Insolvency Laws and Securitisation
Insolvency laws are crucial for securitisation, because a primary legal objective for most securitisation transactions is the insulation of the underlying assets from the originator’s bankruptcy risks. Whether "true sale" is a precondition for the bankruptcy remoteness of financial assets depends on the type and structure of the transaction. (Please note: the concept of true sale may be interpreted differently from legal and accounting perspectives; apart from in 3 Accounting Rules and Issues, the analyses of "true sale" in this guide are based on the legal perspective). For a "credit asset securitisation" or a "trust-type asset-backed note" transaction (the structure of which is elaborated in 9.2 Common Structures) in the Interbank Bond Market, the underlying assets are entrusted by an originator into a special purpose trust (SPT), and the underlying assets’ bankruptcy remoteness is explicitly provided for under Article 15 of the Trust Law of the People’s Republic of China (the Trust Law), meaning that true sale is not an issue for such transactions. However, in the case of a "business asset securitisation" carried out on securities exchanges, and where the underlying assets are transferred from an originator to a special purpose vehicle (SPV) – called an "asset-backed special scheme" – the question of whether or not the transfer of the underlying assets constitutes a true sale is a decisive factor in determining the underlying assets’ remoteness from the originator’s bankruptcy risks.
Characteristics of True Sale v Secured Loan
A true sale and a secured loan are two different legal relationships. According to relevant provisions of the Contract Law of the People’s Republic of China (the Contract Law), a sales contract is an agreement by which a seller transfers the ownership of an underlying asset to a buyer, and the buyer pays a purchase price for the underlying asset. A loan contract is an agreement whereby a borrower borrows money from a lender, and pays interest and repays the principal upon maturity of the loan. The main difference between the two transactions is that in a sales transaction the ownership of the underlying asset will be transferred from the seller to the buyer, whereas in a secured loan transaction the borrower solely grants the lender a security interest over the underlying asset, instead of transferring the ownership of the asset. In China, the typical form of property security is the statutory mortgage and pledge with a clear security agreement between the debtor and the creditor, which is different from a sales contract. In practice, there is an atypical kind of security called "security by transfer" – that is, the debtor or a third party provides security for the debts under a main contract by transferring properties including chattel, real property or equity to the creditor. This kind of transaction has the appearance of property transfer, but the transaction purpose of the parties is not to transfer the property but to secure the realisation of the main debt with the property. In general, such transactions do not violate the mandatory provisions of the law or damage the national and social public interests, and their effectiveness can generally be recognised by the court. However, due to the similarity in form, such transactions are easily confused with true sales.
Security by transfer is a kind of security method gradually confirmed by the court in judicial decisions. The common transaction form is: when the parties enter into a loan transaction or in the case where there are existing debt claims, the borrower transfers its property to the creditor and agrees to take back the property after paying off the debt. Generally, the court will judge the true transaction purpose of the parties according to the contract and other information. If it determines that the purpose of the property transfer is security rather than a true transfer, it will decide following the security legal relationship.
Since China has a relatively short history of securitisation, judicial practice has not come to a clear consensus over its constitutive elements or adjudicative standards. Based on limited judicial cases, a People’s Court, in deciding the nature of a deal, tends to respect party autonomy, thus taking an approach whereby 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 Contract Law (ie, transfer of ownership versus consideration). The courts seldom use the equity principle (from the perspective of the transfer of risks and rewards) to overturn the explicit expressions of will of the parties to a contract, even if the transferor promises to make up for the difference between the income of the transferred underlying assets and the expectation, or the transferor promises to repurchase the underlying assets under certain circumstances (such as the deterioration of the transferor's business condition or material breach of contract).
Obviously, with the expansion of China asset securitisation business and the increase of legal disputes, it remains to be further observed how the judicial practice will evolve in respect of the standards for true sales.
Difference in Protection for Transferred Assets
In respect of the transferred assets, a true sale usually provides stronger protection for the acquirer of the assets compared to a secured loan. In a secured loan transaction (including security by transfer), when a borrower is unable to repay the loan, the lender cannot directly gain ownership of the collateral, but is only entitled to the proceeds from auction, sale or compensation based on the estimated price of the collateral for the sake of repaying the loan, and any proceeds exceeding the amount of the debt should be returned to the borrower. In a true sale, on the other hand, the transferee can assuredly obtain the ownership of the underlying asset, and all the cash value and other proceeds arising from the underlying assets belong to the transferee, unless the parties agree otherwise.
Insolvency Laws for True Sale v Secured Loan
Pursuant to Article 30 of the Bankruptcy Law of the People’s Republic of China (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. On the other hand, if a debtor only creates security rights over certain assets then, according to 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 and wait for the liquidation of the estate.
To conclude, in a secured loan transaction, a creditor’s rights over the collateral will be affected by the debtor’s bankruptcy procedure in terms of the time delay and the decision-making processes of the liquidation; 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.
Opinion of Counsel
In a securitisation transaction, legal counsel will normally be required to issue an opinion on the bankruptcy remoteness of the underlying assets. Whether the legal counsel can issue a clear opinion generally depends on two aspects, the first being the legal character of the underlying assets and the second the design of the deal structure. As for the first aspect, if the underlying assets are future receivables, or the payment on the receivables depends on the continuing operation or performance of duties on the originator’s side (such as freeway/motorway toll rights and property rent claims), then it will be difficult for the legal counsel to issue an opinion that the underlying assets can achieve bankruptcy remoteness. In such projects, if the originator can provide strong credit enhancement with its own or third-party corporate credit as a supplement, investors may still accept such assets.
In regard to the deal structure, the issue of obtaining legal opinions also depends on the particular situation. For credit asset securitisation and trust type asset-backed notes transactions carried out in the Interbank Bond Market, legal counsel is usually able to issue an opinion confirming bankruptcy remoteness pursuant to Article 15 of the Trust Law, provided that the trust has been lawfully and effectively set up and the trust properties have been actually delivered, the settlor is not the sole beneficiary of the trust, and the creation of the trust does not jeopardise the interests of the settlor’s creditors. For business asset securitisation carried out on the securities exchanges, the issuance of an opinion affirming bankruptcy remoteness is conditional on the inclusion of true and explicit expressions of the transferor’s will to transfer the underlying assets in the relevant transaction documents, and the satisfaction of the conditions provided in the transaction documents for the transfer of the underlying assets, including the payment of the purchase price.
Meanwhile, as unrequited transfer and below-market-price transfer may jeopardise the interests of the originator’s creditors and can be revoked pursuant to Article 74 of the Contract Law and Article 31 of the Bankruptcy Law, legal counsel issuing affirmative opinions on bankruptcy remoteness in the aforementioned different types of securitisation transaction shall make the assumptions on or verify that the originator receives reasonable consideration for the transfer of the underlying assets.
In China, the structures that a securitisation deal may adopt are limited to those defined under relevant regulations; namely, only SPTs (for credit asset securitisation and trust-type asset-backed notes) or asset-backed special schemes (for business asset securitisation) can be used to achieve the bankruptcy remoteness of underlying assets. Neither SPTs nor asset-backed special schemes constitute legal entities – which is why it may not be appropriate to refer to them as "special purpose entities" – but rather form contractual relationships, where the trustee or scheme manager conducts transactions or administrative activities on behalf of the trust or the special scheme, and may further engage the servicer, fund custodian and other institutions to provide services for the SPV. Although, in practice, investors may purchase various financial assets through private equity funds in the form of limited partnerships, these transactions are classified as private equity fund business instead of standard securitisation, and so are subject to different laws and regulations.
"Internal Effect" and "External Effect"
Under PRC laws, the transfer of a creditor’s claim can have both "internal effect" and '"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 contract providing for the transfer of assets (transfer agreement) has come into effect, and the preconditions of the transfer provided in the transfer agreement (such as the establishment of the SPV that will receive the assets, and the payment of the purchase price) have been met, then the transfer of the assets will be effective against the transferor. Correspondingly, the ancillary rights of the creditor’s claim (including rights derived from guaranty, mortgage, pledge, etc) will be transferred to the transferee along with the creditor’s claim.
The external effect of the transfer of a creditor’s claim generally means the effect of the transfer in relation to the debtor. According to Article 80 of the Contract Law, any transfer of a creditor’s claim is invalid against the debtor unless the debtor has been informed. This means that 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 issue of external effect of transfer of a creditor’s claim can also extend to the effect on the creditors of the transferor and any third parties. For example, if a transferor signs a transfer agreement with a transferee and, before giving notice of the transfer, it assigns the same claim to a third party, then the question of which party can assert a right on the claim is potentially fraught. Another example is that, in the case where a transferor has transferred a creditor's claim to a transferee but no notice was given to the debtor, and a creditor of the transferor files with a court for a seizure or stay on the transferred claim to satisfy its debt against the transferor, can the transferee file a valid objection to the court's enforcement and exclude the enforcement?
Since China has not established a public notice system for the transfer of creditor’s claims, and no clear and specific judicial interpretation has been given on such questions by the Supreme Court, such questions remain theoretically controversial and are faced with different treatments in judicial practice. Although the People’s Bank of China (PBOC) has published the Measures for the Pledge Registration of Account Receivables, which allow parties to register the transfer of account receivables with the registration and public notice system run by the Credit Reference Centre, PBOC, the legal force of the registration is uncertain due to a lack of support in higher-level law. In addition, as to the mortgage and pledge securing the creditor’s claim, as transfer of such security interests often requires a change of registration or transfer of possession as a method of notice and perfection against unknown bona fide third parties, if the transferor, without consent from the transferee, disposes of the collaterals on its own or in collaboration with the mortgagor/pledgor before such change of registration and transfer of possession could be effected, then the transferor is likely to lose its claim against the bona-fide third party that obtains such collaterals.
In summary, to make a transfer of financial assets definitively enforceable against the debtors, transferor's creditors, and bona fide third parties, certain perfection measures are required. These usually include notifying the debtors of the transfer, change of mortgage/pledge registration, transfer of possession of the pledged movables, etc. For more detailed analysis, see 5.3 Principal Perfection Provisions.
Differences Between True Sale and Secured Loan Transfers
In a true sale, for the purpose of transferee protection, the perfection measures mentioned above are usually foreseen for certain circumstances. In the case of secured loans, since there is no transfer of financial assets, there are no such requirements.
