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. For a "credit asset securitisation" or a "trust-type asset-backed note" transaction (the structure of which is elaborated in 8.2 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 provided 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 the transfer of the underlying assets constitutes a true sale or a financing guarantee is a decisive factor in determining the underlying assets’ remoteness from the originator’s bankruptcy risks.
Insolvency Laws for True Sale v Secured Loan
Pursuant to Article 30 of the Bankruptcy Law 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 the applicable laws, when the debtor enters into a bankruptcy proceeding, these assets shall be part of the debtor’s bankruptcy estate, but the secured party has a priority claim on the assets. Under Article 19 of the Bankruptcy Law, after a court accepts a bankruptcy petition, preservation measures pertaining to the debtor’s estate shall be lifted and enforcement procedures over the estate shall be suspended, which means the secured party must delay the exercise of security rights over the estate 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.
In China, the structures that a securitisation deal may adopt are limited to those defined under relevant regulations – only SPTs (for credit asset securitisations and trust-type asset-backed notes (ABNs) or asset-backed special schemes (for business asset securitisations) 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. In practice, investors may purchase various financial assets through private equity funds in the form of limited partnerships, but these transactions are classified as private equity fund business instead of standard securitisation, and so are subject to different laws and regulations. Therefore, when the settlor, trustee or manager of the SPT or special scheme goes bankrupt, there is no entity consolidation issue, but the current laws or regulations have made corresponding provisions on the property consolidation issue.
An asset-backed special schemeis set up by the scheme manager, who purchases the underlying assets from the originator on behalf of the investors. According to Article 5 of the Administrative Provisions on Asset Securitisation by Securities Companies and Subsidiaries of Fund Management Companies issued by the China Securities Regulatory Commission, the assets of special schemes are independent from the inherent property of the originator, manager, custodian and other business participants, and if the above-mentioned entities are subject to liquidation due to dissolution or revocation in accordance with law, or a declaration of bankruptcy or other matters, the assets of the special scheme do not belong to their liquidation property. Naturally, whether the assets of the special scheme can achieve bankruptcy remoteness from the originator also depends on whether the transfer of the assets from the originator to the special scheme can be recognised by the court as a true sale.
For the SPT, according to Article 15 of the Trust Law, the trust property differentiates from other property which the settlor has not entrusted; after the establishment of the trust, when the settlor is dissolved or revoked in accordance with law, or declares bankruptcy, if the settlor is not the only beneficiary, the trust survives and the trust property shall not be regarded as its estate or liquidation property. Meanwhile, according to Article 16 of the Trust Law, the trust property differentiates from the property owned by the trustee (inherent property), and if the trustee is dissolved or revoked in accordance with law, or declares bankruptcy, the trust property does not belong to its liquidation property. Based on the aforementioned provisions, in credit asset securitisations and ABNs that adopt the trust structure, the underlying assets are generally not consolidated with the bankruptcy estate of the originator or the trustee.
True Sale v Secured Loan
In China, the typical form of property security is the statutory mortgage, pledge and other means, with a clear security agreement between the guarantor and the creditor, which is different from a sales contract. In practice, there is an atypical kind of security called "security by transfer", whereby the debtor or a third party enters into a contract with the creditor to superficially transfer a property under the creditor’s name; if the debtor pays off the matured debt, the creditor shall return such property to the debtor or the third party; if the debtor fails to pay off the matured debt, the creditor could auction or sell the collateral, or be paid off with the collateral based on its estimated price. Due to the similarity in form, such transactions are easily confused with true sales. If the court determines that the purpose of the property transfer is security rather than a true transfer, it will decide following the security law.
Based on limited judicial cases, when deciding the nature of a deal a People’s Court 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 to overturn the explicit expressions of will of the parties to a contract.
Therefore, to achieve the target of a true sale and bankruptcy remoteness, at least the following factors need to be ensured in a transaction:
In some securitisation transactions, the originator may commit to make up for the difference between the income of the transferred underlying assets and the expectation, or to repurchase the underlying assets under certain circumstances (such as the deterioration of the transferor's business condition or a material breach of contract). No judicial case has yet indicated that these arrangements will affect the recognition of a true sale. However, with the increase in legal disputes related to asset securitisations, it remains to be seen how the judicial practice will evolve in respect of the standards for true sales.
"Internal Effect" and "External Effect"
Under PRC laws, the transfer of a creditor’s claim can have both an "internal effect" and an "external effect". The internal effect of the transfer refers to its effect in relation to the transferor and the transferee. In this regard, as long as the contract providing for the transfer of assets (transfer agreement) has come into effect and the preconditions of the transfer provided in the transfer agreement 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 546 of the Civil Code, any transfer of a creditor’s claim is invalid against the debtor unless the debtor has been informed. This means 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 the external effect of the transfer of a creditor’s claim can also extend to the effect on the creditors of the transferor and any third parties. Since China has not established a public notice system for the transfer of account receivables, such questions remain theoretically controversial and meet 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 PBOC's Credit Reference Center, the legal force of the registration is uncertain due to a lack of support in higher level law.
