china-country finance eit 2011

Country Finance

China

Released August 2011 The Economist Intelligence Unit 750 Third Avenue New York NY 10017 USA

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China 1

Country Finance 2011 www.eiu.com © The Economist Intelligence Unit Limited 2011

Contents 3 Regulatory/market assessment

3 Regulatory/market watch

4 China at a glance

5 Fundamental indicators

6 Banks and other financial institutions Overview Bank regulators Regulatory watchlist Domestic banks Foreign banks Investment banks and brokerages Development and postal banks Offshore banks Insurance companies Pension funds Mutual funds and asset-management firms Venture-capital and private-equity firms Factoring firms Financial leasing companies Other institutions

45 Corporate case study

46 Monetary and currency policies/regulations Overview Base lending rates Monetary policy Currency Loan inflows and repayment Repatriation and remittance of capital Restrictions on trade-related payments

55 Short-term instruments/regulations Overview Cash management Payment-clearing systems Receivables management Payables management

Currency spot market Futures and forward contracts

Options Swaps Exotics Bank loans Time deposits Certificates of deposit Treasury bills Repurchase agreements Commercial paper Overdrafts Banker�s acceptances Supplier credit Intercompany borrowing Discounting of trade bills

72 Medium- and long-term instruments/regulations Overview Securities markets Portfolio investment Trading, clearing and settlement Corporate governance Listing procedures Recent initial public offerings Underwritten offerings Rights offerings Private placements GDRs/ADRs Alternative markets Bank loans Financial leasing Corporate bond issues Private placement of notes Structured finance Infrastructure financing Trade financing and insurance

96 Key contacts

Charts 5 Financial assets/GDP 5 Financial regulatory system 70 Deposits 5 Private-sector credit/GDP 8 Financial sector assets & liabilities 70 Indicative investment yields 5 Deposits/GDP 49 Base interest rates 76 Stockmarket indices 5 Financial risk 51 Month-end exchange rates 78 Equity holdings 5 Banking system openness 69 Indicative borrowing rates 88 Loans

2 China


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Sal Genna

Amy Ha

Adriana Defillipi

Tom Ehrbar Managing editor, Country Commerce

Veronica Lara

Debarati Ghosh Managing editor, Country Finance

Andrew Salome Viteritti

China 3


Regulatory/market assessment

• The Chinese monetary agencies, including the People�s Bank of China (PBC�the central bank) and the China Banking Regulatory Commission (CBRC�the industry watchdog), were involved by mid-2011 in implementing a government decision to cool the economy by reining in excessive lending. This followed an aggressive extension of credit in the wake of the 2008 global financial crisis, aimed at keeping growth momentum high in China despite dramatic slowing in key export markets, especially in North America and Europe. 6

• Effective June 1st 2011, China introduced new rules ordering banks to keep an average daily loan-to-deposit ratio of 75%. Previously, they only had to document that this ratio was kept at specific dates. 7

• China�s top state-owned commercial banks moved aggressively to improve their capital base with bond and rights issues in 2010. The banks succeeded in raising their capital-adequacy ratios after expansive lending in the wake of the global financial crisis of 2008�09. 15

• Foreign banks increased their presence in China in 2010, reflecting an optimistic view of business in the country. They reported after-tax profits of Rmb7.79bn for all of 2010, up 20.8% from a year earlier, and posted a nonperforming loan ratio of 0.53% at end-2010, down from 0.85% a year earlier. 21

• Foreign activity in the investment banking business has heated up. For example, in June 2011 Morgan Stanley (US) launched Morgan Stanley Huaxin Securities, a brokerage joint venture with China Fortune Securities. This followed the opening in May 2011 of Huaying Securities, a joint venture between Royal Bank of Scotland (UK) and Guolian Securities. 24

• In August 2010 China issued detailed regulations about permitted investment by insurance companies. It set the maximum investment in both unsecured corporate bonds and shares and equity funds at 20% of the insurer�s total assets, respectively. 30

• Chinese venture capital investment has rebounded after a slow period caused by the global financial crisis; retail, biomedicine and clean technology are likely to be the largest targets of investment in 2011. The global financial crisis has brought about a decisive change in venture-capital financing patterns in China, as most of the funding is now denominated in the Chinese currency, reflecting weaker liquidity of the US dollar. 39

• Within less than a year, a booming offshore market in the renminbi had developed in Hong Kong as of end-July 2011. This is fuelled partly by speculators betting on a continued rise in the value of the Chinese currency. 63