Differences in Rights for Compliant and Non-compliant True Sales
In normal securitisation practice in China, with a view to facilitating the collection of the financial assets, maintaining the originators’ client relationship, and keeping the transaction costs under control, perfection measures are often not required at the delivery of the underlying assets, and are only required upon the occurrence of events unfavourable for the transaction (often called "perfection events").
As mentioned above, a transferee cannot directly assert a claim against a debtor until the debtor has been given notice of the transfer, but the transferee may require the transferor (often acting as the servicer) to remit the collections arising from the assets. With respect to the mortgage or pledge securing the creditor’s claim, the transferee may be harmed by the transferor’s disposal of the collaterals, and the transferee’s right may not be enforceable against a bona fide third party. To mitigate such risks, responsibilities for acts in breach of the agreement are often provided in the transaction documents, including those requiring the transferor to repurchase the damaged assets as ineligible assets.
Since securitisation in China is still in the pilot phase, the transaction structures are relatively “fixed” under the relevant regulations. For now, the bankruptcy remoteness can only be achieved through one of the two means mentioned above.
At present, China has only one regulation that deals exclusively with tax issues in respect of securitisation, namely the Notice of the Ministry of Finance and the State Administration of Taxation on Relevant Issues concerning Taxation Policies on the Securitisation of Credit Assets (Ministry of Finance  No 5 – hereinafter Document No 5). Document No 5 was published with reference to credit asset securitisation pilot programmes. No special tax regulation in respect of asset-backed notes (ABNs) or business asset securitisation has been published yet. Therefore, tax issues arising out of ABNs and business asset securitisation are only subject to general tax laws and regulations.
Potential taxes on the transfer of underlying assets mainly include income taxes and stamp duties. Except for transferring 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  No 36), the transfer of financial asset is not currently subject to VAT. In regard to income taxes, 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 by the acquisition of the assets), then enterprise income tax may be due on the taxable income. On the other hand, if the transfer price is less than the tax basis of the transferred assets, leading to losses being incurred by the transferor, then the transferor may deduct such losses from its taxable income, provided that the transfer price has been based on fair market value, and the transferor has made a timely filing with the competent tax authority. In practice, since the financial assets are usually transferred at parity or discount to their historical cost, it is normally the case that no income tax is due on the transfer. Besides, the originator’s repurchase or substitution of the transferred assets shall be also subject to the currently applicable regulations of enterprise income tax on the transfer or acceptance of assets.
In regard to stamp duties, according to the Interim Regulations of the People's Republic of China on Stamp Duty (the SD Interim Regulations), entities and individuals who execute or receive documents specified in the SD Interim Regulations within the territory of the People's Republic of China shall be subject to stamp duty. Document No 5 provides certain exemptions from stamp duties for credit asset securitisation, including exemption for agreements, such as trust agreements, that the entities providing services to the securitisation transaction enter into, as well as exemption for the fund accounting books established for the trust. So far, there are no special tax exemptions for other types of asset securitisation. Therefore, parties to asset transfer agreements that are subject to stamp duty should pay stamp duty in accordance with the SD Interim Regulations.
In asset securitisation, the transfer of underlying assets to the SPVs generally does not give rise to a tax burden for the SPV. On the other hand, income derived from the underlying assets by SPVs might be subject to enterprise income tax and value-added tax.
In regard to credit asset securitisation, according to Document 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 to avoid double taxation, such income can be deemed after-tax income, meaning that the investors do not need to pay the income tax thereon.
In respect of other types of securitisation, there is no special regulation on the income tax issues arising therefrom. According to the Enterprise Income Tax Law of the People's Republic of China, "enterprises" and “other organisations that have incomes” shall pay the enterprise income tax. Whether the SPV is an SPT or asset-backed special scheme, neither constitutes an "organisation" under the law, and therefore neither is subject to enterprise income tax. That said, the interest or income acquired by institutional investors holding asset-backed securities, or the spread acquired from the trading of asset-backed securities, is still subject to enterprise income tax according to the laws.
If the underlying assets are interest-bearing assets such as loans or financial leases, then after the underlying assets are transferred to the SPV, the SPV will acquire rights to such interest or income. According to the Notice of the Ministry of Finance and the State Administration of Taxation on Specifying the Value-added Tax Policies for Finance, Real Estate Development, Educational Support Services (Ministry of Finance  No 140), the Notice on the Relevant Issues concerning Value-added Tax Levied on Asset Management Products (Ministry of Finance  No 56), and the Notice of the Ministry of Finance and the State Administration of Taxation on the Value-added Tax Policies for the Deduction of Input Taxes on Rented Fixed Assets and Other Matters (Ministry of Finance  No 90), since 1 January 2018, the manager of the asset management products shall pay value-added tax (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.
In addition, regarding the issue of whether the investment income of the investors acquired by holding the securities shall be subject to VAT, according to the Notice of Ministry of Finance  No 36, the interest (principal-guaranteed return, remuneration, fund possession fees, compensation, etc) during the holding period (including on the maturity date) of the financial products shall be subject to VAT, the Notice of Ministry of Finance  No 140 stipulates that the “principal, guaranteed return, remuneration, fund possession fees, compensation” refers to the investment returns clearly promised in the agreement that the principal could be fully returned at maturity. Generally, the relevant offering documents and the agreements of the securities would not promise the full recovery of the principal at maturity, therefore, it is usually considered that the investment returns of the investors are not subject to VAT. According to Notice of Ministry of Finance  No 36, the sale of asset-backed securities by investors in the secondary market falls under the transfer of financial products, the seller shall pay the VAT with the spread of the transfer of the securities as the tax base.
Regarding to the current securitisation practice in China, no foreign entity has yet issued any asset-backed securities in China with its financial assets. Because of the foreign exchange control, transactions where Chinese institutions transfer their financial assets to foreign SPVs for issuing asset-backed securities are also rare. The following discussion only deals with the tax issues of the latter scenario.
So far there is no special Chinese law or regulation for the transfer of domestic financial assets abroad. Therefore, the relevant parties in an overseas assets transfer shall still 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 issue. 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 there will be an issue of paying withholding tax.
Additionally, if the Chinese originator sets up a conduit company for securitisation for tax avoidance purposes, it may be subject to anti-tax avoidance investigation. The Enterprise Income Tax Law of the People's Republic of China, which became effective in 2008, and the Measures for the Implementation of Special Tax Adjustments (Trial Implementation) (State Administration of Taxation  No 2), published by the State Administration of Taxation in 2008, have established the general anti-tax avoidance system, according to which a conduit company may be subject to anti-tax avoidance investigation by the tax authorities for suspected abusive use of corporation form and tax havens in order to avoid taxes. The Enterprise Income Tax Law of the People's Republic of China as amended in 2018, and the implementation rules thereof, reaffirmed this system. As the number of cross-border securitisation transactions is small and there is little public information on the asset transfers contained therein, it cannot be said for certain whether or not the tax authorities will handle the originator's establishment of foreign SPVs in securitisation under the general anti-tax avoidance system.
In addition to the aforementioned kinds of taxes, if the underlying assets in a securitisation transaction (for example, quasi-REITs which are carried out within the securitisation legal framework) 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.
Since China has not published any tax exemption policy for quasi-REITs transactions, in practice tax issues shall be given serious consideration when designing the transaction structure, in order to avoid heavy tax burdens for the originator or other related parties. To achieve this, the direct transfers of real estate shall be avoided in favour of transfers of equity rights in a company that holds the real estate to be transferred.
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 consolidation of SPV and 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, published by the Ministry of Finance, the scope of consolidation for the consolidated financial statements shall be determined on the basis of 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. Regarding the determination of whether the originator can de-recognise certain financial assets, according to the Accounting Standards for Business Enterprises No 33, factors taken into consideration 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. This requires detailed analysis of the provisions of the transaction documents, 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. For most securitisation transactions, before sending the notice of transfer of debt claim, the originator still bears the obligation to pass on the cash flow 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 the inspection on the advance payment and reimbursement by the servicer, asset management method of the servicer, investment of idle funds, establishment of reserve accounts, frequency of cash flow allocation, and many other aspects of the transaction.
For the purpose of de-recognising financial assets, at the request of the accountant, the legal counsel may have to modify the specific provisions of the transaction documents, subject to the agreement of the participating parties. Additionally, according to the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions (Order of CBRC  No 3), a legal opinion from a practising lawyer is needed for proving that the originator does not have any actual or indirect control over the credit assets that have been transferred, and that the originator has achieved bankruptcy remoteness from the transferred credit assets. For the conclusion and general requirement of legal opinion regarding bankruptcy remoteness, please refer to 1.1 Insolvency Laws.
Since the securitisation market in the PRC is segmented, and each market segment and business type is subject to different sets of regulations and rules, introductions to these regulations and rules will be given separately.
Information disclosure regarding credit asset securitisation mainly follows the rules published by the PBOC, including the Rules for the Information Disclosure of Asset-Backed Securities (Announcement of PBOC  No 14), the Announcement of Matters Regarding Information Disclosure of Credit Asset Securitisations' Underlying Asset Pool (Announcement of PBOC  No 16), and the disclosure guidelines for various kinds of underlying assets published by the National Association of Financial Market Institutional Investors (NAFMII), which include micro and small enterprise loans, retail auto loans, personal mortgage loans, redevelopment of shanty towns loans, personal consumer loans, and non-performing loans.
Information disclosure regarding ABNs issued in the Interbank Bond Market mainly follows the rules published by PBOC and NAFMII in relation to information disclosure.
Information disclosure regarding business asset securitisation mainly follows the regulations published by the China Securities Regulatory Commission (CSRC). The Shanghai Stock Exchange (SSE), the Shenzhen Stock Exchange (SZSE) and China Securities Internet System Co, Ltd (which operates the Inter-Institutional Price Quoting and Serving System, referred to hereinafter as the Quoting System) has published disclosure guidelines for different types of underlying assets, including financial lease debt claims, public-private partnership (PPP) assets, account receivables, and infrastructure assets. In addition, the SSE and SZSE issued the relevant guidelines on the content and format of periodic reports and interim reports.
Material Forms of Disclosure
Regarding the forms of information disclosure, in credit asset securitisation, whether the securities will be issued/placed publicly or privately, information disclosure by the trustee shall be conducted via the information disclosure servicing system of NAFMII, China Money website (www.chinamoney.com.cn), the China Bond website (www.chinabond.com.cn), Beijing Financial Assets Exchange and other methods approved by the NAFMII. For ABNs issued publicly, the parties shall disclose the documents via the websites approved by the NAFMII; for ABNs issued privately, the information will only be disclosed to the private investors. For business asset securitisation, the information disclosure channels used by the scheme manager shall be the exchanges where the securities are listed, the information disclosure platform of the Asset Management Association of China (AMAC) and other approved websites (such as the website of the scheme manager). The information disclosure is divided into disclosure during registration, during issuance and during the life cycle of the securities. Please see 4.4 Periodic Reporting for the detailed rules on disclosure of periodic reports.