In addition, regarding the mortgage and pledge securing the creditor’s claim, as the transfer of such security interests often requires a change of registration or the 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 collateral on its own or in collaboration with the mortgagor/pledgor before such change of registration and transfer of possession could be effected, then the transferee is likely to lose its claim against the bona fide third party that obtains such collateral.
As mentioned above, certain perfection measures are required in order to make a transfer of financial assets definitively enforceable against the debtors, the transferor's creditors and bona fide third parties. These usually include notifying the debtors of the transfer, a change of mortgage/pledge registration, the transfer of possession of the pledged movables, etc. In business asset securitisations, to avoid a repeated transfer of underlying assets by the originator and a possible confrontation with the originator’s creditors, some transactions require the originator to conduct a transfer registration for account receivables in the registration and public notice system of the PBOC's Credit Reference Center after the delivery of the underlying assets. For more detailed analysis on right perfection measures, see 5.3 Principal Perfection Provisions.
Opinion of Counsel
In a securitisation transaction, a legal counsel is normally not required to issue an opinion on whether a transfer of the underlying assets constitutes a true sale. However, when legal counsel does issue an opinion on whether the underlying assets could achieve bankruptcy remoteness, it would consider the nature of such transaction and its effect on bankruptcy remoteness.
Since securitisation in China is still in the pilot phase, the transaction structures are relatively “fixed” under the relevant regulations. For now, bankruptcy remoteness can only be achieved through one of the two means mentioned under 1.3 Transfer of Financial Assets.
Potential taxes on the transfer of underlying assets are mainly 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 assets is not currently subject to VAT. Regarding 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. In practice, since the financial assets are usually transferred at parity or at a discount on their historical cost, usually no income tax is due on the transfer.
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. The Notice on Relevant Issues concerning Taxation Policies on the Securitisation of Credit Asset (Ministry of Finance  No 5) provides certain exemptions from stamp duties for credit asset securitisations, including exemptions for the transaction agreements and for the fund accounting books established for the trust. So far, there are no special tax exemptions for business asset securitisations.
In asset securitisations, the transfer of underlying assets to the SPVs does not generally give rise to a tax burden for the SPVs. On the other hand, income derived from the underlying assets by the SPVs might be subject to enterprise income tax and value-added tax.
In regard to credit asset securitisations, according to Ministry of Finance  No 5, if the trustee has allocated the income of the trust to institutional investors during the fiscal year, then the institutional investors shall pay the enterprise income tax on this income and, in order to avoid double taxation, no income tax needs to be paid by the trust. However, the unallocated trust income during the fiscal year shall be subject to enterprise income tax at the trust level. If the income allocated to the investors has already been taxed, then the investors do not need to pay the income tax thereon, to avoid double taxation.
According to the Enterprise Income Tax Law of the People's Republic of China, "enterprises" and “other income-earning organisations” shall pay the enterprise income tax. For other types of asset securitisation business, whether the SPV is an SPT or an asset-backed special scheme, neither constitutes an "organisation" under the law, and therefore neither is subject to enterprise income tax.
If the underlying assets are interest-bearing assets such as loans or financial leases, then the SPV will acquire rights to such interest or income after the underlying assets are transferred to it. According to the 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) and the Notice on the Relevant Issues concerning Value-added Tax Levied on Asset Management Products (Ministry of Finance  No 56), etc, the manager of the asset management products shall pay VAT at a rate of 3% on its taxable activities occurred in the operation of the asset management products. This rule also applies to securitisations. Nevertheless, if an asset securitisation transaction cannot be achieved off-balance sheet, the competent tax authority may require the originator to continue to pay VAT on the proceeds from the transferred underlying assets, which may result in the problem of double taxation. This problem arises due to the discrepancy between the economic substance and legal characteristic of such securitisation transactions, which may be treated differently by tax authorities in different regions, and thus requires the originator and the trustee to communicate with their competent tax authority in order to avoid double taxation.
The relevant parties in an overseas assets transfer shall follow the general tax regulations on the transfer of financial assets. Generally, if the transfer of assets constitutes a true sale, the foreign SPV has not acquired income as transferee during the transfer and the foreign investors have not acquired any income from China, then the transfer will not give rise to any withholding tax 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 the payment of withholding tax will be an issue.
Additionally, a Chinese originator who sets up a conduit company for securitisation for tax avoidance purposes may be subject to an anti-tax avoidance investigation. The Enterprise Income Tax Law of the People's Republic of China and the Measures for the Administration of General Anti-Tax Avoidance (Trial Implementation) (Order of State Administration of Taxation No 32) have established the general anti-tax avoidance system, according to which a conduit company may be subject to an anti-tax avoidance investigation by the tax authorities for suspected abusive use of the corporation form and tax havens in order to avoid taxes. 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.
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. To alleviate the tax burden on the originator or their affiliates, direct transfers of real estate are generally avoided in favour of transfers of equity rights in the company that holds the real estate 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 the consolidation of an SPV and a true sale is, to some extent, based on the economic essence of the transaction reflected in the terms of the transaction agreements. According to the Accounting Standards for Business Enterprises No 33, 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. According to the Accounting Standards for Business Enterprises No 33, factors to be taken into consideration when determining whether the originator can de-recognise certain financial assets include whether or not the originator has transferred almost all the risks and rewards relating to the ownership of the financial assets to the transferee, including whether the originator has transferred the rights to collect the cash flow and, if not, whether it has undertaken to pass on the cash flow of the financial assets. 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 an inspection of the advance payment and reimbursement by the servicer, investment of idle funds, frequency of cash flow allocation, and other transaction arrangements.