• China allowed companies to enter into currency options agreements effective April 2011. A cautious attitude characterises the move, including rules requiring enterprises to document a need to hedge. Additionally, with effect from March 2011, China allowed banks and other financial institutions to carry out cross-currency swaps on behalf of their clients. 67, 68

Regulatory/market watch • New tougher rules on banks� capital ratios based on Basel II and III will be introduced beginning in January 2012. As of end-July 2011, China is working on a list of banks and financial institutions that are systemically important or �too big to fail�. They are likely to include the five major state-owned commercial banks. 10

• As of end-July 2011, China is likely to gradually push for interest-rate reform. However, signs of resistance have emerged among domestic banks, dependent on interest income for their revenues. 46

• China had started preparatory work by end-July 2011 for the reintroduction of bond futures, which were banned in the mid-1990s when speculative trading rose to a level seen as threatening to financial markets. China has also said it will allow qualified foreign institutional investors to trade in stock index futures, but it had not provided a timetable as of end-July 2011. 65

4 China


China at a glance

Elections: National leaders are not elected but emerge from the political-bureaucratic structure of the Chinese Communist Party (CCP). The current government line-up was approved at the National People's Congress (NPC) meeting in March 2008. A new party leadership will be announced at the 18th national congress of the CCP in late 2012. The new government line-up will be announced in March 2013 at the NPC, when Xi Jinping and Li Keqiang are expected to take over from Hu Jintao and Wen Jiabao as president and premier, respectively.

Government: China is a one-party state ruled by the CCP, which maintains an organisation parallel to and with authority over all organs of government. The executive is a 15-member State Council elected by the NPC. State Council members, including the prime minister, may not serve more than two consecutive five-year terms. The unicameral NPC is composed of 2,989 delegates who are elected by provinces, municipalities, autonomous regions and the armed forces. There are 22 provinces, four municipalities directly under central-government control and five autonomous regions. These elect local people�s congresses and are administered by people�s governments.

Major political parties: The CCP.

Fiscal year: January 1st�December 31st.

Standard & Poor�s: AA-

Moody�s Investors Service: Aa3

Fitch: A+

*Senior unsecured long-term foreign-currency debt ratings.

Economist Intelligence Unit country risk rating*

Sovereign risk Currency risk Banking sector risk Political risk Economic structure

risk Country risk BBB BBB B B A BB

* Overall scores for each risk category are on a numerical scale of 0�100 (0 least risky, 100 most risky). There are ten rating bands based on this numeric scale�AAA, AA, A, BBB, BB, B, CCC,

CC, C and D�each comprising ten units of the 0�100 scale. For example, scores 0�10 = AAA and > 10�20 = AA. If the score is in a boundary area between two rating bands (scores ending in 0,

1, 2 and 9), it is at the analyst's discretion whether to assign the higher or lower rating. The overall score for each category of risk is a weighted combination of the scores assigned to the

qualitative and quantitative indicators that inform our credit risk model.

Fu ndam en tal ind ic at or s

Sovereign debt ratings*

Political structure

China 5


Fundamental indicators

Source: Economist Intelligence Unit.

Deposits(% of GDP)

Financial risk(100=high risk)

Banking system openness(5=good)

Financial regulatory systems(5=high quality)

Financial assets(% of GDP)

Private-sector credit(% of GDP)

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ChinaAsia and Australasia (av)