The principal regulators of information disclosure regarding credit asset securitisation and ABNs are the PBOC and the NAFMII (which is a self-regulatory organisation). The China Banking and Insurance Regulatory Commission (CBIRC), which is a successor organisation to the original China Banking Regulatory Commission (CBRC), can also sanction the banking financial institutions that have violated the rules. The principal regulators of information disclosure regarding business asset securitisation are the CSRC and its local counterparts, the AMAC (which is a self-regulatory organisation) and securities exchanges.
Violations and Penalties of Required Disclosure
Regarding to credit asset securitisation, the CBIRC stipulates in the Measures for the Supervision and Administration of the Pilot Scheme on Securitisation for Credit Assets of Financial Institutions that if financial institutions provide false reports or reports concealing important facts when engaging in the credit asset securitisation, then the CBIRC may order correction, confiscate any illegal gains or impose fines. If the circumstances are especially serious or the institution fails to make rectifications within a prescribed time limit, then the CBIRC may order it to suspend its business operation or revoke its permit for operation; criminal activities will be subject to criminal sanctions.
At the same time, in relation to credit asset securitisation and ABNs in the Interbank Bond Market, the NAFMII may impose self-regulatory sanctions on non-compliant information disclosers. These include public denouncement, order to correct, public denouncement of relevant responsible persons and order for relevant responsible persons to participate in mandatory training at the NAFMII on information disclosure. In serious cases, the NAFMII may suspend the relevant business operation. If the non-compliant act is suspected of violating the laws, the NAFMII shall hand the matter over to relevant authorities, including the PBOC.
For misconduct in the disclosure of information regarding business asset securitisation, the CSRC and its local agencies may impose regulatory measures such as orders to correct, issuing warning letters, orders for public explanation, orders to participate in mandatory training and orders to make periodic reports. It also has the power to impose administrative penalties such as confiscation of illegal gains, fines, suspension or revocation of the professional qualification of responsible persons; in cases where the violation constitutes a crime, the relevant parties may be subject to criminal liabilities. The AMAC may conduct regular or ad hoc on-site and off-site self-regulatory investigation of securities companies and fund management company subsidiaries, and may impose disciplinary sanctions such as written warnings, orders to correct within a time limit, public condemnations, suspensions of record-filing and cancellation of membership, depending on the seriousness of the case.
If the circumstances are serious, the case shall be transferred to the CSRC. In addition, according to the self-regulatory rules of the SSE and SZSE, the securities exchange may record disclosure violations in credit files, and prudently process the subsequent application or documents submitted by the relevant parties; if the circumstances are serious, the securities exchange may report to the supervision authorities for investigation, and seek legal action against the relevant parties.
Public Market v Private Market
In China, standard securitisation products are only issued to qualified institutional investors, whether the issuance is public or private. Standard securitisation products are generally issued or traded in specific markets. The rules of different markets are different. Standard securitisation products (whether publicly or privately placed) must be approved, filed and registered by the relevant regulatory authorities, and can only be issued to qualified institutional investors and transferred among institutional investors, with strict information disclosure requirements. Senior securities are generally rated by rating agencies initially and monitored, and credit asset securitisation products need to be rated by two rating agencies. The regulatory supervision of securitisation focuses on the quality of the underlying assets, the rationality of the transaction structure and the fulfilment of due diligence and information disclosure. The regulators will also focus on the creditworthiness of the originators and the guarantors.
In addition to the standard securitisation products, there are also some asset management products issued by trust companies, commercial banks, securities companies and other financial institutions which possess the transaction characteristics of securitisation but are not issued or traded on any trading venue. The regulations on securitisation are not applicable to these products. These products are commonly referred to as "private securitisation products". Due to the lack of prior regulatory review, weak transparency or information disclosure, and the absence of a mature trading market, the liquidity of such products is relatively low. Financial institutions face more restrictions when investing in such products (including quota restrictions, risk capital reserve, etc).
Obtaining Legal Opinion
In credit asset securitisation, lawyers do not generally give legal opinions on whether or not trustees have complied with the information disclosure rules, but only on the overall validity of the transaction structure and the legality of the underlying assets. Compliance with information disclosure rules in the disclosure documents at each stage is mainly reviewed in advance or supervised afterwards by the relevant regulatory authorities or self-regulatory organisations.
In business asset securitisation and ABNs, lawyers need to give legal opinions on whether the relevant transaction documents or offering circulars are in conformity with the relevant rules on information disclosure. Therefore, lawyers generally need to review whether the transaction documents and offering circulars have provided for the format of information disclosure during the life cycle of the securitisation project, contents and time of the information disclosure documents, the storage of and access to information disclosure documents in accordance with the relevant disclosure rules, and whether the offering circulars are compiled in accordance with the regulatory requirements.
There is not a general disclosure law applicable to all the securitisation products mentioned above, but the rules applicable respectively to the different products share some common aspects, as discussed above.
Laws and Regulations on Credit Risk Retention
After the outbreak of the global financial crisis in 2008, asset securitisation in China was suspended, and Chinese regulatory authorities began to study and summarise the international experience and lessons of securitisation. In May 2012, the PBOC, CBIRC and Ministry of Finance jointly issued the Notice of the Peoples Bank of China, China Banking Regulatory Commission and Ministry of Finance on Further Expanding the Pilot Programme on Credit Asset Securitisation (Yin Fa  No 127) and began to require risk retention, namely, that the originator should retain the lowest class of securities, representing no less than 5% of the aggregate volume of the securities issued.
Since the risk retention requirement set by this regulation was very strict, it was difficult to conduct off-balance sheet securitisation. Subsequently, in December 2013, the PBOC and CBIRC made adjustments to the risk retention rules with the Announcement on Further Regulating the Risk Retention of Originators in Credit Asset Securitisation (Announcement of PBOC and CBRC  No 21), which is still in effect today. The adjusted rules require the originator to retain no less than 5% of the total issuance amount of the securitisation product, and the percentage of the lowest class of asset-backed securities held by it shall not be less than 5% of the issuance amount of the corresponding class. The originator may choose either horizontal retention or vertical retention, as long as it meets the minimum requirements.
As far as business asset securitisation under the supervision of the CSRC is concerned, no compulsory requirement on risk retention is stipulated in the general rules. However, since the end of 2017, the SSE, SZSE and Quoting System have issued guidelines on the confirmation of eligibility for the listing of asset-backed securities backed by financial lease debt claims, account receivables and infrastructure, respectively, which clearly stipulate the requirement on risk retention. However, the applicable rules for different types of underlying assets are slightly different.
In respect of ABNs, there are currently no compulsory requirement on risk retention, but if the fund-raising party chooses to retain the risk then such arrangements will generally be disclosed in the offering documents.
Penalties for Non-compliance
If the risk retention arrangements in the transaction documents do not comply with the compulsory requirements described above, the project will not be able to make the pre-issuance record-filing or receive confirmation of listing eligibility. After the issuance is completed, the security depository of the asset-backed securities will conduct verification when reviewing the application for transfer of securities, meaning that the originator cannot generally transfer the prohibited asset-backed securities directly – however, some originators may privately transfer the right to the income on the retained securities to other parties. Such practice does not strictly conform to the requirements of the risk retention rule; besides, several guidelines on confirmation of the listing conditions published by the securities exchanges prohibit “any form of disguised transfer”, which has in fact denied such practice. Currently, there are no explicit rules relating to penalties for violations of the relevant requirements.
Regulation and Enforcement
The risk retention rules for credit asset securitisation are formulated by the PBOC and CBIRC. The risk retention rules for business asset securitisation are formulated by exchanges authorised by the CSRC (the SSE, SZSE, and Quoting System). The CBIRC and PBOC will review the risk retention arrangements for specific projects when accepting applications for record-filing and approval. The exchanges will also supervise the arrangement when confirming whether the listing conditions are met.
The existing regulations make no provision for "substitutive compliance" by foreign issuers complying with any similar laws in the jurisdiction of domicile of the issuer, which means foreign issuers (if allowed) are subject to the same rules as domestic issuers.
Obtaining Legal Opinion
Legal counsels in issuing legal opinion on the overall transaction structure will take into consideration the risk retention arrangement, but it is usually unnecessary for them to issue specific opinion on the legality and compliance of the risk retention arrangement, or to track or verify the actual subscription of securities.
As far as credit asset securitisation is concerned, for the duration of the securities, the trustee shall provide trustee reports at the same frequency as the payments on the securities are made, as well as on an annual basis. These reports must disclose the status of the asset pool in relation to the securities, as well as providing information in relation to the principal and interest payments of each class of the securities, statistics on the asset pool, the reinvestment of the assets (if a revolving structure is involved), disposal of loans in default, etc. The rating agencies shall also disclose the annual monitoring report to the investors, which must include information on the changes in the underlying asset pool and credit risk analysis.
Regarding ABNs, the issuer shall disclose the asset operation report before each payment on the notes, and throughout the life cycle of the notes. The annual asset operation report and semi-annual asset operation report must be disclosed prior to 30 April and 31 August of each year for notes issued publicly; for notes privately placed, the annual asset operation report must be disclosed prior to 30 April each year. The asset operation report must include: the basic information of the notes; the contract performance status; the operation and overall condition of the asset pool; the payment of the returns and taxes on each class of notes; the use of the issuance proceeds; risk retention; the reinvestment arrangement, etc. The rating agencies must disclose the annual monitoring report and intermittent monitoring report in a timely manner, which must include the target products, the condition of the originator and underlying assets, and the analysis of cash flow and macro policy.
In regard to business asset securitisation, throughout the life cycle of the asset-backed securities the scheme manager is required to disclose the income distribution report before each payment date of the securities to the qualified investor; it must also disclose the asset management report annually, including information on the operation status of the originator, the inflow and outflow of the funds in the special scheme, the payment of principal and interest on each class of securities, etc. The fund custody report, by the fund custodian, must also be disclosed at the same time as the asset management report. The monitoring report must also be disclosed annually, including information on the change in the underlying assets, efficiency of the revolving structure (if involved), the payment of the securities, the operation of cash flow, the result of the stress test, the credit analysis and ratings of the originator and other parties, etc. In addition to the annual rating report, the rating agencies is required to disclose its intermittent monitoring report in a timely manner.