For 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. 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 also 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 transferred credit assets have achieved bankruptcy remoteness from the originator.
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 securitisations mainly follows the rules published by the PBOC, including the Rules for the Information Disclosure of Asset-Backed Securities (Announcement of PBOC  No 14) and 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 shall mainly follow Administrative Measures for Debt Financing Instruments of Non-Financial Enterprises in the Interbank Bond Market (Order of PBOC  No 1) published by the PBOC, and the rules published by NAFMII in relation to information disclosure, such as the Rules for Information Disclosure on Debt Financing Instruments of Non-Financial Enterprises in the Interbank Bond Market (2017) (Announcement of NAFMII  No 32), the Guideline on Asset-Backed Notes by Non-Financial Enterprises and the Registration Documents and Forms for the Public Offerings of Asset-Backed Notes by Non-Financial Enterprises (Announcement of NAFMII  No 27), and the Registration Documents and Forms for Private Offerings of Asset-Backed Notes by Non-Financial Enterprises (2018 Trial Implementation).
Information disclosure regarding business asset securitisations shall primarily follow the Administrative Provisions on Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of CSRC  No 49) and the Disclosure Guidelines for the Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of CSRC  No 49). Based on these provisions, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) have respectively published disclosure guidelines for different types of underlying assets, including the Disclosure Guidelines on Financial Lease Claim Asset-Backed Securities, the Disclosure Guidelines on Public-Private Partnership Project Asset-Backed Securities, the Disclosure Guidelines on Account Receivable Asset-Backed Securities and the Disclosure Guidelines on Infrastructure Asset-Backed Securities. In addition, in respect of periodic reports and interim reports, the SSE and SZSE respectively issued the Guidelines on the Content and Format of Periodic Report of Asset-Backed Securities and the Disclosure Guidelines on Interim Report of Asset-Backed Securities, which stipulate in detail the relevant periodic reporting and interim information disclosure requirements in a business asset securitisation.
There is no general disclosure law that applies to all securitisation products, but the rules that apply to each different product share some common aspects.
Laws and Regulations on Credit Risk Retention
Following the global financial crisis in 2008, in May 2012 the PBOC, China Banking Regulatory Commission (CBRC) and Ministry of Finance jointly issued 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) 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. The risk retention rule was criticised by the market for being too strict. Subsequently, in December 2013 the PBOC and CBRC made adjustments to the risk retention rules with the 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 (ABS) 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 China Securities Regulatory Commission (CSRC) is concerned, no compulsory requirement on risk retention is stipulated in the general rules. However, since the end of 2017, the SSE and SZSE have issued guidelines on the confirmation of eligibility for the listing of ABS backed by financial lease debt claims, account receivables of enterprises, etc, which clearly stipulate the requirement on risk retention. However, the applicable rules for different types of underlying assets are slightly different.
There are currently no compulsory requirements on risk retention regarding ABNs, but if the fund-raising party chooses to retain the risk then such arrangements will generally be disclosed in the offering documents.
Regulation and Enforcement
The risk retention rules for credit asset securitisation are formulated by the PBOC and the China Banking and Insurance Regulatory Commission (CBIRC). The risk retention rules for business asset securitisations are formulated by the SSE and SZSE, authorised by the CSRC. The issuing/listing supervisory authorities will generally review the risk retention arrangements. 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 obtain the pre-issuance approval/registration or confirmation of listing.
Penalties for Non-compliance
Currently, there are no explicit rules relating to penalties for violations of the risk retention requirements, but the relevant regulatory authorities can take regulatory measures such as issuing an order to correct, a warning letter, and an order for public explanation, etc.
Requirements about Periodic Reporting
In a credit asset securitisation, the trustee shall provide reports when the payments on the securities are made, and on an annual basis, for the life cycle of the securities. These reports must disclose the status of the asset pool in relation to the securities, and provide information on 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), the 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, 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, and it must include the target products, the condition of the originator and underlying assets, and the analysis of cash flow and macro policy.
In a business asset securitisation, the scheme manager is required to disclose the income distribution report before each payment date of the securities to the qualified investor, throughout the life cycle of the ABS; 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 monitoring report must also be disclosed annually, including information on the change in the underlying assets, the 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.
The SSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities and the SZSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities stipulate the compilation of and 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.
Regulators and Penalties for Non-compliance
The disclosure of trustee reports in credit asset securitisations and ABNs is subject to self-regulatory management by NAFMII and supervision by 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 the Asset Management Association of China (AMAC), and to supervision by the CSRC and its local counterparts.
In relation to credit asset securitisations and ABNs in the Interbank Bond Market, NAFMII may impose self-regulatory sanctions on non-compliant information disclosers. These include public denouncements, orders to correct, public denouncements of the relevant responsible persons and orders for the relevant responsible persons to participate in mandatory training at NAFMII on information disclosure, etc. In serious cases, NAFMII may suspend the relevant business operation. If the non-compliant act is suspected of violating the laws and regulations, NAFMII shall hand the matter over to the relevant authorities, including the PBOC.
