Structured finance and securitisation in China: overview
A Q&A guide to structured finance and securitisation law in China.
This Q&A provides an overview of, among others, the markets and legal regimes, issues relating to the SPV and the securities issued, transferring the receivables, dealing with security and risk, cash flow, ratings, tax issues, variations to the securitisation structure and reform proposals.
To compare answers across multiple jurisdictions, visit the Structured finance and securitisation Country Q&A tool.
This Q&A is part of the global guide to structured finance and securitisation. For a full list of contents visit www.practicallaw.com/securitisation-guide.
Market and legal regime
How developed is the market and what notable transactions and new structures have emerged recently?
What impact have central bank programmes (if any) had on the securitisation market in your jurisdiction?
Is securitisation particularly concentrated in certain industry sectors?
As a background, the Chinese securitisation market developed steadily for a few years until 2008 when it was halted by the global financial meltdown. In 2012, the regulators started to revive the credit asset securitisation market, against the backdrop of implementing Basel III.
The authors have seen a huge boom in both the volume and value of China's securitisation transactions in 2014 and 2015. Issuance of asset-backed securities rocketed by 25% to US$26.3 billion in the first eight months of 2015, compared to US$20.8 billion in the same period in 2014, which easily pushes China to the top spot as Asia's biggest securitisation market, eclipsing more developed markets like South Korea and Japan.
There was a string of high-profile transactions over the past two years:
In July 2014, Postal Savings Bank of China sold a CNY6.8 billion residential mortgage-backed security.
In June 2014, Ping An Bank issued CNY2.6 billion consumer loan asset-backed securities on the Shanghai Stock Exchange, which is the first asset-backed securities product on China's securities market.
Issuance of auto loan-backed securities continues the momentum. In the first half of 2015, the financing arms of large car makers, including Ford Motor, BMW and Volkswagen AG, issued US$4 billion of securities backed by auto loans, more than double last year's figure.
From a macro perspective, new securitisation products are concentrated in collateralised bank loans (CLOs) and asset-backed securities backed by car loans. In terms of CLOs, the vast majority of them are tied up with a relatively small number of underlying bank loans, which is different from the mature Western market where securitised products are more diversified.
What are the main laws governing securitisations?
What is the name of the regulatory authority charged with overseeing securitisation practices and participants in your jurisdiction?
Currently, there is neither a unified nor a comprehensive securitisation law in China. Instead, the central Chinese bank, the People's Bank of China (PBOC), the banking industry regulator, the Chinese Banking Regulatory Commission (CBRC) and the securities market regulator, the China Securities Regulatory Commission (CSRC), have issued administrative rules or circulars on an ad hoc basis in relation to securitisation transactions carried out under various structures. Therefore, essentially, PBOC, CBRC and CSRC are the main regulatory authorities with oversight over securitisation transactions in China.
The following is a non-exhaustive list of the major laws governing securitisation in China:
Trust Law of the People's Republic of China, issued by the Standing Committee of the National People's Congress on 28 April 2001 and effective from 1 October 2001(PRC Trust Law).
Law of the People's Republic of China on Securities Investment Funds, issued by the Standing Committee of the National People's Congress on 24 April 2015 and effective from 24 April 2015 (PRC Securities Investment Law).
Administration of Pilot Projects for the Securitisation of Credit Asset Procedures, issued by PBOC and CBRC on 20 April 2005, and effective from the same date (Pilot Measures).
Circular on Further Expanding the Pilot Programme on Credit Assets Securitisation, issued by PBOC, CBRC and the Ministry of Finance (MOF) on 17 May 2012 and effective from the same date (Pilot Circular).
Measures for the Supervision and Administration of Pilot Projects of Credit Asset Securitisation of Financial Institutions, issued by CBRC on 7 November 2005 and effective from 1 December 2005.
Customer Asset Management Business of Securities Companies Administration Measures Circular, issued by CBRC on 26 June 2013 and effective from the same date (Securities Companies Circular).
Administrative Provisions on the Asset Securitisation Business of Securities Companies and the Subsidiaries of Fund Management Companies, issued by CSRC on 19 November 2014 and effective from the same date (Administrative Provisions).
