, subject to the consent of the participating parties. According to the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions, a legal opinion from a practising lawyer is also needed to prove that the originator does not have any actual or indirect control over the credit assets that have been transferred, and that the transferred credit assets have achieved bankruptcy remoteness from the originator.