For misconduct in the disclosure of information regarding business asset securitisations, the CSRC and its local agencies may impose regulatory measures such as orders to correct, issuing warning letters, orders for public explanation and orders to make periodic reports, etc. 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, etc. AMAC may conduct regular or ad hoc on-site and off-site self-regulatory investigations 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, etc, depending on the seriousness of the case. In addition, according to the self-regulatory rules of the SSE and SZSE, the securities exchange may record disclosure violations in credit files, and may prudently accept and process the subsequent application or documents submitted by the relevant parties.
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 (SROs). The substantive regulations may be divided into the following three categories:
The rules vary depending on the rated product and market concerned. The Chinese regulators have started to permit foreign RAs to provide rating services via their local branches or subsidiaries. In 2018, three rating agencies – Moody's, Fitch and S&P – established Chinese subsidiaries, among which S&P Ratings (China) Co, Ltd. and Fitch (China) Bohua Credit Ratings Limited have been officially admitted to provide credit rating services in 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 the PBOC, which is responsible for the supervision of credit rating business across the country, and has the authority to formulate the market entry principles and fundamental rules; the latter refers to the National Development and Reform Commission, the Ministry of Finance and the CSRC, which regulate 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, impose administrative sanctions such as fines, suspension of business, revocation of business approval, etc, or impose regulatory measures such as issuing a directive to correct, a warning letter, a directive to make public explanation, a directive to attend training, a directive to make regular reports, etc.
Applicable Capital and Liquidity Rules
The volume of risk-weighted assets will affect a commercial bank’s capital adequacy ratios, and the securitisations that a commercial bank engages in will affect the measurement of its risk-weighted assets. 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, engaging in securitisation or investing in ABS will affect a commercial bank's liquidity coverage ratio or high-quality liquid asset adequacy ratio, net stable funding ratio and liquidity gap ratio. The Measures for Administration of Liquidity Risk of Commercial Banks do not include RMBS as high-quality liquid assets (HQLA).
According to the Administrative Measures for Risk Control Indicators of Securities Companies (2020 Revision) and the Provisions on the Calculation Standard for Risk Control Indicators of Securities Companies (2020), securities companies shall calculate the risk control indicators such as net capital, risk coverage ratio, capital leverage ratio, liquidity coverage ratio, net stable funding ratio, etc, in line with the principles of prudence and substance over form. Securities companies shall set aside capital reserves for ABS held according to the measurement standard provided by the CSRC; in measuring indicators such as liquidity coverage ratio and net stable funding ratio, different measurement factors shall be applied to ABS of different ratings.
The most important regulatory indicator for insurance companies 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 ABS of different outside ratings in which such an insurance company has invested.
Regulation of Capital for Securitisation
In respect of traditional securitisation transactions, the sponsor may deduct the securitised assets from the calculation of risk-weighted assets if:
As for the capital measurement of securitisations, Annex 9 of the Measures for Administration of Capital of Commercial Banks (Trial Implementation) – Rules on Risk Weighted Asset Measurement in Securitisation provides for two rating approaches: the standardised approach and the internal ratings-based approach.
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. Taking the long-term ratings as an example, the corresponding risk weights of securitisation exposures are as follows:
If a securitisation risk exposure is not rated, or if the rating is not admitted by the commercial bank 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 that have external ratings or 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 that 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%.
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 are mainly 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, while the latter is 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 NAFMII, the SAC, AMAC, the SSE and the SZSE. Due to various reasons (including transaction party qualifications and transaction cost, etc), they have only been utilised for a few products.
Due to lack of strong demand, interest rate swaps are also seldom used in current securitisation transactions. In addition, currency swaps may be used in cross-border securitisation transactions. A body of rules promulgated by the PBOC, the China Foreign Exchange Trade System (CFETS) and the National Interbank Funding Centre are applicable to interest rate swaps and foreign currency 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 licences 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 PBOC's applicable rules participants in the interbank market engaging in derivatives trading shall also be enrolled with NAFMII as members of the interbank market, and must execute the master agreement prepared and published by NAFMII.
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, while the State Administration of Foreign Exchange (SAFE), under the authorisation of the PBOC, supervises and manages the forward exchange market. Other than that, NAFMII is authorised by the PBOC to conduct self-regulatory administration over members of the interbank market and the transactions carried out therein; the CFETS provides services related to transactions carried out by members of the interbank market, and conducts day-to-day monitoring of transactions under the authorisation of the PBOC.
Banking financial institutions engaging in derivatives trading activities without approval will be subject to administrative sanctions including confiscation, fine, suspension of business and revocation of business licence, etc, by the CBIRC. 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.
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 and the Securities Investment Fund Law of the People's Republic of China, etc, as well as various securitisation regulations. These laws and regulations cover matters such as investor qualifications and limits on the number of investors (see 4.14 Entities Investing in Securitisation), due diligence, credit risk retention (see 4.2 General Disclosure Laws or Regulations) and market trading rules, as well as information disclosure (see 4.1 Specific Disclosure Laws or Regulations) and many other aspects.