Generally, securitisation in China can be divided into two main types based on asset classes: credit asset securitisation and corporate asset securitisation.
Credit asset securitisations involve eligible assets originated from financial institutions, and are done under the trust structure. PBOC and CBRC are the main stakeholders in this field.
Corporate asset securitisations are carried out under the asset management plan structure, subject to the regulation of CSRC.
Reasons for doing a securitisation
Accounting practices in your jurisdiction, such as application of the International Financial Reporting Standards (IFRS)?
National or supra-national rules concerning capital adequacy?
Risk retention requirements?
Implementation of the Basel III framework in your jurisdiction?
Usual reasons for securitisation
There are a variety of reasons for carrying out and expanding securitisation in China's market. One of them is regulatory driven: the government is making attempts to help ease lending so that small and medium-sized companies can have easier access to funds amid China's economic slowdown.
For financial institutions, securitisation appears to be an effective way to move their existing loans off-balance sheet, therefore reducing exposure to non-performing loans.
In addition, the off-balance sheet treatment allows banks to free up more capital to give credit to cash-stripped companies and projects in need of cash.
On the demand side, more and more investors seeking higher returns are willing to invest in China's nascent securitisation market, prompting more innovative products and sustainable structures.
The accounting rules for asset securitisations are primarily set out in the Chinese Accounting Standard for Business Enterprise No. 23 - Transfer of Financial Assets, issued by MOF effective 15 February 2006. The most complex part of calculating securitised assets lies in deciding an issuer's underlying assets, as this affects the extent of risks transferred.
On the international front, China observes the International Accounting Standard No. 39 – Financial Instruments: Recognition and measurement. This outlines the requirements for the recognition and measurement of financial assets, financial liabilities and some contracts to buy or sell non-financial items. The authors understand that in practice, the issuer needs to submit to the authorities an accounting opinion from a duly qualified accounting firm when applying to engage in securitisation business.
The Pilot Circular imposes a risk retention requirement on the originators of credit asset securitisations, requiring them to hold a certain percentage of the lowest credit rating of the asset-backed securities. This will, in principle, be no lower than 5% of all classes of the issued asset-backed securities, for a period no less than the term of the securities of the lowest credit rating.
The special purpose vehicle (SPV)
Establishing the SPV
What form does the SPV usually take and how is it set up?
What is the legal status of the SPV?
How the SPV is usually owned?
Are there any particular regulatory requirements that apply to the SPVs?
The SPV usually takes the form of a special purpose trust (SPT), which is set up by a duly approved trust company. Under this structure, an SPT holds the underlying assets which are to be securitised and issues asset-backed securities in the form of trust beneficiary certificates.
An SPT does not have independent legal status, as the trust company carries out the above activities on behalf of the SPT.
In terms of securitisation of corporate assets, an SPV structure in the form of a special asset management plan (SAMP) applies, which is established by security companies or the subsidiaries of fund management companies for the purpose of conducting asset securitisation business. Like an SPT, such a structure does not have independent legal status, as it is controlled by the security company or the subsidiary of the fund management company that establishes it.
For the purpose of carrying out securitisation business, the SPV should be established onshore. An SPV is not an independent legal entity. It is more of a legal concept created by law (see Question 4).
Ensuring the SPV is insolvency remote
Has the ability to achieve insolvency remoteness been eroded to any extent in recent years?
Will the courts in your jurisdiction give effect to limited recourse and non-petition clauses?
Under the trust structure used for credit asset securitisation, the PRC Trust Law requires that the trust assets are separate and independent from the originator's assets. Moreover, the law makes clear that the trust assets will not be deemed as the liquidated assets of the trustee if it becomes insolvent.
A similar ringfencing legal arrangement is also in place for an SAMP. The PRC Securities Investment Law provides that assets under management are separate and isolated from the fund manager and the fund custodian, even if they are declared bankrupt.
To the authors' knowledge, there has not yet been a transaction that has been tested in an insolvency proceeding. Therefore, it is unclear how the remoteness would play out in practice.