In addition, on 11 May 2018, the SSE and SZSE issued 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, which stipulate the compilation and the disclosure requirements for the annual asset management report and annual fund custodian report, making information disclosure more targeted and effective for the purpose of helping investors to make better investment decisions and enhancing risk disclosure.
The disclosure of trustee reports in credit asset securitisation and ABNs is subject to self-regulatory management by the NAFMII and the supervision of the PBOC. The disclosure of asset management reports and income distribution reports in business asset securitisations is subject to self-regulatory management by the securities exchanges, the Securities Association of China (SAC) and AMAC, and supervision by the CSRC and its local counterparts. Please see 4.1 Specific Disclosure Laws of Regulations for the administrative handling of violations of the relevant rules on disclosure of periodic reports.
Rating services provided by rating agencies (RAs) are regulated by the regulatory authorities of the respective issuance/trading markets and the professional self-regulatory organisations. The substantive regulations may be divided into three categories, as follows:
The rules vary on the subject product and market concerned. It is worth mentioning that the regulators are recently starting to permit foreign RAs to provide rating services within China via their local branches or subsidiaries. In 2018, three international rating agencies, Moody's, Fitch, and S&P established Chinese subsidiaries. In January 2019, PBOC, along with NAFMII, announced that S&P Global (China) Ratings Co, Ltd has been officially admitted to provide credit rating services to the Interbank Bond Market.
Regulators of RAs include the credit rating industry regulating authority and the credit rating business administration authorities. The former refers to PBOC, which is responsible for the supervision of credit rating business across the country, and has the authority of formulating the market entry principles and fundamental rules; the latter refers to the National Development and Reform Commission, the Ministry of Finance, and CSRC, which regulates the credit rating business in their respective jurisdictions.
RAs are also subject to the regulation of SROs in the corresponding markets. The regulators and SROs have the power to supervise and inspect the RAs providing rating services in the markets under their respective jurisdictions. If RAs are found to be violating any law, regulation or rule, then the regulators may, according to the respective rules: (i) impose administrative sanctions such as fines, suspension of business, or revocation of business approval; or (ii) impose regulatory measures such as issuing a directive to correct, warning letter, directive to make public explanation, directive to attend training, directive to make regular reports, etc.
Applicable Capital and Liquidity Rules
In respect of the capital measurement of commercial banks, the Measures for Administration of Capital of Commercial Banks (Trial Implementation) provide the minimum requirement for the core tier 1 capital adequacy ratio, the tier 1 capital adequacy ratio, and the capital adequacy ratio of commercial banks. The volume of risk-weighted assets will affect such capital adequacy ratios, and the securitisations that a commercial bank engages in will affect the measurement of its risk-weighted assets.
According to the Measures for Administration of Capital of Commercial Banks (Trial Implementation), if a financial institution incurs securitisation risk exposure as a result of its business of credit asset securitisation, then the institution shall set aside corresponding capital reserves according to the risk-weighted asset measurement rules. In terms of liquidity risk regulatory indicators, according to the Measures for Administration of Liquidity Risk of Commercial Banks, which came into effect on 1 July 2018, there are five liquidity risk regulatory indicators:
Engaging in securitisation or investing in asset-backed securities will affect a commercial bank's liquidity coverage ratio or high-quality liquid asset adequacy ratio, net stable funding ratio and liquidity gap ratio.
In respect of securities companies, according to the Administrative Measures for Risk Control Indicators of Securities Companies (2016 Revision) and the Provisions on the Calculation Standard for Risk Control Indicators of Securities Companies, securities companies shall, in line with the principles of prudence and substance over form, calculate the risk control indicators such as net capital, risk coverage ratio, capital leverage ratio, liquidity coverage ratio, net stable funding ratio, etc. Securities companies shall set aside capital reserve for asset-backed securities held according to the measurement standard provided by the CSRC; in measuring such indicators as liquidity coverage ratio and net stable funding ratio, different measurement factors shall be applied to asset-backed securities of different ratings.
In regard to insurance companies, the most important regulatory indicator is the solvency ratio (ie, the ratio of the actual capital to the minimum capital); the relevant regulations require that an insurance company's solvency ratio shall not be lower than 100%. Actual capital refers to the difference between the recognised assets and the recognised liabilities. In evaluating an insurance company's solvency ratio, different recognised values will be assigned to the credit asset-backed securities of different outside ratings in which such an insurance company has invested.
Comparison to the Basel Rules
As for the capital measurement of securitisation in China, Annex 9 – Rules on Risk Weighted Asset Measurement in Securitisation of the Measures for Administration of Capital of Commercial Banks (Trial Implementation) is similar to the relevant contents of the Basel framework in terms of applicable definition, rules and structure. However, there are some differences in the measurement of risk-weighted assets. For instance, the Basel framework provides for four measurement approaches – (i) the standardised approach (SEC-SA), (ii) the internal ratings-based approach (SEC-IRBA), (iii) the external ratings-based approach (SEC-ERBA), and (iv) the internal assessment approach (IAA) – whereas Annex 9 of the Measures for Administration of Capital of Commercial Banks (Trial Implementation) provides two broad approaches – the standardised approach and the internal ratings-based approach – with the latter further divided into the ratings-based approach and the regulatory formula approach. Commercial banks shall decide whether to use the standardised approach or the internal ratings-based approach according to the approval and requirements of the CBIRC.
As for liquidity risk management, the Measures for Administration of Liquidity Risk of Commercial Banks, which came into effect on 1 July 1 2018, drew on the net stable funding ratio rule published by the Basel Committee in 2014, and, in line with the business realities of China's commercial banks, introduced three new quantitative indicators – (i) the net stable funding ratio, (ii) high-quality liquid asset adequacy ratio, and (iii) liquidity matching rate – in addition to the original two indicators of liquidity ratio and liquidity coverage ratio. However, Basel III included qualified residential mortgage-backed securities as level 2B assets with a discount factor of 75% within the high-quality liquid assets (HQLA) category, and left it to the discretion of national authorities whether to include them as level 2 HQLA under the national regulations, whereas the Measures for Administration of Liquidity Risk of Commercial Banks did not include RMBS as level 2 HQLA.
Some of the rules on regulatory capital reserve and risk-weighted asset measurement related to securitisation are listed in "Regulation of Capital and Liquidity for Securitisation" below. It should be noted that credit asset securitisation in China is still in the pilot phase, during which the regulatory authorities do not allow resecuritisation or synthetic securitisation products. The following list of regulations therefore pertains only to traditional securitisations.
Regulation of Capital and Liquidity for Securitisation
In respect of traditional securitisation transactions, the sponsor may deduct the securitised assets from the calculation of risk weighted assets if:
Under the standard approach, if external ratings issued by qualified rating agencies evaluated by the commercial banks are used to determine the risk weight, then the risk weight of the securitisation risk exposure should be determined according to the conversion table of risk weights for ratings provided by the regulations. The different long-term ratings and the corresponding risk weights of securitisation exposures are as follows:
The different short-term ratings and their corresponding risk weights of securitisation exposures are as follows:
If a securitisation risk exposure is not rated, or the rating is not recognised by the CBIRC to be admitted as a reference for risk weight, then the following rules shall apply when measuring capital reserves:
Under the internal ratings-based approach of securitisation, there are two sub-categories: the ratings-based approach and the regulatory formula approach. For securitisation risk exposures which have external ratings or which are unrated but whose ratings can be inferred, the ratings-based approach shall be used to measure the regulatory capital requirement. For securitisation risk exposures which have no external ratings and whose ratings cannot be inferred, the risk-weighted asset may be calculated under the regulatory formula approach or calibrated at 12.5 times the exposure. The risk weight for securitisation risk exposures calculated under the regulatory formula approach shall not be lower than 7%.
Principal Regulators and Enforcement of Rules
For commercial banks, the aforementioned regulations are mostly included in the Measures for Administration of Capital of Commercial Banks (Trial Implementation) and the annexes thereto, the Measures for the Supervision and Administration of Pilot Credit-Based Asset Securitisation of Financial Institutions, and the Measures for Administration of Liquidity Risk of Commercial Banks, which are all published and enforced by the CBIRC.
According to the above-mentioned regulations, to effectively mitigate the risks associated with securitisation, commercial banks shall set aside regulatory capital reserves on the basis of the economic substance of a transaction, rather than just the legal form of the transaction. The CBIRC has the authority to make a determination on a commercial bank’s securitisation risk exposure on the basis of the economic substance of the securitisation transactions, and impose methods to set aside capital reserves. Commercial banks shall disclose the capital adequacy ratio in a timely manner, according to the regulations. Disclosures shall be made on a quarterly, semi-annual, or annual basis, supplemented by ad hoc disclosures. Commercial banks shall file the liquidity regulatory indicators on a monthly basis (unless otherwise required by the CBIRC), and shall file the liquidity risk management report of the previous year to the banking regulatory and administrative authority before the end of April each year.
"Simple, Transparent and Comparable" Principle
Generally, all credit asset securitisation conducted in China at this stage is in compliance with the "simple, transparent and comparable" (STC) principle. For instance, the Measures for the Supervision and Administration of Pilot Credit-Based Asset Securitisation of Financial Institutions require that the credit assets to be securitised by the sponsor shall have relatively high homogeneity. The Notice of the People's Bank of China, China Banking Regulatory Commission and Ministry of Finance on Further Expanding the Pilot Program on Credit Asset Securitisation (Yin Fa  No 127) requires that the structure of credit asset securitisation products shall be simple and clear, and in the expanded pilot stage no resecuritisation or synthetic securitisation shall be allowed. The Announcement of PBOC  No 16 and the information disclosure guidelines published by the NAFMII on certain types of underlying assets set out clear rules on information disclosure, which would allow the investors of credit asset securitisation to effectively obtain sufficient information on the underlying assets, transaction structure and transaction parties. At the current stage, all securitisation products in China shall be held to the capital and liquidity rules mentioned above.
Derivatives such as interest rate swaps, currency swaps, foreign exchange swaps and credit risk mitigation instruments could be used in securitisation transactions, based on the needs of the particular transactions. Currently, there are no specific laws or regulations on the use of derivatives in securitisations; however, relevant parties (including the scheme manager, trustee and investors) shall comply with the general rules applicable to the trading of derivatives and to each type of specific derivatives.