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 investor protection is the due diligence requirements for the relevant intermediaries, with the more detailed regulations being within the realm of business asset securitisations. In November 2014 the CSRC issued the Guidelines for Securities Companies and Subsidiaries of Fund Management Companies on Due Diligence for Asset Securitisation, specifying the scheme manager as the overall responsible party for due diligence, and proposing the relevant due diligence requirements. In June 2019, AMAC promulgated three detailed guidelines to specify the requirements for due diligence on the securitisation of financial leases, public-private partnership (PPP) projects and account receivables.
Two kinds of authorities are in charge of the implementation of the investor protection mechanism.
Commercial banks as originators will be subject to the same regulatory measures on credit asset securitisations, along with other financial institutions under the supervision of the 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.
Securitisations in China mainly include credit asset securitisations, business asset securitisations (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) stipulates that the SPV for credit asset securitisations shall be an SPT. The Guidelines on Asset-Backed Notes by Non-Financial Enterprises (Announcement of the NAFMII  No 27) stipulates that the SPV for ABNs shall be an SPT, a special-purpose company or another special-purpose vehicle approved by 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.
In regard to business asset securitisations, the Administrative Provisions on Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of CSRC  No 49) stipulates that the SPV shall be an asset-backed special scheme or other special-purpose vehicle 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 Civil Code are also applicable. The asset-backed special scheme is essentially a contractual relationship rather than an independent entity. Since the Company Law and the Bankruptcy Law do not contain any rules on special-purpose companies, China does not currently have a precedent of adopting a special-purpose company as the SPV in securitisations.
At present, the main difference between the various types of SPVs used for securitisations lies in the qualifications of the scheme manager or the trustee. The trustee of an SPT shall be a trust company or other institution approved by the CBIRC. However, the CBIRC has not yet approved any institutions other than trust companies as trustees, and trust companies shall specifically apply for the trustee qualification for the special-purpose trust. Securities companies or subsidiaries of fund management companies usually serve as the scheme manager 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 institutions 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 forms not specified in the regulatory rules will not be adopted. Non-financial companies can choose to issue ABNs in the Interbank Bond Market, or to conduct business asset securitisations 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.
Except for standard securitisation products, financial institutions such as trust companies, commercial banks, securities companies and others have also designed some asset management products in reference to ABS, which are called “quasi securitisation transactions” in the market and belong to non-standard products. Special regulations are applicable to “asset management products” and “non-standard products” in China; however, the aforementioned credit asset securitisations, business asset securitisations and ABNs are explicitly exempted from such regulations. Activities of the relevant SPEs are mainly confined by the relevant pilot rules and generally applicable laws.
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 include over-collateralisation, securities classification, cash collateral accounts, spread accounts (or cash reserve accounts), etc. Forms of external credit enhancement include shortfall payment commitments, third-party guarantees, 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 – 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.
Credit asset securitisation products and ABNs are traded in 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 are as follows:
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, and the scope of qualified investors thereof is basically the same as that of credit asset securitisations.
In addition to the restrictions on commercial banks’ investment in the securitisation products discussed in 4.9 Banks Securitising Financial Assets, the current regulatory restrictions on securities investments by different types of qualified investors also include the following:
In credit asset securitisations, the transfer of assets while maintaining bankruptcy remoteness is achieved through the provisions of the "trust agreement". The trust property is independent and will not be affected by the bankruptcy of the settlor and the trustee, which meets the requirement of risk insulation in securitisation. Meanwhile, the trust can achieve limited recourse – both the settlor’s and the trustee’s liabilities to the beneficiaries are limited to the trust property. The trust agreement is one of the core transaction documents in credit asset securitisation transactions, and its main provisions include the following:
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 following:
"Asset warranties" refer to the representations and warranties on the underlying assets of the originator as of a specific date or time of the securitisation project (such as the cut-off date, the effective date of the trust or the special scheme). 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.
Considering factors such as facilitating the collection of the assets and reducing transaction costs and others, right perfection measures are not normally required to be taken at the delivery of the underlying assets, and are only required upon the occurrence of right perfection events provided in the transaction documents.
Right perfection events usually include but are not limited to the situations in which:
After the occurrence of right 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:
If the underlying assets are secured by a mortgaged or pledge, and the corresponding mortgage or pledge is required to be registered in accordance with Chinese law, the asset seller or the originator must conduct the transfer registration of the mortgage or pledge promptly after the occurrence of a right 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 asset seller or the originator must deliver the pledged assets or their title documents to the scheme manager or the trustee promptly upon the occurrence of a right perfection event.
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 to be in default of the contract and liable for indemnities and other liabilities upon breach of any covenant.
The contents and conditions of the 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 if any of its representations, warranties and commitments under the servicing agreement is materially false, inaccurate or misleading, the servicer is deemed to be in default and becomes liable for the breach of contract and shall continue to perform, take remedial measures and/or compensate for loss. Meanwhile, the servicer’s obligations regarding the underlying assets are generally limited to those agreed upon in the servicing agreement, which does not provide any guarantee or assurance for the collections.
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 compensate for loss. Specifically, in terms of the originator and the trustee, it is generally specified in the trust agreement that the ABS are not liabilities of the originator or the trustee, and the investment institutions’ right of recourse is only limited to the trust property; however, the liability for compensation of the originator or the trustee in the event of default under the trust agreement is not limited by the aforementioned provisions.
