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) on 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 Enterprise 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.
If a debtor only creates security rights over certain assets then, according to the applicable laws, when the debtor enters into a bankruptcy proceeding, these assets shall be part of the debtor’s bankruptcy estate, but the secured party has a priority claim on the assets. Under Article 19 of the Bankruptcy Law, after a court accepts a bankruptcy petition, preservation measures pertaining to the debtor’s estate shall be lifted and enforcement procedures over the estate shall be suspended, which means the secured party must delay the exercise of security rights over the estate. In bankruptcy liquidation and bankruptcy settlement proceedings, while a secured party may make a claim to the administrator at any time to exercise the priority of compensation with respect to the disposition and liquidation of the security property, the administrator may decide to dispose of the security property with the rest of the bankruptcy estate as a whole if the disposition of such security property alone would reduce the value of the rest of the bankruptcy estate, and the disposition and distribution plan of the bankruptcy estate shall be approved by the meeting of creditors, which makes the exact timing of the realisation of the security rights ultimately uncontrollable. In the bankruptcy reorganisation proceeding, if there is any evidence proving that the security property is necessary for the reorganisation, and the administrator or the debtor can provide a corresponding guarantee or compensation, the People’s Court may rule not to approve the resumption of the exercise of the security right. Thus, in a secured loan transaction, a creditor’s right over the collateral will be affected by the debtor’s bankruptcy procedure in various aspects; in a true sale situation, by contrast, a transferor’s bankruptcy will not have any impact on the transferee’s exercise of rights over the underlying assets.
Currently, China’s Company Law, Securities Law, Bankruptcy Law and other laws and regulations fail to provide room for the development of SPVs in the form of special purpose companies and special purpose limited partnerships. The Trust Law was enacted in 2001, wherein the principle of trust property independence provided the legal basis for the pilot securitisation of credit assets that began in 2005. Therefore, in credit asset securitisations and trust-type asset-backed notes (ABNs) where a trust company serves as an issuer/issuing vehicle manager, SPTs are adopted. As for business asset securitisations on the securities exchanges, the initial issuers were limited to securities companies or subsidiaries of securities companies, and due to the separate operation of the trust industry and securities industry under the Chinese legal framework, SPTs are not adopted; instead, asset-backed special schemes are used.
Neither SPTs nor asset-backed special schemes (collectively referred to as SPVs) constitute legal 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 according to the contracts, and no operations or debts unrelated to the securitisation are allowed. The trustee or scheme manager may further engage the servicer, fund custodian and other institutions to provide services for the SPV.
An asset-backed special scheme is 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 (Announcement of the China Securities Regulatory Commission (CSRC)  No 49) (the Administrative Provisions on Asset Securitisation) 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, revocation or declaration of bankruptcy, the assets of the special scheme do not belong to the 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 an SPT, according to Article 15 of the Trust Law, the trust property is differentiated from other property which the settlor has not entrusted; after the establishment of the trust, when the settlor is dissolved, revoked or declares bankruptcy, 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, revoked 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 or pledge, with a clear security agreement between the guarantor and the creditor, which is different from a sales contract. In practice, there is an atypical kind of security called “security by transfer”, whereby the debtor or a third party enters into a contract with the creditor to superficially transfer a property under the creditor’s name; if the debtor pays off the matured debt, the creditor shall return such property to the debtor or the third party; if the debtor fails to pay off the matured debt, the creditor could auction or sell the collateral, or be paid off with the collateral based on its estimated price. Due to the similarity in form, such transactions are easily confused with true sales. If the court determines that the purpose of the property transfer is security rather than a true transfer, it will decide following the Security Law.
China is a country with a statutory law system, where a judge’s discretion is relatively limited. Based on limited judicial cases, when deciding the nature of a deal, a 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 Civil Code (ie, transfer of ownership versus consideration). The courts seldom use the equity principle to overturn explicit expressions of the 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:
A basic premise is implied in this type of transaction: that the underlying assets can legally generate steady cash flows which can match the payment of the securitisation products.