Ensuring the SPV is treated separately from the originator
Due to a lack of information and market practice, the authors are unable to assess the risk that Chinese courts would treat the assets of the SPV as those of the originator in these circumstances. Many practitioners consider that the risk that the courts would treat the assets of the trust as those of the originator or manager if they become subject to insolvency proceedings is remote. However, the PRC Enterprise Insolvency Law does not provide clear guidance on this issue. In fact, the transactions could be voided by the court due to an unreasonable purchase price under the PRC Enterprise Insolvency Law.
Issuing the securities
Credit asset securitisation allows for asset-backed securities to be publicly issued on the National Interbank Bond Market (NIBBM). The transfer of asset-backed securities of corporate asset securitisation is limited to no more than 200 qualified investors on multiple platforms, including:
The National Equities Exchange and Quotations.
The inter-agency offer and service system for privately-raised products.
The over-the-counter (OTC) market.
According to the Guidelines on Asset-backed Notes for Non-financial Enterprises on the Interbank Bond Market, the National Association of Financial Market Institutional Investors (NAFMII) has the mandate to regulate asset-backed notes originated by non-financial institutions which can be traded on the interbank market.
Are the securities usually listed on a regulated exchange in your jurisdiction or in another jurisdiction?
If in your jurisdiction, please identify the main documents required to make an application to list debt securities on the main regulated exchange in your jurisdiction. Are there any share capital requirements?
If a particular exchange (domestic or foreign) is usually chosen for listing the securities, please briefly summarise the main reasons for this.
For credit asset securitisations, the securities are usually sold on the intra-bank market, which is not a regulated exchange.
For corporate asset securitisations, the securities can be sold on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. Both are regulated by the China Securities Regulatory Commission (CSRC). Unless the securitisations have necessary regulatory approvals, currently most such corporate asset securitisations are listed on domestic stock exchanges.
For credit asset securitisations, the application to the People's Bank of China (PBOC) to issue asset-backed securities must include the following:
The application report.
The articles of association of the promoter institution, or the written document of consent of the promoter institution as provided for in the documents which are, by nature, articles of association.
Drafts of the trust contract, loan service contract, fund preservation contract and other relevant legal documents.
Relevant approval documents issued by the Chinese Banking Regulatory Commission.
Accounting advice of a certified public accountant.
Draft of the credit rating report issued by the credit rating institution, as well as the relevant introduction of the follow-up tracking rating arrangement.
For corporate asset securitisations, the application documents are more or less the same as above, with variations among different platforms.
Constituting the securities
Transferring the receivables
Classes of receivables
The assets eligible to be securitised under the credit asset securitisation scheme are typically assets originating from financial institutions, including residential mortgage loans, corporate loans and auto loans. Further, the Pilot Circular expands the scope of eligible assets to include:
Consumer auto loans.
Infrastructure project loans.
Loans to small and medium-sized enterprises.
Qualifying loans to financing vehicles of local governments.
Loans related to energy-saving projects, strategic emerging industries, cultural and creativity and affordable housing projects.
The underlying assets for corporate asset securitisations can include:
Creditors' rights under leases.
The right as a trust beneficiary to other property rights of an enterprise.
The actual assets of, or the right to obtain proceeds from, infrastructure, commercial properties and other real estate properties.
Transferring receivables from the originator to the SPV
The transfer is usually done through selling the underlying assets to the SPT or SAMP. However there is some uncertainty about whether the sale is merely a transfer of possession or a transfer of ownership. The authors tend to agree with it being a transfer of ownership, as the law requires the assets to be segregated from the originator.
Notice to debtors about the assignment is required under PRC Contract Law though, in practice, the consensus is that the assignment can still be effected without such notice.
PRC law does not appear to specifically ban certain types of receivables from being securitised. In fact, future receivables are one of the most common types of securitised assets for corporate asset securitisation (see Question 11).
The People's Bank of China (PBOC) has a set of rules regarding the registration of pledges of account receivables, notably the Measures for the Registration of Pledges over Accounts Receivable. However, uncertainty may arise as to the effect of the transfer of underlying receivables which are not registered with PBOC.