In credit asset securitisations, the issuers are SPTs (represented by the trustee of the SPT). In business asset securitisations, 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 entrusts the underlying assets to the trustee to set up an SPT, and the SPT (represented by the trustee), acting as the issuing vehicle, issues the ABNs (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 securitisations, the issuer or the issuing vehicle manager shall be a trust company with the SPT trustee qualification approved by the CBIRC. For business asset securitisations, the issuer shall be a securities company (or a subsidiary of a securities company) or a subsidiary of a fund management company with the qualification for client asset management business approved by the CSRC. Recently, trust companies have been admitted as scheme managers as well. For ABNs, if the issuing vehicle is an SPT, the trustee acting as the issuing vehicle manager shall be a trust company with the SPT 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.
In credit asset securitisations, business asset securitisations and trust-type ABN business, the issuer 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:
In the relevant Chinese securitisation regulations, the sponsor is generally the originator of the securitisation. According to the relevant regulations, in credit asset securitisations the sponsor is the financial institution that transfers the credit assets through the establishment of an SPT. In ABNs, the sponsor is a non-financial enterprise engaging the ABN business for financing purposes. In business asset securitisations, the relevant regulations do not have the concept of "sponsor", but the entity that transfers the underlying assets to the special scheme manager is referred to as an "originator"; in practice, the concepts of "sponsor" and "originator" are often interchangeable.
In terms of credit asset securitisations, 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 securitisations, 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. In terms of ABNs, the sponsor (originator) can only be one of 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, redeeming or replacing the ineligible underlying assets, co-ordinating and supporting the issuing vehicle manager and related intermediaries in performing their duties, and providing relevant disclosure information to the issuing vehicle manager 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 account 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 underwriter or placement agent is the organisation responsible for the sale of the ABS. Its general duties include the promotion and sale of the ABS, organisation of the underwriting syndicate, presiding or participating in the bookbuilding or bidding procedure of issuance of the securities, collection of issuance proceeds of the securities, etc. The lead underwriter normally acts as the transaction arranger or financial adviser, taking the lead in the design of the transaction structure, the co-ordination of the progress of the project participants, filing with the regulatory authorities and other matters. The underwriters are generally domestic financial institutions that meet certain requirements on registered capital, sales capacity, etc, and are mainly banks and securities companies, as well as foreign-owned banks registered in China. Regarding ABN projects, in addition to banks and securities firms, trust companies can also act as underwriters of the notes.
For securitisations in China, servicers are generally also the originators of the underlying assets, or their affiliates. Certain kinds of securitisation (such as commercial mortgage-backed securities – 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 underlying assets 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 ABS generally do not actively participate in the management of the SPV, but passively collect the principal and returns on the ABS. The investors can only participate in the security-holders' meeting and vote in situations where the investors’ rights might be affected. The main obligations and responsibilities of the investors include paying the subscription price in accordance with the terms of the subscription agreement, complying with the relevant laws and regulations and the provisions on the trading of ABS in the transaction documents, complying with the provisions on the exercise of rights, and maintaining confidentiality regarding trade secrets. At present, investors in China's securitisation market are generally 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 6.1 Issuers, Chinese securitisation practice mainly adopts two forms of issuing vehicles: the SPT and the asset-backed special scheme. These are not independent legal entities but are represented by the trustees or scheme manager, so the issuer often overlaps with the trustee. The entity type and main obligations of the trustees are described in 6.1 Issuers. 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 the following:
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 currently explicitly prohibited. 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 real economy.
Regulatory authorities require that the underlying assets of a credit asset securitisation must be "credit assets". The common underlying assets of credit asset securitisations 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.
Common underlying assets of business asset securitisations include petty loans, financial lease debt claims of non-financial institutions, rights of returns related to infrastructure and public utilities, various kinds of account receivables, commercial mortgage loans, lending fund claims, trust beneficial rights, etc. According to the regulatory Q & A issued by the CSRC in April 2019, 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.
The scope of underlying assets of ABNs is similar to that of business asset securitisations. However, whether future account 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 asset, it may be more suitable to adopt the structure of pledge-type ABNs, without employing a trust structure.
Credit Asset Securitisation
The basic transaction structure of a credit asset securitisation has been clearly stipulated in the Administrative Measures for the Securitisation of Credit Assets, and is therefore relatively fixed, as follows:
The laws and regulations that have a material effect on the transaction structure of credit asset securitisations include the Civil Code 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 Supervising and Administrating the Pilot Securitisation of 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 by the General Office of the China Banking and Insurance Regulatory Commission on Issues Concerning Information Registration of Credit Asset Securitisation of Banking Financial Institutions (Order of General Office of CBIRC  No 99) and the Announcement on Issues Concerning the Administration of the Issuance of Credit Asset Securities (Announcement of the PBOC  No 7).
Business Asset Securitisation
The basic transaction structure for a business asset securitisation is as follows:
The laws and regulations that have a 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 Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of 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 transaction structures for ABNs: trust-type ABNs and pledge-type ABNs. Since the latter structure is rarely used today, only the first transaction structure is introduced below:
The laws and regulations that have a material effect on the transaction structures of 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 Guidelines for Asset-Backed Notes by Non-Financial Enterprises and the Registration Documents and Forms for the Public Offerings of Asset-Backed Notes by Non-Financial Enterprises published by NAFMII.