In some securitisation transactions, the originator may commit to make up for a shortfall in cash flows of the underlying assets compared to the predicted value, or to repurchase the underlying assets under certain circumstances (such as the deterioration of the transferor’s business condition or a material breach of contract). No judicial case has yet indicated that these arrangements will affect the recognition of a true sale. However, with the increase in legal disputes related to securitisation, it remains to be seen how judicial practice will evolve in respect of the standards for true sale.
“Internal Effect” and “External Effect”
Under PRC laws, the transfer of a creditor’s claim can have both an “internal effect” and an “external effect”. The internal effect of the transfer refers to its effect in relation to the transferor and the transferee. In this regard, as long as the 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.
Generally, the external effect of the transfer of a creditor’s claim first refers to the effect of the transfer in relation to the debtor. According to Article 546 of the Civil Code of the People’s Republic of China (the Civil Code), which came into effect on 1 January 2021, 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 external effect of the transfer of a creditor’s claim also includes the effect on the creditors of the transferor and any third parties. Although it’s not a requirement, the transfer of account receivables can be registered in the Movable Property Financing Unified Registration and Public Notice System (the Registration and Public Notice System) of the Credit Reference Center of the People’s Bank of China (PBOC). According to Article 768 of the Civil Code and Article 66 of the Interpretation of the Supreme People’s Court on the Application of the Security System of the Civil Code of the People’s Republic of China (the Interpretation of the Security System), when one account receivable is the underlying asset of a factoring, pledge, and transfer simultaneously, the People’s Court will determine the order of priority based on factors such as whether the registration of transfer has been completed, the time order of the registration, and the arrival time of the notice of the transfer to the debtor.
In addition, regarding the mortgage and pledge securing the creditor’s claim, although these security rights are transferred to the transferee along with the creditor’s claim, the transferee’s right may not be able to confront a bona fide third party if no change of mortgage/pledge registration has been made to put the transferee’s right on public notice.
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 include registering the transfer of account receivables, notifying the debtors of the transfer, a change of mortgage/pledge registration, and the transfer of possession of the pledged movables, etc. For a more detailed analysis on right perfection measures, see 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 China has formulated specialised regulations for various types of securitisations, the transaction structures are relatively “fixed” under the relevant regulations. For now, bankruptcy remoteness can only be achieved through the two means mentioned under 1.3 Transfer of Financial Assets.
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), a transfer of financial assets is not currently subject to VAT. The transfer of underlying assets is not subject to stamp duty as well because a trust agreement or a purchase and sale agreement in asset securitisation transactions are not regarded as taxable documents listed in the Stamp Duty Law of the People’s Republic of China (2022) (the “Stamp Duty Law”).
A potential tax on the transfer of underlying assets is income tax. If the transfer price is greater than the tax basis of the transferred assets (ie, the historical cost or the actual amount of costs incurred 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.
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 still require the originator to continue to pay VAT at a rate of 6% on the proceeds from the transferred underlying assets, which may result in the problem of double taxation. Although originators and trustees in many transactions have communicated with the competent tax authorities, this issue has not been effectively resolved because the State Taxation Administration has not yet provided any clear instruction on it.
The Notice on Relevant Issues concerning Taxation Policies on the Securitisation of Credit Assets (Ministry of Finance  No 5) provides certain exemptions from stamp duties for credit asset securitisations. An originator or trustee is temporarily exempted from stamp duty arising from taxable agreements between the originator, the trustee and the fund custodian, the securities depository or other service providers in a securitisation transaction. The trustee’s sale and the investors’ purchase and sale of credit asset securities, as well as accounting books established for the trust, are temporarily exempted from stamp duty. So far, there are no special tax exemptions for business asset securitisations.
The relevant parties in an overseas assets transfer shall follow the general tax regulations on the transfer of financial assets. Generally, if the transfer of assets constitutes a true sale, the foreign SPV has not acquired income as transferee during the transfer and the foreign investors have not acquired any income from China, then the transfer will not give rise to any withholding tax 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.