Prohibitions or restrictions on transfer
There do not appear to be any express prohibitions on the transfer of receivables under PRC Law. Under the SPT structure, the originator transfers receivables and other contractual rights to the trustee. In the SAMP scheme, the originator transfers the receivables and other contractual rights to qualified security companies or subsidiaries of fund companies.
However, there might be contractual restrictions agreed by both parties regarding the transfer of receivables. Since registration of receivables is not statutorily required, questions may arise as to how the contractual restrictions are enforced against a bona fide third party's claims.
Consumer data is protected under a fairly different regulatory framework, with rules scattered across a range of legislation. For example, the People's Bank of China (PBOC) has special rules for banking institutions regarding the collection, storage, use and transfer of personal financial information. The authors understand that such rules may also apply to the consumer data involved in securitisation transactions.
Avoiding the transfer being re-characterised
Can this risk be avoided or minimised?
Are true sale legal opinions typically delivered in your jurisdiction or does it depend on the asset type and/or provenance of the securitised asset?
There is a risk of re-characterisation due to there being no "legal true sale" concept under Chinese law. Under the PRC Contract Law, a party must obtain the consent of the original counterparty before assigning the claims or duties to a third party. This perfection requirement of having the approval from the original debtor is rarely met in practice, as it is a costly process to seek the approval from a large number of debtors. The absence of true sale could potentially hinder the consummation of an asset securitisation, given the re-characterisation risk.
This does not seem to be a big issue for an SPT, as the trust approach is pretty solid in isolating the assets of the originator from those of the trustee. In an SAMP the risk level appears to be higher, as it is not entirely clear how the ringfence works in practice. A lack of precedents makes it more difficult to gauge a court's position on this issue. However factors that might be considered could include the parties' intention, consideration for the assignment, and other economic characteristics.
Ensuring the transfer cannot be unwound if the originator becomes insolvent
According to the PRC Enterprise Insolvency Law, the originator's transactions can be unwound by the bankruptcy administrator on any of the following grounds:
Assigning assets for no consideration.
Carrying out a transaction at an obvious undervalue.
Providing asset security interests over debts not previously secured by asset security interests.
Repaying in advance debts that have not fallen due.
Abandoning its own credits.
The above events are revocable if they occurred during the one-year period prior to the court accepting the insolvency application.
Moreover, during the six-month period prior to the court accepting a bankruptcy application, if an originator with a going concern made an individual settlement of a debt owed to a creditor, the bankruptcy administrator can request the court to revoke the transaction, unless the individual debt settlement was beneficial to the originator's assets.
One way to minimise the unwinding risk is to ensure that any transaction is conducted in a fair manner, bearing in mind the clawback scenarios set out in applicable laws and regulations. From the perspective of the counterparty, a proper due diligence should be carried out to check the originator's financial standings. Also, it needs to be mindful of any "windfall" transactions, which the originator would not do under normal circumstances.
Establishing the applicable law
The rule is that as long as at least one party to the contract is not a Chinese company or individual it is classified as a foreign-related contract, so foreign governing law and offshore arbitration/courts are permitted for dispute resolution. China only recognises foreign court judgments including English law court judgments on the basis of reciprocity or a bilateral agreement, failing which the overseas judgement will be unenforceable in China. Therefore, Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention) state arbitration, typically in Hong Kong or Singapore, is strongly recommended to give a better chance of enforcement in China, as China is a member of the New York Convention.
Unless securitisations have any foreign-related factors, currently the authors do not think there is any other option but choosing Chinese law as the governing law for domestic asset securitisation transactions in China.
Security and risk
The main types of security that can be taken over an SPV's assets are a mortgage and a pledge. A mortgage can be imposed on various assets, including real estate, land use rights, production facilities and transportation tools. Registration is the perfection requirement for mortgage.
A pledge mainly applies to future receivables. A pledge should be registered with the People's Bank of China to ensure its enforceability (see Question 13).
The trustee holds the security in an SPT scheme. The manager (securities company or subsidiary of a fund company) is the security holder under the SAMP scheme.
The basic requirements for setting up a trust are set out in the PRC Trust Law, which states that:
A trust must be created for lawful purposes.
There must be definite property under the trust, and such property must be lawfully owned by the settlor.
A trust must be in writing, being a trust contract or a will.