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6 China


Financial regulation in China

China�s financial sector is large but generally immature, with significant structural weaknesses. The quantity of household savings has risen significantly in recent years, as the declining level of social welfare offered by the state has encouraged increased saving for retirement, healthcare and the education of children. The reforms of the past few years have meant that risk-management techniques, and hence the quality of bank lending, has improved. However, the continued dominance of five large state-owned banks suggests that savings are not being used efficiently. Banks are now largely free to lend to whomever they want, but pressure from local governments means that lending decisions are still occasionally driven by political factors rather than a desire for profit. The pace of financial-sector reform has been unsteady, but its direction has generally been towards liberalisation. Following concessions made as part of China�s accession to the World Trade Organisation (WTO), a number of foreign banks now operate in competition with the state-owned sector, both in joint ventures and independently. Although a number of barriers on the operations of foreign banks have now been removed (following the deadline in December 2006 for China to comply with its WTO obligations on retail-banking liberalisation), foreign banks still only account for around 2% of the Chinese banking system�s assets. Acquiring a larger share of this market will take the foreign banks years, if not decades, to achieve. The securities market is also gradually developing in terms of the sophistication and range of products available. China�s decision to abandon the renminbi�s peg to the US dollar spurred the development of a new range of foreign-exchange-related services, even though the exchange rate is still tightly controlled by Chinese authorities. The listing of China�s major state-owned commercial banks overseas is increasing the pressure on them to improve management techniques. The banking sector�s assets are lent primarily to state-owned companies, making it difficult for the private sector to access capital. For most companies, other means by which to access funds remain largely unavailable. The stockmarkets are characterised by high levels of market manipulation, and bond markets are significantly underdeveloped. Standards of transparency and regulation still need to be raised before the market can achieve its potential. China�s banking system is regulated by the Commercial Bank Law, which became effective in July 1995. The law formalises a 1994 policy to make the banking system adhere to market principles. The more detailed General Rules on Lending, issued in 1996, largely reiterate the main principles of the Commercial Bank Law, stressing that banks should rate borrowers� creditworthiness using objective criteria. The law�s most important feature is that it liberates the state commercial banks from political pressure and requires them to �go fully commercial�. The law requires banks to conduct their lending operations on the basis of profitability, liquidity and risk minimisation. However, this new freedom can be limited or suspended when it runs counter to the interests of the state�the State Council �may direct the banks to conduct their loan business in accordance with the need for development of the national economy�. Losses arising from such loans are to be compensated by the State Council, although these measures have not been clearly defined.

Banks and other financial institutions

The Chinese monetary agencies, including the People�s Bank of China (PBC�the central bank) and the China Banking Regulatory Commission (CBRC�the industry watchdog), were involved by mid-2011 in implementing a government decision to cool the economy by reining in excessive lending. This followed an aggressive extension of credit in the wake of the 2008 global financial crisis, aimed at keeping growth momentum high in China despite dramatic slowing in key export markets, especially in North America and Europe.

Following this lending binge, China was faced in 2010 by new problems, including rapid growth in so-called local-government financing vehicles designed to attract funds from banks for investment primarily in local infrastructure projects. The credit expansion has led to concerns about deterioration in banks� asset quality. This situation persisted as of end-July 2011. Liu Mingkang, the CBRC chairman, repeatedly warned in the first half of 2011 and most recently in remarks published in the newspaper Study Times on June

Overview

China 7


6th 2011 about the need to curb lending to these financing vehicles as well as to the real estate market.

In another bid to curb excessive lending, the CBRC issued new rules effective June 1st 2011 ordering banks to prepare monthly statements showing an average daily loan-to-deposit ratio of 75%; previously, they only had to document this ratio at longer dates (eg, at the end of each quarter).

The CBRC recorded a total of 3,769 financial institutions under its supervision as of December 31st 2010, a slight decline from 3,857 a year earlier; the number of employees at the institutions rose to 2.99m from 2.85m over the same period. The dominant players in the market remain the state-owned commercial banks. These include Agricultural Bank of China (ABC), Bank of China (BOC), Bank of Communications (BoCom), China Construction Bank (CCB) and the Industrial and Commercial Bank of China (ICBC).

In addition to these five dominant institutions, there are national and regional commercial banks, rural and urban credit co-operatives, and foreign and joint-venture financial institutions. Three policy banks were set up in 1994 with instructions to take over government-mandated lending from four of the state commercial banks (ICBC, BOC, CCB and ABC). China also has two private banks.

In the years that have passed since China�s entry to the World Trade Organisation in 2001, the country�s financial sector has moved gradually towards a more market-oriented system, but the state continues to dominate the sector. Agreements that the Chinese authorities negotiated with foreign countries before the country�s December 2001 entry into the trade body require the gradual opening of the banking, insurance and fund-management sectors. Other sources of change to the financial sector are attributable to the rise of domestic investment banks and securities brokers.

China�s nonbanking financial institutions have evolved from the heavily regulated, state-dominated financial system of the pre-reform area. In some industries, such as insurance, this has meant developing a competitive, market-oriented system out of a previous state monopoly; in others, such as fund management, development has had to take off virtually from scratch. This process is by no means over; hence, China�s nonbanking financial sector is still much less advanced than in countries where capitalism has had decades or centuries to take root.

Insurers have vast growth potential in China because of the country�s low coverage, combined with the need for most Chinese to find alternatives to the crumbling social-security network, much of it provided in the past by the state-owned enterprises.