If the underlying assets in a securitisation transaction (for example, REITs which are partially carried out pursuant to the securitisation regulations) 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 financial statements consolidation 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. In most securitisation transactions, before sending the notice of transfer to the debtors, the originator still bears the obligation to pass on the cash flows of the financial assets. Therefore, the accountant needs to conduct the “pass-through test” by examining whether the originator has complied with the “no-advance”, “no-misappropriation” and “no-delay” principles, which involves an inspection of the advance payment and reimbursement by the servicer, investment of idle funds, frequency of cash flow allocation, and other transaction arrangements.
For the purpose of de-recognising financial assets, at the request of the accountant, the legal counsel may have to modify some specific provisions in the transaction documents, subject to the consent of the participating parties. According to the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions (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 China 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 Guidelines on Asset-Backed Notes by Non-Financial Enterprises (Announcement of NAFMII  No 27), the Registration Documents and Forms for the Public Offerings of Debt Financing Instruments by Non-Financial Enterprises (2020) (Announcement of NAFMII  No 5), the Rules for Information Disclosure on Debt Financing Instruments of Non-Financial Enterprises in the Interbank Bond Market (2021) and the Duration Information Disclosure Forms for Debt Financing Instruments by Non-Financial Enterprises (2021) (Announcement of NAFMII  No 10).
Information disclosure regarding business asset securitisations shall primarily follow the Administrative Provisions on Asset Securitisation by the CSRC and the Disclosure Guidelines for the Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (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, 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) first began to require the originator to retain the lowest class of securities for no less than 5% of the aggregate volume of the securities issued, which requirement was criticised by the market for being too strict. Subsequently, 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 in the meantime no less than 5% of the lowest class of securities. The originator may choose either horizontal retention or vertical retention, as long as it meets the minimum requirements.
As far as 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 asset-backed securities (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 Regarding 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 rating agency’s 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, warning letters, orders for public explanation 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, etc. AMAC may conduct regular or ad hoc on-site and off-site investigations into securities companies and fund management company subsidiaries, and may impose disciplinary sanctions such as written warnings, orders to correct, public condemnations, suspensions of record-filing and cancellation of membership, etc, depending on the seriousness of the case. In addition, 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.
One important regulatory indicator for insurance companies is the solvency ratio. According to the Administrative Provisions on the Solvency of Insurance Companies (2021 Revised), the comprehensive solvency ratio of an insurance company (ie, the ratio of the actual capital to the minimum capital) shall not be lower than 100%. The actual capital of an insurance company refers to the difference between the recognised assets and the recognised liabilities. In calculating recognised assets, different recognised values will be assigned to the credit ABS in which an insurance company has invested, depending on the outside ratings of the products.
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.
Since the interest rates of securitisation products are generally designed to be based on the interest rate types (fixed/floating) of the underlying assets to avoid interest rate mismatch risk as much as possible, 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 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), the duration of standard operational responsibilities 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. For ABN, the Procedure of the Meeting of Holders of the Non-Financial Enterprises Debt Financing Instruments in the Interbank Bond Market, specially promulgated by the NAFMII, shall apply.
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. In the ABN area, in January 2021, NAFMII published the Guidelines for Due Diligence on the Asset-Backed Notes by Non-Financial Enterprises (Trial Implementation).
Two kinds of authorities are in charge of the implementation of investor protection mechanisms.
Authorities that have administrative law enforcement power, such as the CBIRC, the PBOC and the CSRC, which may impose a number of administrative penalties or regulatory measures on the trustee or scheme manager for failure to fulfil the duties of honesty and diligence, including orders to rectify, warning letters, orders to make public statement, etc. Administrative penalties include fine, suspension of business for rectification or revocation of business licence.
Self-regulatory organisations, including mainly AMAC (for business asset securitisation), NAFMII (for ABNs and credit asset securitisation) and the securities exchanges (for business asset securitisations). AMAC, for example, according to the Measures for the Administration of the Record Filing of Asset-Backed Special Schemes published by it, may respond to behaviours that violate the self-regulatory rules by imposing written warnings, orders to correct, public condemnations, suspensions of filing, revocations of membership and/or other actions based on the type and seriousness of the violation.