In respect of credit derivatives, the available instruments in securitisation transactions mainly include credit risk mitigation agreements and credit risk mitigation warrants. The former is a kind of financial agreement between the buyer and seller of credit protection, the latter a kind of security of value created by the warrant issuer. The trading of such instruments is mainly subject to a series of rules published by the NAFMII, SAC, China Futures Association (CFA), AMAC, SSE, and SZSE. Although it is admissible to use such credit risk mitigation instruments in securitisation, due to various reasons (including transaction party qualifications and transaction cost) they have only been utilised for a few products.
Due to the lack of strong demand, interest rate swaps are also seldom used in current securitisation transactions. In addition, currency swap may be used in cross-border securitisation transactions. A body of rules promulgated by the PBOC, the China Foreign Exchange Trade System, and the National Interbank Funding Centre are applicable to the swaps.
The Interim Measures for Administration of Derivative Product Transactions of Banking Financial Institutions mainly impose requirements on financial institutions regulated by the CBIRC (such as commercial banks, trust companies and financial asset management companies), regarding their eligibility and license for derivatives trading, risk management, product marketing and subsequent service, as well as sanctions for non-compliance. Securities companies and other financial institutions are also required to obtain approval from or file with the corresponding supervisory authorities. According to the applicable rules by PBOC, participants in the interbank market engaging in derivatives trading shall also be enrolled with the NAFMII as members of the interbank market, and execute the master agreement prepared and published by the NAFMII; members of the interbank market participating in the interbank forward exchange transactions shall also file with the State Administration of Foreign Exchange (SAFE) via the China Foreign Exchange Trade System.
The compliance of particular institutions with the regulations will be supervised by the regulatory authorities relevant to each particular institution. The PBOC has the power to supervise the derivatives business in the national interbank market; SAFE, under the authorisation of the PBOC, supervises and manages the forward exchange market. Other than that, the NAFMII is authorised by the PBOC to conduct self-regulatory administration over members of the interbank market and the transactions carried out therein; the China Foreign Exchange Trade System 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; the Shanghai Clearing House provides clearance services for interest rate swaps, foreign exchange swaps and credit risk mitigation warrants.
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 by the CBIRC; anything constituting criminal activity will be subject to criminal punishment by law. For banking financial institutions that have failed to effectively implement derivatives trading risk management and internal control systems, the CBIRC 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 self-regulatory sanctions, based on the seriousness of the violation.
Securitisation businesses in China must comply with a series of Accounting Standards for Business Enterprises published by the Ministry of Finance, especially the Accounting Standards for Business Enterprises No 23 – Transfer of Financial Assets and the Accounting Standards for Business Enterprises No 33 – Consolidated Financial Statement.
China has not published any law or regulation dealing exclusively with the protection of investors in ABS products. Investor protection is provided for in the basic laws, including the Securities Law of the People's Republic of China, Securities Investment Fund Law of the People's Republic of China, etc, as well as various securitisation regulations. These laws and regulations cover matters including investor qualifications and limits on the number of investors (see 4.15 Entities Investing in Securitisation), due diligence, credit risk retention (see 4.2 General Disclosure Laws or Regulations), market trading rules, as well as information disclosure (see 4.1 Specific Disclosure Laws or Regulations), among many others, and provide comprehensive protection of the interests of the investors.
One of the mechanisms for investors' protection is the meeting of security-holders. The various securitisation regulations all require the issuing vehicle to establish the institution of the meeting of security-holders as the governing organ of the issuing vehicle, to conduct decisions on important matters of the issuing vehicle.
Another mechanism for investors' protection is the due diligence requirements for the relevant intermediaries. Among such, the more detailed regulations are within the realm of business asset securitisation. In November 2014 the CSTC formed the Guidelines for Securities Companies and Subsidiaries of Fund Management Companies on Due Diligence for Asset Securitisation, specifying the scheme manager as the overall responsible party for due diligence, and the relevant due diligence requirements are proposed. In June 2019, SAC promulgated three detailed guidelines to specify the requirements for due diligence on the securitisation of financial leases, public-private partnership (PPP) projects, and account receivables.
In addition, many rules for investor protection are found in the trading stage. The Measures for the Administration of Bond Transactions in the National Interbank Bond Market and the Rules for Bond Trading on the National Interbank Market set out clear rules for various trading activities on the Interbank Bond Market, forbid violations including malicious manipulation of trading prices for bonds and fabrication of false prices of bonds, and authorises the Interbank Funding Centre to conduct daily monitoring of the market trading; meanwhile the Interbank Funding Centre has the right to report the abnormal trades and conduct of violations to PBOC. The rules of SSE and SZEX also clearly enumerated the abnormal trading activities which may affect the trading price or trading volume of the securities, and the exchanges will monitor the abnormal trading activities; securitisation guidelines of both the exchanges stipulate that in the occurrence of a material event or abnormal fluctuation of securities trading prices, the exchanges may suspend trading of the asset-backed securities, and decide whether to resume trading depending on the circumstances after the relevant situation is resolved.
Two kinds of authorities are in charge of the implementation of the investor protection mechanism: the first kind are the authorities that have administrative law enforcement power, such as the CBIRC, PBOC and CSRC. These may impose a number of administrative penalties or regulatory measures on the trustee or the scheme manager for failure to fulfil the duties of honesty and diligence, including order to rectify, regulatory talk, warning letter, order to make public statement, etc. Administrative penalties include fine, suspension of business for rectification, and revocation of business licence.
The second kind of authorities are the self-regulatory organisations, including mainly AMAC (for business asset securitisation), NAFMII (for ABNs and credit asset securitisation), and the securities exchanges. AMAC, for example, according to the Measures for the Administration of the Record Filing of Asset-Backed Special Schemes published by it in 2014, may respond to behaviours that violate the self-regulatory rules by imposing written warning, order to correct, public condemnation, suspension of filing, revocation of membership and/or other actions based on the type and seriousness of the violation. The trading rules of both SSE and SZEX stipulate that the exchanges have the right to conduct onsite or offsite investigations into abnormal trading activities that my affect the price or volume of the securities trading, and take actions including warning, trading restrictions of relevant securities accounts, and reporting to CSRC against serious abnormal trading activities.
Commercial banks as originators will be subject to the same regulatory measures on credit asset securitisation, along with other financial institutions under the supervision of CBIRC; however, commercial banks investing in credit asset securitisation products are subject to certain specific rules, including the following:
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 products shall be treated in a manner consistent with the "look-through approach", according to which the ultimate obligor of the underlying assets of the securitisation products 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 a number of 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 to avoid the look-through treatment or other regulatory arbitrage activities, then the investment can be exempted from the look-through approach, in which case the securitisation product itself shall be identified as the counterparty and deemed a non-interbank single client. The risk exposure of the underlying assets shall be counted towards the risk exposure of this client.
As mentioned above, different types of securitisation products on the Chinese market are subject to different rules. Banks engaging in credit asset securitisation should comply with the laws and regulations on credit asset securitisations in the Interbank Bond Market, which do not differ from laws and regulations applicable to other financial institutions in such aspects as information disclosure, credit risk retention, reporting, accounting treatment, etc.
Securitisations in China mainly include credit asset securitisation, business asset securitisation (securitisations by securities companies and the subsidiaries of fund management companies) and ABNs. The regulations relating to SPVs are different for each type of securitisation. Among them, the Administrative Measures for the Securitisation of Credit Assets (Announcement of the PBOC and CBRC  No 7) stipulate that the SPV for credit asset securitisation shall be a special purpose trust. The Guidelines for Asset-Backed Notes Issued by Non-Financial Enterprises (Announcement of the NAFMII  No 27), meanwhile, stipulate that the SPVs for ABNs shall be a special purpose trust, a special purpose company or other special purpose vehicle approved by the NAFMII. Whether in the case of credit asset securitisation or trust-type ABNs, the establishment and operation of the trust shall be governed by the provisions of the Trust Law, and the trust company acting as the trustee shall abide by the provisions of the Administrative Measures for Trust Companies.
In regard to business asset securitisation, the Provisions on the Administration of the Securitisation Business of Securities Companies and the Subsidiaries of Fund Management Companies (Announcement of the CSRC  No 49) stipulate that the SPV shall be an asset-backed special scheme or other special purpose vehicles approved by the CSRC. Meanwhile, since the legal relationship between the originator and the scheme manager under the asset-backed special scheme is generally considered as a principal-agent relationship, the relevant provisions of the Contract Law and the General Principles of Civil Law are also applicable. The asset-backed special scheme is essentially a contractual relationship rather than an independent entity.
According to the existing regulations, credit asset securitisation can only use SPT as the bankruptcy remote vehicle. In addition to the asset-backed special scheme, business asset securitisation can use other forms approved by the CSRC. However, the forms recognised by the CSRC are neither specified in regulations nor confirmed in practice at present. The Guidelines for Asset-Backed Notes Issued by Non-Financial Enterprises allow SPVs to adopt the form of specific purpose companies, or other forms recognised by the NAFMII. However, the forms recognised by the NAFMII are neither specified in regulations nor confirmed in practice at present. Since the Company Law of People's Republic of China and the Bankruptcy Law do not contain any rules on special purpose companies, China currently does not have a precedent of adopting the special purpose company as the SPV in securitisation.
At present, the main difference between the various types of SPVs used for securitisation lies in the qualifications of the scheme manager or the trustee. The trustee of an SPT shall be a trust company or other institutions approved by the CBIRC. However, the CBIRC has not yet approved other institutions other than trust companies as trustees, and trust companies shall specifically apply for the trustee qualification for the specific purpose trust. Securities companies or subsidiaries of fund management companies usually serve as the scheme managers of the asset-backed special scheme. However, if recognised by the CSRC, futures companies, securities finance companies, other companies under the supervision of the CSRC, commercial banks, insurance companies, trust companies and other financial companies may also serve as scheme managers, and there have been trust companies serving as scheme managers in practice.
As mentioned above, due to the separate industry supervision and market segmentation in China, the SPVs for different types of securitisation are usually narrowly defined under the regulatory rules, and there is not much room for choice. Non-financial companies can choose to issue ABNs in the Interbank Bond Market, or they can choose to conduct business asset securitisation on the securities exchanges. Originators may pay more attention to the issuing costs on different markets, the difficulty of obtaining approval, the product innovativeness, etc, of the securitisation. At least from the current perspective, neither the trust structure nor the asset-backed special scheme has any obvious advantages or disadvantages over the other in terms of tax treatment or bankruptcy remoteness.