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From the legal perspective, 2020 was the most important year in the history of China’s securitisation market. On 1 March 2020, the most recently revised Securities Law promulgated by the National People’s Congress (hereinafter referred to as “the new Securities Law”) came into effect. This amendment unequivocally provides that the general principles of the new Securities Law are applicable to the offering and trading of asset-backed securities. On 28 May 2020, the National People’s Congress deliberated and passed the Civil Code of the PRC, which will come into force on 1 January 2021. The Civil Code has made substantial amendments to several important legal matters involved in asset-backed securitisations, such as the assignment of creditors’ rights, the registration of security interests and types of transferable debt. Another milestone in 2020 was the efforts of the China Securities Regulatory Commission (CSRC) and the National Development and Reform Commission (NDRC) to promote the development of China’s REITs market by virtue of asset-backed securities. However, on the current pilot programme, the only REITs product available for offering is the infrastructure-based REIT.
Integration between the New Securities Law and the Legal System of China’s Asset-Backed Securities
China’s asset-backed securities market has evolved into three parts: credit asset-backed securities, exchange asset-backed securities and asset-backed notes. Credit asset-backed securities, such as collateralised loan obligations (CLO) and residential mortgage-backed securities (RMBS), are securitisations of credit assets from commercial banks, financial leasing companies, auto finance companies and other financial institutions. Exchange asset-backed securities are supported by future cash flows and accounts receivable generated by the underlying assets of companies other than financial institutions. They are mostly traded in the Shenzhen Stock Exchange and the Shanghai Stock Exchange, subject to the regulations of the CSRC; as a result, they are usually referred to as “exchange asset-backed securities”. The asset-backed notes are regulated by National Association of Financial Market Institutional Investors (NAFMII). There is not much difference between asset-backed notes and exchange asset-backed securities, except that the asset-backed notes are traded in the Chinese interbank market and governed by the People's Bank of China. According to the Rules for Identification of Standardised Debt-Based Assets issued by the People's Bank of China on 3 July 2020, the insurance asset-backed securities regulated by the former China Insurance Regulatory Commission are no longer viewed as asset-backed securities.
These three asset-backed securities are currently governed by different laws and regulations. The basic rules for the offering and trading of credit asset-backed securities are the Administrative Measures on the Pilot Programme for Securitisation of Credit Assets (promulgated by the People's Bank of China and the former China Banking Regulatory Commission in 2005) and the Measures for the Supervision and Administration of the Pilot Programme Securitisation for Credit Assets of Financial Institutions (promulgated by the former China Banking Regulatory Commission in 2005). The basic rules for the offering and trading of exchange asset-backed securities are the Administrative Provisions on Asset Securitisation of Securities Companies and Subsidiaries of Fund Management Companies (promulgated by the CSRC in 2014). The basic rules for the offering and trading of asset-backed notes are the Guidelines on Asset-backed Notes of Non-financial Enterprises issued by NAFMII in 2017.
It seems that the three market segments developing independently has played a positive role in promoting the development of China's asset-backed securities market in the short term. However, in the long term, it is likely to make the securitisation laws and regulations more complicated, and may even lead to regulatory arbitrage, which will cause market disruptions, especially with regard to the deterrence of international investors from China's asset-backed securities market. According to the new Securities Law, asset-backed securities, like stocks and bonds, shall comply with the new Securities Law, Article 2 of which specifically authorises the State Council to enact administrative measures for the offering and trading of asset-backed securities in accordance with general principles of the new Securities Law. The arrival of a uniform set of rules applicable to all three asset-backed securities market segments is eagerly awaited.
Huge Influence of the Civil Code of the People’s Republic of China
There is no doubt that the enactment of the Civil Code is the greatest national legislature scheme to date. On the date of implementation of the Civil Code, the Uniform Principles of the Civil Law, General Rules of the Civil Law, Contract Law, Property Law and Guaranty Law will be replaced, and some new legislation that has a great impact on asset-backed securities will also take effect.
Notice to Obligor of Assigned Creditors’ Rights, Obligor’s Consent to Assignments of Creditors’ Rights and Offsetting
Article 79 of the Contract Law provides that the creditor may assign its contractual rights to a third party in whole or in part, unless the parties have agreed that the rights may not be assigned. Therefore, in practice, a large number of account receivables cannot be assigned or securitised, because large-scale Chinese enterprises as obligors would usually stipulate in relevant contracts that their creditors shall not assign to any third party the accounts receivable arising out of sales of goods. In order to help more small and medium-sized enterprises to better engage in account receivables financing, Article 545 of the Civil Code provides that “where the parties agree that the monetary claims shall not be assigned, such an agreement shall not be enforceable against a third party.” This leaves the door open for the corporate asset securitisation business of account receivables.
Article 80 of the Contract Law provides that the assignment “shall be notified to the obligor” and that “the assignment shall have no effect in relation to the obligor” where such notification is not provided. This article has caused great confusion to the assignors of creditors’ rights. From the perspective of encouraging assignments of creditors’ rights and promoting asset liquidity in the market economy, Article 546 of the Civil Code no longer requires the obligor to be notified of any assignment of creditors’ rights, and only provides that “where the creditor assigns its claims without notifying the obligor, such assignment is not binding on the obligor.”