Commercial banks as originators will be subject to the same regulatory measures 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 by the CSRC 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. Since the Company Law and the Bankruptcy Law do not contain any rules on special purpose companies (SPCs), the SPC has not been adopted in any securitisation transaction in China.
Non-financial companies can choose to issue ABNs in the Interbank Bond Market, or to conduct business asset securitisations on the securities exchanges. Their choices of market are mainly affected by the issuance cost and the efficiency of the approval/registration procedure. At least so far, 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.
SPVs are established for the purpose of securitisation; therefore, their activities are limited to the needs of carrying out securitisation business, which are generally agreed and stated in the transaction documents. At the same time, relevant laws or regulatory provisions stipulate the prohibited activities of the trustee or the manager. For example, in credit asset securitisation and ABN business, trust companies shall avoid misappropriating trust property for any non-trust purpose, promising the trust property will suffer no loss or guaranteeing a minimum return, or creating security rights over trust property. In business asset securitisation, the manager shall not embezzle or encroach on the assets of the special scheme, or provide guarantees with the assets of the special scheme.
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, or SOEs) constitute an important part of the market economy of China and therefore participate in all kinds of securitisation practices. However, SOEs in the Chinese market need to be differentiated from the government-sponsored entities (GSEs) – such as Ginnie Mae, Freddie Mac or Fannie Mae – in the US market. SOEs in the Chinese market participate in the securitisation business equally with other market participants, and are not entitled to special treatment or exemptions under the laws and regulations applicable to securitisation. The products issued by SOEs do not contain an 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 through different means.
The scope of qualified investors for the securities exchange market is basically the same as the Interbank Bond Market, except that foreign investors have a comparatively narrower access to the securities exchange market: they can only invest in such market after being recognised as a qualified foreign investor (QFII/RQFII) by the CSRC.
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 investments by different types of 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 trust property delivery date/effective date of the special scheme or the revolving purchase date). 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.
Currently, the prevailing right perfection measures include two kinds: (i) sending right perfection notice to the debtor and the guarantor, and (ii) conducting the transfer registration for the related mortgage or pledge. Since the notice and the transfer registration need to be conducted one by one, for the purposes of facilitating the collection of the assets and reducing the transaction costs, such measures are not normally required to be taken at the delivery of the underlying assets, 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 a right perfection event, the asset seller or the settlor generally send right perfection notice to the debtor or the guarantor (referred to collectively as the obligor):
If the underlying assets are secured by a mortgage or pledge, and the corresponding mortgage or pledge is required to be registered in accordance with PRC law, the asset seller or originator must conduct the transfer registration of the mortgage or pledge promptly upon the occurrence of a right perfection event, to ensure that the mortgage or pledge held by the scheme manager or the trustee will be valid against any bona fide third party.
In addition, based on new changes brought by the Civil Code and the Interpretation of the Security System (see 1.3 Transfer of Financial Assets), more securitisation transactions will consider registering the transfer of account receivables in the Registration and Public Notice System of PBOC’s Credit Reference Center. However, the actual time of conducting such registration (immediately after the transfer or after the occurrence of an agreed trigger event, that is, the right perfection event) may be decided based on the credit status of the settlor or the asset seller.
In order to ensure a smooth transaction, the originator 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.
In securitisation transactions, the events involving default mainly include (i) accelerated payment events; (ii) events of default; and (iii) termination events of the trustee/scheme manager, the servicer, the fund custodian, and other key securitisation service providers. Both accelerated payment events and events of default will result in changes of cash flow distribution order and early amortisation of securities, but accelerated payment events are generally less severe than events of default.
Accelerated payment events generally include:
Some accelerated payment events are not caused by default of participants in the transaction, but rather circumstances that may have a detrimental impact on the project.
Events of default generally include:
Termination events of the trustee/scheme manager, the servicer and the fund custodian usually include:
Upon occurrence of any aforementioned termination event, the meeting of security holders shall replace the corresponding institution.