For credit asset securitisation, business asset securitisation and ABNs, the form of the SPV is chosen according to the applicable regulatory requirements; forms not specified in the regulatory provisions will not be adopted.
Special regulations are applicable to “asset management products” and “non-standard assets” in China; however, the aforementioned credit asset securitisation, business asset securitisation and asset-backed notes are explicitly exempted from such regulations. Activities of the SPEs are mainly confined by the relevant pilot rules and generally applicable laws.
Based on the sources of the credit enhancement, credit enhancement in the securitisation market can be divided into internal credit enhancement and external credit enhancement. The former derives its credit from the underlying assets and the structural design of the securitisation products, whereas the latter derives its credit from third-party institutions beyond the SPV. Forms of internal credit enhancement mainly include overcollateralisation, securities classification, cash collateral accounts, spread accounts (or cash reserve accounts), etc. Forms of external credit enhancement mainly include shortfall payment commitments, third-party guaranties, and external liquidity support, insurance, credit risk mitigation documents, etc. In this respect, securitisation products subject to different regulations and different structural considerations present different characteristics.
State-invested or state-controlled enterprises (referred to collectively as state-owned enterprises, or SOEs) 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 explicit or implicit guaranty by the government. The current securitisation products in China do not distinguish between “agency deals” or “non-agency deals”. SOEs participating in securitisation will have to abide by the rules for the management of state-owned assets and special rules applicable to SOE themselves. For instance, according to the Measures for the Supervision and Administration of the Trading of State-owned Assets in Enterprises, transfer of SOE assets above a certain value has to be, in principle, conducted publicly in an asset exchange, and third-party agencies shall be engaged to appraise the assets to be transferred and the price shall be determined accordingly.
Credit asset securitisation products and ABNs are traded on the Interbank Bond Market. Entities investing in such products must open an interbank market account, either on their own or by commissioning another institution to do so. At present, the main institutional investors in the Interbank Bond Market include: commercial banks; credit unions; securities companies; insurance companies and other financial institutions; securities investment funds; enterprise annuities; national social security funds; insurance funds; asset management products issued by various financial institutions; private equity funds; and non-financial companies. In addition, foreign investors can enter the Interbank Bond Market for investment in the following methods based on their types:
Business asset securitisation products are mainly traded in the securities exchange market. The scope of qualified investors is similar to that of credit asset securitisation investors with slight differences.
In addition to the restrictions on commercial banks’ investment in the securitisation products discussed in 4.10 Banks Securitising Financial Assets, the current regulatory restrictions on securities investments by different types of qualified investors also include:
In credit asset securitisations, the transfer of assets while maintaining bankruptcy remoteness is achieved through the provisions of the "trust agreement". The originator entrusts its underlying assets to the trustee to create the trust, and the trustee manages, uses and disposes of the trust property. The trust property is independent and is not affected by the bankruptcy of the settlor and the trustee, which meets the requirements of the risk insulation in securitisation. Meanwhile, the trust can achieve limited recourse, and 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 in credit asset securitisation transactions, and its main provisions include: 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; rights perfection mechanism; rights and obligations of the trust parties; types and characteristics of the securities; cash flow allocation order; trust termination and liquidation; organisational form and power of the security holders; liability for defaults and indemnities.
In business asset 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 scheme manager of the special scheme. The originator transfers the ownership of the underlying assets to the scheme 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 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; effectiveness and termination of the agreements, etc.
"Asset warranties" refer to the representations and warranties on the underlying assets of the originator as of a specific date or time (such as the cut-off date, the effective date of the trust or the special scheme) of the securitisation project. The contents of asset warranties may differ based on the different types of underlying assets, but the contents of an asset warranties clause usually include the following:
If the underlying assets do not satisfy the requirements of the asset warranties at the time of entering the asset pool or transfer, then the underlying assets will be recognised as ineligible assets and must be redeemed by the transferor or originator in accordance with the terms of the transaction documents. The eligibility criteria are significant criteria stipulated by the transaction parties for selecting the underlying assets when creating the asset pool. In the case of the underlying assets being well-performing loans, the criteria usually include: the validity of the ownership and/or other legal rights of the underlying assets; the debts not being overdue (or within the grace period allowed); loan risk classification; debtor criteria (eg, nationality, age, credit score, records on past overdue); maturity of the claims; amount limit of a single claim; no litigation, arbitration, enforcement, or disputes; no military or national secrets involved, etc. The eligibility criteria for different types of underlying assets will be adjusted as necessary based on the features of the assets.
Perfection events in an asset securitisation transaction document usually include the situations in which:
The parties may also agree on other circumstances that could trigger the perfection provisions.
After the occurrence of perfection events, the asset seller or the settlor shall generally take the following measures to protect the rights acquired by the asset buyer or the trustee:
In addition, the asset seller or the settlor must issue an authorisation letter to the scheme manager or the trustee before the establishment date of the special scheme or the trust, authorising the scheme manager or the trustee to perform such a notification obligation in the name of the asset seller or the settlor if the asset seller or the settlor fails to perform the aforementioned notification obligations.
If the underlying assets are mortgaged or pledged, and the corresponding mortgage or pledge is required to be registered in accordance with Chinese law, the originator must conduct the transfer registration of the mortgage or pledge promptly after the occurrence of a perfection event to ensure that the mortgage or pledge held by the scheme manager or the trustee will be valid against any bona fide third party. If the pledge of the underlying assets is perfected through the delivery of the pledged assets or their title documents, the originator must deliver the pledged assets or their title documents to the scheme manager or the trustee promptly upon occurrence of the perfection events. If there are any bona fide third-party claims of ownership or security interests in the property, pledge or title documents prior to the occurrence of the perfection events, resulting in the failure of the scheme manager or the trustee to assert a valid claim against the bona fide third party, then the originator shall redeem the underlying assets as ineligible assets.
In order to ensure a smooth transaction, the originator in the transaction usually makes covenants as to the following matters in the transaction documents:
The originator will be deemed in default of the contract and be liable for indemnities and other liabilities upon breach of any covenant.
The servicer in a securitisation transaction is usually the originator itself. The contents and conditions of the service provided by the servicer are stipulated in the servicing agreement and vary according to the types of the underlying assets. However, the main services can be summarised into the following categories:
If the servicer fails to perform its obligations under the servicing agreement or any of its representations, warranties and commitments under the servicing agreement is materially false, inaccurate or misleading, it is deemed in default. The servicer is liable for the breach of contract and shall continue to perform, shall take remedial measures and compensate for all losses suffered by the non-breaching party, and shall compensate for all losses caused by the breach to the special scheme assets or the trust property. However, the servicer’s obligations regarding the underlying assets are limited to those agreed upon in the servicing agreement and other contracts or agreements in relation to the underlying assets. It does not provide any guarantee or assurance for the amount to be collected, nor does it undertake any responsibilities or liabilities for the losses that may arise in the securitisation. Generally, the servicer is not responsible for the defaults of its predecessor or successor servicer organisations under the transaction documents.
See 5.7 Principal Indemnities.
The defaults and liabilities clauses are usually stated together in the transaction documents. The fundamental principle of defaults and liabilities is that if one party fails to perform its obligations stipulated in the contract, or if one party’s representations or warranties under the contract are materially false or inaccurate, then that party is the default party. Unless otherwise stipulated in the contract, the default party shall be liable to the non-breaching party and shall continue to perform, take remedial measures, and/or compensate the non-breaching party for all losses suffered. Specifically, the possible actions of the originator that might result in breach of transaction documents include the following:
If the originator commits any of these breaches, the scheme manager or the trustee has the right to request the originator to pay damages in accordance with the transaction documents.
The transaction documents often also cover the issue of set-off regarding the underlying assets. According to Article 83 of the Contract Law, when a debtor receives notice of the assignment of a creditor’s claims, it can assert the same set-off right against the assignee that it may assert against the assignor. Therefore, the transaction documents usually stipulate that if the debtor of the underlying assets exercises the set-off right lawfully and the claims thus set off belong to the securitised assets that have been transferred from the originator, then the originator shall pay an amount equal to the amount set off to the trustee, the scheme manager, or their designated servicers.
The current content has touched all material aspects of enforcement of securitisation in China.
In general, China’s securitisation legal system (especially for credit asset securitisation and business asset securitisation) is improving gradually. In the light of advancement in the streamlining of administration, self-regulatory transactions in the Interbank Bond Market and exchange market are now given more authority to formulate rules and supervise the transactions. Since 2014, the approval and record-filing processes regarding the issuances in the two markets have been significantly simplified, and the issuance efficiency has been greatly improved. The self-regulatory organisations of the two markets have strengthened the requirements for information disclosure and the compliance of intermediaries, and provided more guidance for the organisations participating in the market through the refinements of the operational guidebooks for transactions in various kinds of underlying assets.
Nevertheless, it could be said that the problem of over-regulation in China’s asset securitisation markets still exists, exemplified by the excessive examination of the originator and the underlying assets by the regulatory authorities or the market self-regulatory organisations when reviewing specific transactions, which could delay the issuance and reduce the predictability of the transactions.
In credit asset securitisation, the issuers are special purpose trusts (represented by the trustee of the special purpose trust). In business asset securitisation, the issuers are the asset-backed special schemes (represented by the scheme managers). For ABNs, it is necessary to distinguish between two transaction structures: in the first structure, the originator directly entrusts the underlying assets to the trustee to set up a special purpose trust, and the special purpose trust (represented by the trustee), acting as the issuing vehicle, issues the asset-backed securities (this structure is often referred to as a "trust-type ABN"); in the second structure, the originator itself acts as the issuing entity, and the originator provides the underlying assets as security for the repayment of the ABNs (this structure is usually referred to as a "pledge-type ABN").
In regard to credit asset securitisation, the issuer or the issuing vehicle manager shall be a trust company with the special purpose trust trustee qualification approved by the CBIRC; for business asset securitisation, the issuer shall be a securities company (or a subsidiary of a securities subsidiary company) or a subsidiary of a fund management company with the qualification for client asset management business approved by the CSRC. For ABNs, if the issuing vehicle is a special purpose trust, the trustee acting as the issuing vehicle manager shall be a trust company with the specific purpose trust trustee qualification approved by the CBIRC; if the issuing vehicle is the originator, then according to current regulations the originator should be a non-financial enterprise, generally a corporation or company.