Regarding an SAMP, the manager should make sure that the transfer of the underlying assets has satisfied relevant approval or registration requirements. For an SAMP using the generated revenue to buy the same types of underlying assets, relevant legal documents should specify the conditions and the size of purchase of the underlying assets, liquidity risks and risk control measures.
Foreign trusts do not appear to be recognised under the Chinese legal system. The authors are not aware of any bilateral treaties or international treaties concerning trusts to which China is a party. Therefore, caution should be taken when an offshore trust is intended to be recognised in China.
Risk management and liquidity support
Cash flow in the structure
Distribution of funds
Any money left over after all payments have been made is extracted from the SPV and paid back to the originator using the following profit extraction techniques:
The originator taking fees for administering the receivables contracts and managing and servicing collections of the receivables.
The originator holding subordinated notes issued by the SPV.
The originator receiving any remaining amounts of the SPV by way of a final success fee as investment income.
In China, caution should be taken when an originator wants to extract profit from the securitisation, as this may cause tax issues.
The role of the rating agencies
On the whole, the sovereign rating of China is very positive, with AA- from Standard & Poor's Ratings Services, Aa3 from Moody's Investors Service, Inc. and A+ from Fitch Ratings, Inc. However, since China does not allow offshore securitisations backed by assets located in China for the time being, we do not think sovereign rating plays a big role in the credit rating of domestic asset-backed securities.
Issuance and trading of asset-backed securities under the SPT scheme needs to have credit ratings from two licensed credit rating agencies. For SAMP, credit rating does not seem to be a pre-condition for issuing asset-backed securities but if it plans to receive credit rating from approved agencies, there must be an initial credit rating and follow-up rating. Currently, international rating agencies are not allowed to rate a domestic securitisation.
What transfer taxes may apply to the transfer of the receivables? Please give the applicable tax rates and explain how transfer taxes are usually dealt with.
Is withholding tax payable in certain circumstances? Please give the applicable tax rates and explain how withholding taxes are usually dealt with.
Are there any other tax issues that apply to securitisations in your jurisdiction?
Does your jurisdiction's government have an inter-governmental agreement in place with the US in relation to FATCA compliance, and will this benefit locally-domiciled SPVs?
The current securitisation regulatory regime provides a tax friendly environment for the securitisation market.
Transfer and entrustment of credit assets from the originator to the SPV
Business tax/value added tax (VAT). The full amount of loan interest received by the trustee from trust assets is subject to business tax.
In the process of credit asset-backed securitisation, a servicing fee derived by a loan servicer, compensation received by a custodian and other services income is subject to business tax/value added tax in accordance with prevailing business tax/VAT regulations. From 1 August 2013, a VAT pilot in lieu of business tax in the transportation industry and certain modern service industries has been activated nationwide. Under Circular Caishui  No.106, certain modern services are subject to VAT.
Trading gains derived by certificate investors from buying and selling credit asset-backed certificates are subject to business tax.
Corporate income tax. The gains (which include interest collection and permitted investment income) derived from the SPT and distributed to certificate investors within the same year are temporarily not subject to corporate income tax in the hands of the SPT. The gains (which include interest collection and permitted investment income) derived from the SPT but not distributed to certificate investors within the same year are subject to corporate income tax in the hands of the SPT, and the trustee must report and settle corporate income tax pursuant to prevailing corporate income tax regulations.
During the period in which the SPT is temporarily not subject to corporate income tax on the profit derived, distribution from the SPT to certificate investors in the same year is recognised as taxable income in the hands of the certificate investors, based on the accrual principle and subject to corporate income tax.
Servicing fees derived by a loan servicer, custodian bank, security depository/clearing agency and other service provider in an ABS project are subject to corporate income tax in accordance with prevailing corporate income tax rules.
Trading gains of buying and selling of credit asset-backed securities by institutional investors is subject to corporate income tax in accordance with prevailing corporate income tax rules. Trading losses from the buying and selling of credit asset-backed securities are deductible from a corporate income tax perspective.
Income derived by security investors from the liquidation distribution of the trust scheme is subject to corporate income tax in accordance with prevailing corporate income tax rules, and losses from the liquidation are deductible from a corporate income tax perspective.