Typical indemnification provisions in securitisations include indemnification for breach of contract by the servicer, the fund custodian and other securitisation service providers; and indemnification for trustee/scheme manager’s failure to manage the assets of the SPV in accordance with laws and transaction documents. The fundamental principle of indemnification is that if one party fails to perform its obligations as 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, and 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/scheme manager, it is generally specified in the transaction documents that the ABS are not liabilities of the originator or the trustee/scheme manager, and the investment institutions’ right of recourse is only limited to the trust property/assets of the special scheme; however, the liability for compensation of the originator or the trustee/scheme manager in the event of default under the transaction documents is not limited by the aforementioned provisions.
In credit asset securitisations, the issuers are the trustees of the SPTs. In business asset securitisations, the issuers are the managers of the asset-backed special schemes. 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 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 SPT trustee qualification approved by the CBIRC. For business asset securitisation, the issuer can be a securities company (or a subsidiary of a securities company), a subsidiary of a fund management company, or a trust company. 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, the originator should be a non-financial enterprise, generally a corporation.
When the issuer is also 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, its basic responsibilities include:
In the relevant Chinese securitisation regulations, the sponsor is generally the originator of the securitisation. In credit asset securitisations the sponsor is a 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 use the concept of “sponsor”, but the entity that transfers the underlying assets to the special scheme 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 financial institutions. In terms of business asset securitisations, although the relevant regulations do not put restrictions on the entity type of the originator, the majority of sponsors (originators) are non-financial enterprises. In terms of ABNs, the sponsor (originator) can only be non-financial enterprises.
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.
In a pledge-type ABN transaction where the originator itself acts as the issuer and the underlying assets are pledged to the noteholders, for the purpose of completing pledge registration and protecting the rights of the investors, the lead underwriter will generally be designated as the bond agent, whose duties generally include the following:
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 trading limits set in the relevant laws, regulations and transaction documents, complying with the provisions on the exercise of rights, and maintaining confidentiality regarding trade secrets. The business types of investor are introduced under 4.14 Entities Investing in Securitisation.
As the character of a trustee often overlaps with an issuer, the entity type and main obligations of the trustees are described in 6.1 Issuers.
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, intellectual property, 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, the Trust Law, 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), and the Announcement on Further Regulating the Risk Retention of Originator in Credit Asset Securitisation (Announcement of the PBOC and CBRC  No 21).
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 Civil Code, the Security Law of the People’s Republic of China, the Securities Investment Fund Law of the People’s Republic of China, and the Administrative Provisions on Asset Securitisation by the CSRC.
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 Civil Code, the Trust Law, the Measures for Administration of Debt Financing Instruments Issued by Non-Financial Enterprises in the Interbank Bond Market (Order of PBOC  No 1), and Guidelines for Asset-Backed Notes by Non-Financial Enterprises.
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The Direction of China’s Securitisation Market
China’s economy continues to be heavily affected by COVID-19 in 2022. Accordingly, enterprises are faced with multiple difficulties, especially those in the real estate industry. As the risks taken by the real estate industry have been exposed speedily, the industry built around asset-backed securities (ABS) has been significantly affected. Compared with the previous year, the deal volume and size of both credit ABS issued by financial institutions and ABS issued by non-financial institutions declined sharply in 2022. In these circumstances, a series of regulatory measures for financial leasing and factoring business have been promulgated by Chinese financial regulators in the past three years, which had an increasing influence on the ABS industry. Meanwhile, in early 2022, the Supreme People’s Court issued the Provisions of the Supreme People’s Court on the Adjudication of Civil Compensation Cases Involving the Tort of Misrepresentations in the Securities Market which imposes great legal risks on underwriters, lawyers, accountants and rating agencies. How judges determine civil liability for misrepresentations of ABS has begun to attract a great deal of attention from investment banks and other advisors.
Credit asset securitisations
China’s credit asset securitisation sector made its debut in 2005, was suspended in 2008 due to the financial crisis and restarted in 2012. In the past decade, the credit asset securitisation market has developed into the most significant component of China’s asset securitisation market, under a regulatory framework with the People’s Bank of China (PBC) and the China Banking and Insurance Regulatory Commission (CBIRC) as the core regulators. So far, there are six types of products in the credit asset securitisation market, namely, residential mortgage-backed securities (RMBS), auto loans ABS, consumer loan ABS, small and micro-enterprise loans ABS, credit card receivables ABS, and non-performing loan ABS (NPL ABS). A total of 1,150 credit ABS were issued from 2011 to 2021, with the aggregated issuance scale over RMB5 trillion. Among them, RMBS and auto loans ABS are the largest securitisation products issued in terms of the issuance scale, thanks to the support from regulators.