In credit asset securitisation, business asset securitisation, and trust-type ABN business, the issuer (ie, issuing vehicle manager) is the trustee or scheme manager, who stands in a trustee-settlor relationship or agent-principal relationship with the investors, and therefore owes fiduciary duties to investors. Their basic responsibilities include:
However, it should be noted that the issuer (issuing vehicle manager) often does not have sufficient capacity to manage the asset pool professionally. Therefore, the issuer (or the issuing vehicle manager) will generally retain the originator as the servicer to provide daily management, collection, disposal and other services concerning the asset pool. In respect to pledge-type ABNs, the issuer is the debtor on and mortgagor/pledger for the notes, and its main obligation is to repay the principal and interests of the ABNs, hold and manage the underlying assets in accordance with the agreement, and disclose relevant information. The lead underwriter may be designated to exercise certain rights on behalf of the noteholders, such as the right to convene the meeting of noteholders, to hold the pledged collateral and exercise the right of pledgee on behalf of the noteholders.
In the relevant Chinese securitisation regulations, the sponsor is generally the originator of the securitisation. According to the relevant regulations, in credit asset securitisation, the sponsor is the financial institution that transfers the credit assets through the establishment of a special purpose trust. In ABNs, the sponsor is a non-financial enterprise engaging the ABN business for financing purposes. In business asset securitisation, the relevant regulations do not have the concept of "sponsor", but the entity that transfers the underlying assets to the plan manager is referred to as an "originator"; in practice, the concepts "sponsor" and "originator" are often interchangeable. One exception is when the underlying assets are not directly transferred to the special plan by the fund-raising party, but through certain conduits (such as factoring companies or trust companies); the sponsor should be the actual fund-raising party, rather than the originator of the underlying assets.
In terms of credit asset securitisation, only financial institutions approved by the CBIRC can act as originators. These include commercial banks, policy banks, automobile finance companies, consumer finance companies, financial leasing companies, financial asset management companies and other Chinese financial institutions, as well as foreign-funded incorporated banks. In terms of business asset securitisation, the relevant regulations do not put restrictions on the entity type of the originator, but the majority of the sponsors (originators) in the market are non-financial enterprises, such as real estate developers, property management companies, infrastructure and utilities enterprises, commercial factoring companies, financial leasing companies previously supervised by the Ministry of Commerce, and various other providers of goods or services. In terms of ABNs, the sponsor (originator) can only be the various types of non-financial enterprises, and the types of participating entities in the market are similar to those in the business asset securitisation market.
The responsibilities of a sponsor mainly include providing underlying assets that meet the eligibility criteria, not encroaching on or damaging the underlying assets, redeeming or replacing the ineligible underlying assets, co-ordinating and supporting the issuing vehicle and related intermediaries in performing their duties, and providing relevant disclosure information to the issuing vehicle and related intermediaries in a timely manner, ensuring that the information provided is true, accurate and complete. If the cash flow of the underlying assets depends on the continued operation of the sponsor – a scenario which mainly concerns the securitisation of future receivables – then the sponsor should also maintain normal production and operation throughout the life cycle of the securitisation, and provide reasonable support to and necessary protection for the generation and transfer of cash flow of the underlying assets.
An underwriting agency or a placement agent is the organisation responsible for the sale of the asset-backed securities. Its general duties include the promotion and sale of the asset-backed securities, as well as organisation of the underwriting syndicate. The duties of lead underwriters generally also include: drafting the offering circulars and other issuance documents; presiding over the book-building or bidding process for the sale of the asset-backed securities; collecting issuance proceeds; distributing underwriting fees among the members of the underwriting syndicate; design of the transaction structure during the preparation of the transaction; co-ordination of the progress of the project with other project participants; and filing with the regulatory authorities.
The underwriters of securitisation products in China are generally domestic financial institutions that meet certain requirements on registered capital, sales capacity, sales channels, etc, and are mainly banks and securities companies. The underwriters of some asset securitisation transactions targeting foreign investors may also include foreign-owned banks registered in China. In regard to ABNs, in addition to banks and securities firms, trust companies can also act as underwriters of the notes.
Servicers are generally also the originators of the underlying assets, or their affiliates. Certain kinds of securitisation (such as commercial mortgage-backed securities, or CMBS) backed by real properties or incomes thereof may also use third-party professional property management institutions as servicers. The general responsibilities of the servicers include collecting the cash flow of the asset and transferring it to the SPV, managing the asset pool, safeguarding the underlying assets, including legal documents and related records thereof, providing regular service reports to the SPV manager, and other duties as stipulated in the servicing agreement.
Investors in asset-backed securities generally do not actively participate in the management of the SPV, but passively collect the principal and returns on the asset-backed securities. Only in situations where the investors’ rights might be affected may the investors participate in the security-holders' meeting and vote. 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 relevant laws and regulations and the provisions on the trading of asset-backed securities in the transaction documents; complying with the provisions on the exercise of rights; and maintaining confidentiality regarding trade secrets (especially in privately placed deals).
At present, investors in China's securitisation market generally include financial institutions such as banks, insurance companies, securities companies, fund companies, asset management products managed by the aforementioned institutions, social security funds, public funds, private equity funds and other non-financial companies that meet the requirements for qualified investors.
As detailed in 7.1 Issuers, Chinese securitisation practice mainly adopts two forms of issuing vehicles: special purpose trust and asset-backed special scheme. These are not independent legal entities but are represented by the trustees or plan manager. Therefore, the issuer often overlaps with the trustee. The entity type and main obligations of the trustees are described in the above-mentioned section.
Only in the pledge-type ABN transactions will the originator itself act as the issuer, and the underlying assets are not transferred, but mortgaged or pledged to the noteholders. In such circumstances, for the purpose of completing mortgage or pledge registration and protecting the rights of the investors, the lead underwriter will generally be designated as the agent acting on behalf of the noteholders, whose duties generally include: supervising the issuer's use of issuance proceeds; completing mortgage or pledge registration and holding the rights thereof on behalf of the investors; monitoring the underlying assets; supervising the contract performance by the issuer; convening the meeting of the noteholders, when necessary, to resolve important matters and take action to protect the interests of the creditors ( for example, requiring the issuer to provide additional security, taking property preservation measures against the issuer, filing lawsuits or filing bankruptcy petitions on behalf of the noteholders); and disclosing the information regarding the issuer's contract performance and the status of the underlying assets to the noteholders.
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  No 127), the piloting of re-securitisation and synthetic securitisation is not allowed within the Expanded Pilot Programme on Credit Asset Securitisation. In practice, the regulatory authorities will strictly control the transaction structure and make it simple and clear at the approval or record-filing stage of the transaction. In the fields of business asset securitisation and ABNs, although there is no explicit prohibition, re-securitisation and synthetic securitisation are not allowed in practice, which is in line with the goal of serving the productive economy.
See 8.1 Synthetic Securitisation.
See 8.1 Synthetic Securitisation.
See 8.1 Synthetic Securitisation.
See 8.1 Synthetic Securitisation.
See 8.1 Synthetic Securitisation.
Regulatory authorities require that the underlying assets of credit asset securitisation must be "credit assets", and the common underlying assets of credit asset securitisation include corporate loans, small and micro-enterprise loans, personal residential mortgage loans, personal consumer loans, auto loans, credit card assets, financial leasing debt claims of the financial institution and non-performing loans.
Regulatory authorities require that the underlying assets of business asset securitisation must be property rights or financial assets in conformity with the laws and regulations, the ownership of which is clear, and which are capable of generating independent and predictable cash flow. These can be a single property right or financial asset, or a portfolio of multiple rights or assets.
Common underlying assets of business asset securitisation include: petty loans; financial lease debt claims of non-financial institutions; rights of returns related to infrastructures and public utilities; various kinds of account receivables; commercial mortgage loans; margin trade or securities lending debt claims; stock pledge-style repo debt claims; right of returns on commercial papers, etc. Among them, with regard to the asset securitisation products of which the underlying assets are future operating receivables such as infrastructure tolls, according to the regulatory Q & A issued by CSRC in April 2019, it is required that the cash flow of such products shall be originated from the debt claim or other right formulated by specific originators based on the following operations: public-private partnership (PPP) projects; operation and maintenance of infrastructure in industries and fields encouraged by national policies; or municipal utilities with a chartered or exclusive nature such as gas, electricity, water, heat, sewage and garbage treatment, transportation facilities (eg, roads, railways, airports); and public services such as education and healthcare. According to the Q & A, future operating receivables such as movie tickets, property management fees, and park admission vouchers without a chartered or exclusive nature are no longer allowed to be the source of cash flow for the underlying assets of asset securitisation products. Additionally, in particular, REITs projects in China are currently operated within the legal framework of securitisation, therefore REITs are also a special business field of securitisation in China.
Regulatory authorities require that the underlying assets of ABNs must be assets, property rights, or a combination of the two, which are in conformity with laws and regulations, the ownership of which is clear, and which are capable of generating independent and predictable cash flow. The scope of underlying assets of ABNs is similar to that of business asset securitisation. However, whether future receivables and rights to the income of certain assets that are not independent can be recognised as trust property is controversial under the law. For this kind of underlying assets, it may be more suitable to adopt the structure of pledge-type ABNs, without employing a trust structure. Moreover, it is generally believed that even if the trust structure is adopted, this kind of underlying assets may fail to achieve risk insulation from the originator.
Credit Asset Securitisation
The basic transaction structure of credit asset securitisation has been clearly stipulated in the Administrative Measures for the Securitisation of Credit Assets, and is therefore relatively fixed. The basic transaction structure of credit asset securitisation is as follows:
The laws and regulations having material effects on the transaction structure of the credit asset securitisations include the Contract Law of the People’s Republic of China, the Trust Law of the People’s Republic of China, the Administrative Measures for the Securitisation of Credit Assets, the Measures for the Supervision and Administration of the Pilot Scheme on Securitisation for Credit Assets of Financial Institutions (Order of CBRC  No 3), the Announcement on Further Regulating the Risk Retention of Originator in Credit Asset Securitisation (Announcement of the PBOC and CBRC  No 21), the Notice on the Workflow for the Record Registration of Credit Asset Securitisation (Yin Jian Ban Bian Han  No 1092) and the Announcement on Issues concerning the Administration of the Issuance of Credit Asset Securities (Announcement of the PBOC  No 7).