Pursuant to Article 546 of the Civil Code, the assignment has no legal effect between the obligor and the assignor, nor between the obligor and the assignee where the assignment is not notified to the obligor, but is effective between the assignor and the assignee – ie, the assignee obtains the creditors’ rights even if the assignment is not notified to the obligor. However, it should be noted that the defences and rights of offset that the obligor could assert against the assignor remain available against the assignee. In particular, Article 549 of the Civil Code provides that “under any of the following circumstances, the obligor may assert offsetting against the assignee: … (II) the creditors’ rights of the obligor and the assigned creditors’ rights arise from the same contract.” This new right of offset is not embodied in the existing Contract Law. It may bring some new legal risks to the securitisation of ordinary leasing, financial leasing and account receivables after 2020.
Registration of Change of Security Interests
The provisions of the existing Property Law are ambiguous as to whether a change of the security interests holder must be registered when the creditors’ rights are assigned. Judges and legal scholars have different views on this issue. For the past 15 years, this question has been like the Sword of Damocles hanging over the head of the securitisation of security interests-attached assets. The Civil Code now completely solves the problem by providing that “the accessory rights obtained by the assignee shall not be affected only because the accessory rights are not registered for assignment or are not transferred for possession.” Commercial banks will not be required to register for the change of residential house or automobile mortgages when conducting businesses of credit asset securitisation like RMBS and securitisations of automobile mortgage loan beginning from 2021.
The Civil Code Recognises the Pledge and Factoring of Future Accounts Receivable
Before the promulgation of the Civil Code, there has been a heated dispute on whether future income derived from the supply of gas, power, water, heating and other infrastructure can work as the securitised assets. Article 440 of the Civil Code provides that “current and future account receivables” may be pledged, and Article 761 provides that a creditor of account receivables may “assign its current or future account receivables to the factor.” From the general understanding of the PRC’s legal system, the assets that can be pledged and factored are naturally transferable assets. Therefore, there seems to be no legal dispute on the legality of the transfer of future account receivables. This rule cannot be found in the existing Contract Law or Property Law. If the future revenue generated from the supply of gas, power, water, heating and other infrastructure can be treated as future account receivables and be securitised, the legal risks of such securitisation business could be resolved. However, the term “account receivables” is not defined in the Civil Code, and the securitisation of future account receivables also involves issues of bankruptcy law. Therefore, whether the securitisation of account receivables has a good prospect is yet to be seen.
The Pilot Programme of Infrastructure Real Estate Investment Trusts (REITs)
On 24 April 2020, the CSRC and the NDRC jointly released the Notice of the Work Related to Promoting the Pilot Programme of Infrastructure Real Estate Investment Trusts (REITs). On 6 August 2020, the CSRC issued the Guidelines for Publicly Offered Infrastructure Securities Investment Funds (for Trial Implementation). Since then, the pilot programme of Chinese-style REITs, based on US experiences, has officially started. During the pilot period, REITs are only allowed to purchase infrastructure assets such as toll roads, warehousing and logistics facilities, and data centres, and are not allowed to purchase commercial real estate such as commercial office buildings, shopping malls, apartments or hotels.
Chinese-style REITs take a more sophisticated approach than US REITs. According to the above-mentioned pilot rules, Chinese-style REITs adopt the product structure of "publicly offered funds plus infrastructure asset-backed securities". Under this special structure, an institution that has obtained the qualification for public offered fund managers can set up a REIT in the form of a unit trust, with an aim to raise funds from the public. Meanwhile, subsidiaries controlled by the aforementioned public offered fund manager or corporations controlled by the de facto controllers of the public offered fund manager, both with the qualification for issuing exchange asset-backed securities, will issue asset-backed securities to the REIT established by the public offered fund manager. The public offered fund manager then subscribes for all the asset-backed securities with the funds raised by issuing the REIT, after which the issuer of the asset-backed securities will use such subscription proceeds to purchase the entire equities of a company that holds one or more infrastructure assets. After completing the above transactions, the fund manager shall be in charge of the infrastructure projects proactively and allocate 90% of the amount available for distribution held by the REIT each year to investors.
Whether it is for fund managers or regulatory institutions of REITs, dealing with the complexity of Chinese-style REITs is definitely a formidable challenge. Some market participants with important influence have noticed the complex legal situation of the product structure of infrastructure-based REITs, and are calling on the State Council to enact a simplified set of REITs legal rules. Furthermore, they propose that various government authorities related to the regulation of REITs should co-operate to promote the amendment of the legal system in relation to tax, land and the transfer of state-owned assets.
The Opening-up of the PRC’s Assets Securitisation Market
The PRC’s asset-backed securities market was further opened to international players in 2020. According to public information, Standard & Poor's and Fitch (two of the top three rating agencies worldwide) have started to provide rating services for asset-backed securities in Mainland China through their wholly owned Chinese subsidiaries. According to the market’s reaction, these agencies' rating services have begun to cast a positive influence on the sale of asset-backed securities.