The issuance scale of RMBS decreased rapidly in 2022, as a result of continued strengthening of financial policies in the real estate area in the first half of this year. RMBS issuance is expected to return to normal in 2023 as a set of new policies supporting sound development of real estate enterprises were introduced. Compared to RMBS, auto loan ABS remained solid in 2022, becoming the top product in terms of issuance scale. In particular, green ABS based on new energy vehicle loans have not only received strong support from financial regulators, but also attracted attention from international investors. In addition, in order to accelerate the resolution of problems derived from non-performing loans, NPL ABS have become the key task of the asset securitisation departments of Chinese commercial banks and achieved a new record of issuance. In the context of the issuance in 2022, in addition to credit card receivables non-performing assets, non-performing personal residential mortgage loans represent an increasing proportion of the underlying assets in non-performing asset securitisations. This is primarily because of the seriously adverse impacts on borrowers’ repayment ability caused by COVID-19 in the past three years. As for corporate loans securitisation products, only a small number of small and micro-enterprise loans ABS were issued in 2022, including non-performing small and micro enterprise loans ABS.
Business asset securitisation
The securitisation market in China consists of two separate markets: the market for ABS traded on the Shanghai and Shenzhen Stock Exchanges, and the market in asset-backed notes (ABN) traded in the China Interbank Bond Market. In the past five years, some of the exchange-traded ABS failed to pay principals or interests at maturity. Whether underlying assets are remote from bankruptcy of originators under the current structure of the deal in a Chinese securitisation is highly valued by the regulators. For instance, the Shanghai Stock Exchange further emphasises the principle of “true sale and bankruptcy remoteness” in its ABS Rules (draft for comments) recently released on 2 December 2022.
Under the influence of regulatory policy on real estate and local government debt, exchange-traded ABS trading decreased sharply in 2022. Financial leasing assets have become the most important type of underlying asset. Meanwhile, commercial mortgage-backed securities (CMBS), whose underlying assets are commercial mortgage loans, developed rapidly. In addition to the high quality of the target property, the determination of a “green” label is one of the most important reasons for the regulators to support CMBS. With the policy of “carbon dioxide emission and carbon neutrality”, China’s economy is entering a period of deepening green development, and financial regulators intend to guide funds to support the development of the green economy. In addition, it is worth noting that in the past five years, financial leasing companies and factoring companies have acted as originators in a large number of ABS while the real financiers were actually real estate enterprises and urban investment companies controlled by local governments. Therefore, when the central government makes adjustments to real estate policy or local government debt policy, the asset securitisation market is bound to fluctuate accordingly. In the authors’ opinion, it is likely that China’s asset securitisation market will develop rapidly under such policies in the next two years.
Asset-backed commercial paper and quasi-REITs
The National Association of Financial Market Institutional Investors (NAFMII) launched its scheme for asset-backed commercial paper (ABCP) in June 2020. The issuance scale of ABCP in the China Interbank Bond Market increased greatly in 2022. However, unlike the US market where the originator of ABCP is a commercial bank, the originator of Chinese ABCP is a non-bank commercial enterprise. While these enterprises own the relevant underlying assets according to ABCP regulatory requirements, they can quickly raise funds through simpler financing instruments. Therefore, the outlook for China’s ABCP market remains to be seen. NAFMII also gave major support to quasi-real estate investment trusts (quasi-REITs) and commercial mortgage-backed notes (CMBNs). Any enterprise that owns utility infrastructure, transportation infrastructure, warehousing and logistics, industrial parks or commercial real estate can raise funds through a quasi-REIT or CMBN, as long as it is in line with major national strategies and policy requirements, especially green economy policies.