Business Asset Securitisation
There are two kinds of common transaction structures for business asset securitisation. In the first, which is mainly applicable to various existing debt claims and infrastructure income rights:
The second kind of transaction structure, which is also called a dual SPV structure, consists of two layers of SPVs, and is mainly suitable for CMBS and future receivables debt claims:
The laws and regulations that have material effect on the transaction structure of business asset securitisations include the Security Law Of the People’s Republic of China, the Securities Investment Fund Law of the People’s Republic of China, the Administrative Provisions on Asset Securitisation of Companies and Subsidiaries of Fund Management Companies (Announcement of the CSRC  No 49), the Measures for the Administration of the Record Filing of Asset-Backed Special Schemes and the accompanying rules published by the AMAC (Letter of the AMAC  No 459).
There are two main transaction structures for ABNs. In the first, trust-type ABNs, the specific transaction structure is as follows:
For the other structure, pledge-type ABNs, the specific transaction structure is as follows:
The laws and regulations that have material effect on the transaction structures of the ABNs include the Trust Law of the People’s Republic of China, the Measures for Administration of Debt Financing Instruments Issued by Non-Financial Enterprises in the Interbank Bond Market (Order of PBOC  No 1), and Announcement of the Publication of Issuance Guidelines for Asset-Backed Notes Issued by Non-financial Enterprises and the Registration Documents and Forms of Public Offerings of Asset-Backed Notes by Non-financial Enterprises (Announcement of NAFMII  No 27).
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The securitisation market in the PRC comprises four parts: the credit loan-backed market, supervised by the People’s Bank of China (PBOC, the Chinese central bank) in conjunction with the China Banking and Insurance Regulatory Commission (CBIRC); the stock exchange asset-backed securities (ABS) market, supervised by the China Securities Regulatory Commission (CSRC); the insurance asset-backed securities market, supervised by CBIRC; and the asset-backed notes market, supervised by the National Association of Financial Market Institutional Investors (NAFMII).
Some practitioners mistakenly regard the real estate investment trust (REIT) as one kind of ABS. Many companies holding real estate raised a large amount of funds by issuing REIT-like products under the guise of REITs in 2018 and 2019. However, the basic logic and functions of REITs are apparently different from ABS. Although no substantial progress was made in terms of legislation in 2019, the relevant regulatory authorities recognised the difference between REITs and ABS. It is expected that relevant regulations with regard to REITs may be promulgated in 2020, and that such regulations can establish the correct concept of REITs for the market.
Regulations for the Asset Securitisation Market
The most significant development in 2019 was the issuance and implementation of industry self-discipline rules for due diligence in the securitisation market. On 26 June 2019, CSRC issued three guidelines on due diligence exercise in the areas of PPP projects, financial leasing and company receivables, applicable to ABS traded on the Chinese stock exchanges. For example, the guideline on company receivables requires due diligence on each receivable, if the number of receivables to be injected into the pool is less than 50, or on a sampling basis by selecting no less than 5% (50 as the minimum) of such receivables if the number is between 50 and 10,000, or no less than 0.5% (200 as the minimum) if between 10,000 and 100,000, or at a discretionary percentage subject to the features of receivables and the sampling system (300 as the minimum).
These guidelines also require law firms, accounting firms and credit-rating agencies to focus on the underlying transaction contracts that generate the receivables, for the purpose of verifying the genuineness and validity of such receivables, as well as to check the cash flow process with an aim to setting up a closed, independent collection mechanism. Failure to comply with these guidelines in terms of due diligence will result in public censure or even disqualification from engaging in the stock exchange ABS market.
CSRC further issued a Q&A on 19 April 2019, clarifying the scope of securitisable assets. This is the first step to confine the scope of future receivables serving as qualified receivables to build up the foundation of securitisation transactions. For example, the Q&A confirms that future receivables to be generated by municipal facilities (such as supply of gas, electricity, water and heating, disposal of waste water and wastes), transportation facilities (such as highway, railway and airports) and public services (such as occupational education and healthcare) may be securitised, but such future receivables arising from non-exclusive or non-monopoly rights (such as the ticket revenues of parks or cinemas) shall not be qualified.
In terms of information disclosure, NAFMII (upon the authorisation of PBOC) issued information disclosure guidelines on consumer loan-backed securitisation transactions on 1 February 2019. This supplements the information disclosure requirement on this type of products which adopt a revolving structure for the loan receivables pool.
Legal Rules and Court Practice
During the past 15 years, practitioners in the PRC securitisation market have been troubled by the issue of whether the mortgage registration securing the underlying loan assets should be changed under the name of the SPV issuer when such loan assets are so transferred. As a matter of practice, sponsors did not carry out such mortgage registration change. Even if a sponsor intends to do so, the IT system of mortgage registrars could not support a large-scale change of mortgage registration over a short time, especially when thousands of underlying loan assets (for example, in RMB mortgage-backed securities) are involved.
In November 2019, the Supreme People’s Court issued a judicial policy paper, outlining the latest judicial attitude in this regard. It provides that the courts will not support the defence of one mortgagor on the ground that, after the transfer of secured debts, the assignee is not a party to the mortgage contract or has not changed the mortgage registration to the assignee’s name. This is the first time that the judicial policy has clarified that the mortgage right may not need to be updated for registration purposes when it is transferred together with the secured debt to a new assignee or transferee. It is understood that the PRC Civil Code, which is expected to be promulgated in 2020, will include a similar rule indicating that there is no need to change the mortgage registration if the mortgage right is transferred together with the secured debt.
Interestingly, there were a few cases in 2019 involving the question of how to define and treat the cash flow generated by the underlying assets in securitisation transactions. In a typical case, the defendant had securitised the future receivables (such as rentals) to be generated by the underlying assets. When the defendant defaulted in another financing deal, its creditor sued the defendant and applied to the competent court to freeze the collection account of the defendant that was used to collect the cash flow from the underlying assets for the securitisation transaction. Since the defendant had not become bankrupt, the relevant court rejected the creditor’s application by confirming that the cash flow paid or payable into such collection account had already been earmarked for the securitisation transaction’s purpose. This is a good sign to support the collection account arrangement and the segregation from the sponsor’s own credit risk. However, it is still unclear whether and to what extent such arrangement and segregation can be used to defend the claims of a liquidator in the event that the sponsor becomes bankrupt. This issue remains outstanding and is worthy of further exploration.
Regulations on the Credit Rating of ABS
On 26 November 2019, the PBOC, the National Development and Reform Commission, the Ministry of Finance of the PRC and the CSRC jointly promulgated the Provisional Administration Measures for Credit Rating Industry (Credit Rating Measures), which so far has the supreme legal authority in the regulation of the credit-rating industry in the PRC. The Credit Rating Measures became effective on 26 December 2019 and applies to the credit rating of structured financing products such as ABS. According to the Credit Rating Measures, the credit-rating agencies shall comply with the principle of independence, objectivity, justice, and prudence, diligent and responsible and operating with integrity. It prescribes that the credit-rating agencies shall update constantly and disclose promptly the credit-rating method, mode and critical assumptions of the structured financing products such as ABS, in accordance with Article 44 of the Credit Rating Measures.
In respect to regulating the conflict of interests between the credit-rating agencies and rating target, the Credit Rating Measures makes provisions mainly from the perspectives of independence and prohibited behaviour instead of using wording such as “conflict of interest”. In terms of independence, in addition to restrictions on the connected relationship between credit-rating agencies and rating target, the Credit Rating Measures requires credit-rating agencies to establish an avoidance system for the credit-rating personnel.
Furthermore, the NAFMII promulgated the Administrative Rule on the Conflicting Interests of the Credit Rating on Debt Financing Instruments of the Non-Financing Enterprise in Interbank Bond Market (the Rule) on 10 October 2019, which is the self-discipline rule on the prevention of conflicting interests among credit-rating agencies. According to the Rule, if an employee resigns from the credit-rating agency and then is employed by the rating target, the entrusting party for rating, or the lead underwriter of bonds who was involved in the credit rating, then the credit-rating agency should examine whether such employee’s credit-rating work related to the hiring agency is affected by any conflict of interest.
Loan Prime Rate (LPR) Replaces Benchmark Interest Rates of Loan
On 16 August 2019, the PBOC promulgated Announcement  No 15 of the PBOC, deciding to reform and improve the formation mechanism of LPR and stop using the Benchmark Interest Rates of Loan announced by the PBOC as the benchmark for pricing. As from 20 August 2019, the PBOC authorised the National Interbank Funding Centre (NIFC) to announce the LPR at 9.30am on the 20th day of each month (postponed in the event of holidays). The coverage of the LPR is expanded from one variety of one-year LPR to two varieties – namely, one-year LPR and over-five-year LPR. The interest rates of banks' one-year and over-five-year loans shall be priced with reference to the LPR for corresponding maturities, and the interest rates of loans with a maturity of less than one year and between one and five years shall be priced by the banks by reference to the LPR varieties selected at their own discretion.
From the release date of the aforesaid Announcement No 15, the newly granted loans, other than housing loans for individuals, shall mainly refer to the LPR pricing and adopt the LPR as the pricing benchmark in the floating-rate loan contracts. The interest rates of the outstanding loans shall still be subject to the original contracts.
As for the interest rates of housing loans for individuals, the PBOC promulgated Announcement  No 16 on 25 August 2019, in which the PBOC determined that – starting from 8 October 2019 – the interest rate of newly-disbursed personal commercial housing loan shall be formed by adding certain base points to the pricing benchmark of the LPR of the corresponding loan term in the latest month, with the base points to be added remaining fixed within the loan contract period. According to the aforesaid Announcement  No 16, personal commercial housing loans that have been disbursed before 8 October 2019, together with personal commercial housing loans that have not been disbursed but for which contracts have been signed before 8 October 2019, shall still be governed by their original contracts.
The change frequency of the Benchmark Interest Rates of Loan issued by the PBOC is extremely low. Therefore, the floating-rate-backed securities based on the asset pool of floating-rate loans are not much different from the fixed-rate bonds in the past. Neither the issuers nor the investors of the ABS are sensitive to the interest rate risk. With the reform of the LPR, whether it is CLO or RMBS, whether it is ABS of automobile loan or ABS of financial rental assets, the management of the interest rate risk by the issuers and the investors will become increasingly urgent, and the interest rate swap instrument will increasingly be used in the ABS market.
Considering that the PBOC has not yet made clear when the Benchmark Interest Rates of Loan will be cancelled, or the pricing policy on the outstanding floating-rate loan after such possible cancellation, at this stage it is still difficult to pinpoint the influence with regard to the reform of the LPR on the outstanding ABS.