The trustee and depositor/paying agent must provide full financial information and detailed information on distribution to investors to the tax authority in charge of the SPT and institutional investors respectively.
A trust agreement signed between the originator and the trustee to entrust receivables to the SPT for securitisation purposes is temporarily not subject to stamp duty.
A service agreement signed between the trustee and the loan servicer to entrust the loan servicer to manage the trust asset is temporarily not subject to stamp duty.
In the process of credit asset-backed securitisation, the trustee is temporarily exempt from stamp duty on other dutiable contracts concluded with the originator, loan servicer, account bank, depositor/paying agent and other service providers.
Credit asset-backed certificates issued by the trustee and certificate investors trading credit asset-backed certificates are not subject to stamp duty.
Accounting books of the originator for the purpose of securitisation projects are subject to stamp duty.
Recent developments affecting securitisations
The Administrative Provisions are a major reform of the regulatory framework governing corporate asset securitisations. Unlike the previous regulations, the Administrative Provisions do not require pre-approval from the China Securities Regulatory Commission (CSRC) for each transaction. Instead, it adopts a post-event reporting approach. Managers only need to report to the Asset Management Association of China within five working days of a SAMP being established. Also, the Administrative Provisions significantly enlarge the base of eligible underlying assets for SAMP by using a "Negative List", which means assets that are not on the list could be securitised under SAMP.
Another trend is that the People's Bank of China (PBOC) has started to give more mandates to the National Association of Financial Market Institutional Investors. Following PBOC's 2015 Announcement No.7, NAFMII has issued guidelines on information disclosure requirements on auto loans and on residential mortgage-backed securities. The authors understand that PBOC expects that NAFMII's supervision would be more efficient, given that its frequent interaction with market players may help it gain a better understanding of the market.
Other securitisation structures
The securitisation market is growing exponentially in scale and market revenue and has proved a game-changer in driving China's economic growth (see Question 1). The authors believe that as China regulators grow comfortable with this development, there will be more rules further up the legislation hierarchy, which could add another layer of legal certainty and legislative authority for asset securitisation.
We believe that the recent legal developments and policy reforms have played a positive role in reviving investors' interests in China's securitisation market.
For example, a growing number of foreign banks' local branches and overseas funds with access to domestic security markets have been investing in China's securitisation products. Earlier this year, International Finance Corp purchased more than CNY100 million of Ford's first issue of auto loan-backed securities, which was rated as Aa3 by Moody's Investors Service, Inc. Intense market competition has led to more high credit quality issuers and originators who are, in turn, attracting more investments from both domestic and overseas institutions.
National People's Congress
Description. An official website of PRC laws and regulations. It is maintained by the National People's Congress, the legislative body of China. No English translation is available on this website.
National Association of Financial Market Institutional Investors
Description. Industry association for credit asset securitisations
Asset Management Association of China
Description. Industry association for corporate assets securitisations
China Central Depository & Clearing Co., Ltd. (CCDC)
Description. Official website of CCDC, and a media designated by the PBOC and CBRC where issuers of SPT products make disclosures
China Securitisation Forum
Description. An industry organisation consisting of various market participants.
Chinese Banking Regulatory Commission
Chinese Securities Regulatory Commission
The People's Bank of China (Chinese central bank)
Shengzhe Wang, Counsel
Hogan Lovells International LLP
Professional qualifications. Admitted to the Chinese bar (attorney), 1998; Solicitor, England and Wales, 2010.
Areas of practice. Debt capital markets; acquisition finance
Non-professional qualifications. LL.M., University of Frankfurt
- Daimler AG, Volkswagen Bank GmbH and Volkswagen Leasing GmbH, BMW Leasing/Bank GmbH: German, Chinese and international ABS transactions.
- Several conduit transactions.
- Chongqing Light Industry&Textile Holding (Group) Co., Ltd.: acquisition of automotive supplier SaarGummi Group, one of the largest China outbound acquisitions in Germany.
Languages. Chinese, English, German
Professional associations/memberships. China Securitisation Forum
Publications. True Sale Securitisation in Germany and China, June 2006, Dr. Müller Publishing.