Infrastructure securities investment funds (Infrastructure REITs)
In China, REITs are deemed as securitisation of real estate and constitute a component of the asset securitisation market. Currently, the only type of REIT that can be publicly offered and traded on the stock exchange for public investors is the infrastructure REIT. Any issuance of infrastructure REITs must first obtain approval from the National Development and Reform Commission (NDRC) on whether the target infrastructure assets are compliant with the regulatory criteria, before an application for issuance can be made to the China Securities Regulatory Commission (CSRC) and then an application for listing on the stock exchange. The NDRC has been actively promoting the participation of local governments and state-owned enterprises in infrastructure REIT applications in the first half of 2022, and further clarified that private enterprises participating in REIT pilots should also be encouraged. The infrastructure assets that can be issued as REITs have been expanded to affordable rental housing assets and new energy assets such as wind power and hydroelectric facilities. Meanwhile, in order to lower the tax risk of REITs, the Ministry of Finance (MOF) and the State Taxation Administration (STA) issued the Announcement on Tax Policies for the Pilot Programme of Real Estate Investment Trusts in the Infrastructure Sector on 29 January 2022, which, to some extent, clarified the taxation standards for some REITs. However, given the complex legal structure of current China-REITs, the tax risks around REITs cannot be fully resolved in a short period of time.
The outlook for regulation
Although the 2019 revision of the Securities Law of the People’s Republic of China placed asset-backed securities under the regulation of the Securities Law, there are still no uniformly applicable legal rules for the entire asset securitisation market, including without limitation rules on special purpose vehicles and asset sale. It is still the regulatory rules set by the CSRC, PBC and CBIRC that have the greatest impact on asset securitisation.
On 28 November 2022, CBIRC officially released the Notice of Issues Concerning Strengthening the Compliance Regulation of the Financial Leasing Business of Financial Leasing Companies on its website, which had already been practice since February 2022. The Notice clearly requires financial leasing companies to abandon the “quasi-credit” business concept, but to focus on the function of “leasing assets” in a manner complementary with traditional banking business. It is strictly prohibited to include the following in the scope of leased objects: roads, municipal pipelines, water pipelines, bridges, dams, weirs, waterways, holes, non-equipment property under construction, and structures which are suspected of increasing local government hidden debts or which may affect the normal supply of public services after being disposed of. Although the notice is aimed at financial leasing companies, it will certainly affect other leasing companies which are not of a financial nature in the securitisation market. Moreover, CBIRC is expected to soon require other leasing companies to abandon the “quasi-credit” concept. Therefore, in the near future, the structured financial products of “quasi-credit” assets can no longer label themselves as a type of “asset securitisation” in the Chinese market.
Stock Exchanges and NAFMII
The Shanghai and Shenzhen Stock Exchanges released the Asset-Backed Securities Rules (draft for comments) on their respective official websites, on 2 December 2022, under the unified arrangement by CSRC. One of the main purposes of the stock exchanges rules is to “further strengthen the asset credit and bankruptcy remoteness system and enhance investor protection”. The formulation of the new rules crystalises the regulatory experience since the CSRC relaunched the asset securitisation market in 2014, for example, defining which institutions are information disclosure obligors in the practice of asset securitisation. It will certainly have a positive effect on clarifying the duties and legal responsibilities of each participating institution in asset securitisation.
NAFMII may also revise its asset securitisation rules in conjunction with experience in the practice of ABCP.
The Supreme People’s Court
The Supreme People’s Court released the Interpretation of the Supreme People’s Court on the Application of the Part on Contracts of the Civil Code of the People’s Republic of China (Draft for Comments) on 4 November 2022. The judicial interpretation aims to further clarify some specific issues involved in the transfer and assignment of contractual rights and obligations, in particular the effectiveness of assignment notice for claims. For example, Article 50 of the draft judicial interpretation provides that “if the assignee sues the debtor to perform the obligation, but has no evidence to prove that the creditor or the assignee has notified the debtor [of the assignment], the people’s court shall support the claim that the notice of assignment is effective when the copy of the statement of claim is served.” If the above provision is retained in the final version of the judicial interpretation, it will certainly play a positive role in properly resolving the issue of notice in relation to the transfer of underlying assets in asset securitisation transactions.