A large portion of China�s nonbanking financial sector is not directly comparable to that of other countries. For instance, asset-management firms do not perform functions similar to their Western counterparts, but are special-purpose-built vehicles to rid the banks of their huge problem with nonperforming loans. Similarly, international trust and investment firms are

8 China


leftovers from a borrowing frenzy in the 1980s; they are now being consolidated.

China has gradually established a framework of regulatory agencies in charge of supervising nonbank financial institutions, and taking over responsibilities from the PBC. The China Insurance Regulatory Commission, established in 1998, oversees insurance firms, and the CBRC oversees the asset-management companies, the international trust and investment companies and the banks� factoring activities. The China Securities Regulatory Commission supervises the mutual funds and also the emerging share-investment activities of the national pension fund. The Ministry of Commerce has a large say in their investment activities since foreign money is frequently involved in venture-capital firms.

Foreign investors in China fill most of their renminbi financing needs through foreign commercial banks, specialised banks and other members of the commercial-banking system. Offshore sources of finance continue to play an important role in meeting foreign companies� financing needs. The World Bank is a big lender to China, and the International Finance Corp�the World Bank�s private-sector financing arm�has an office and a growing presence in Beijing.

Despite its vast size, China has a highly centralised political system; nearly all governmental authorities are in Beijing, the capital. By contrast, the main economic centres are Shanghai in the east and Shenzhen in the south. The country�s stockmarkets and many of its most dynamic companies are in those two cities.

Financial sector assets and liabilities(US$ bn)


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The National People�s Congress (NPC) passed the Law on Banking Regulations and Supervision in December 2003, which designated the China Banking Regulatory Commission (CBRC) as the top industry watchdog in China. The law, which took effect on February 1st 2004, authorises the CBRC to oversee all banks and nonbanking financial institutions. The law gives the CBRC authority for approving new banking institutions, charges it with formulating prudential rules and regulations, and gives it wide-ranging powers of examination, including off-site and on-site investigation. The commission is also responsible for detecting risk in the banking sector. It established an early-warning system in October 2008 to help the CBRC identify problem banks at an early stage.

Bank regulators

China 9


On February 18th 2008, the CBRC issued Guidelines for the Consolidated Supervision of Banks. The rules aimed to introduce more efficient supervision of domestic and foreign banks as they expand to new business areas with a growing number of subsidiaries engaged in nonbanking operations. Large Chinese banks are gradually expanding into neighbouring industries such as insurance, asset management and financial leasing, motivating the authorities to update existing regulatory frameworks. The guidelines charge the CBRC with taking steps to supervise the operations of diversified banking groups and to ensure that the banks extend their rules on corporate governance, risk management and internal controls to their nonbanking subsidiaries.

On October 29th 2009, the CBRC issued Liquidity Risk Management Guidelines for Commercial Banks, requiring lenders to carry out quarterly reviews of possible risks posed by the failure of borrowers to repay debt at maturity. The reviews, which are to be carried out under the supervision of the CBRC, reflect the CBRC�s concerns that a growing number of companies will go bankrupt as a result of a government drive to consolidate sectors characterised by overcapacity and that rapid credit growth during 2009 may lead to rising nonperforming loans (NPLs).

The Central Bank Law, which came into effect in 1995, defines the duties and responsibilities of the People�s Bank of China (PBC�the central bank). The law established the PBC as a modern central bank with a role similar to that of the US Federal Reserve, though with less autonomy than its US counterpart since it answers directly to the State Council. Under the law, the PBC�s monetary-policy committee is a direct copy of the Federal Open Market Committee in the US. Regional committee members are responsible for monitoring policy implementation within their respective zones. Since December 2002, the governor of the PBC has been Zhou Xiaochuan, formerly the chairman of the China Securities Regulatory Commission. As of end-July 2011 the PBC had a network of some 2,105 sub-branches at the provincial capital prefecture and county levels, as well as operational offices in Beijing and Chongqing.

The PBC audits the operations and balance sheets of all financial institutions in China. It requires banks to maintain minimum capital reserves, fixes the nation�s base lending rates and provides rediscounting facilities (for the purchase and sale of enterprise receivables that have already been sold or discounted to the creditor firms� commercial banks). The PBC controls the banking system�s payment, clearing and settlement systems. Under the Central Bank Law, the PBC can no longer act as guarantor for any organisation or individual. Only the State Council can give such guarantees.

The PBC was also barred from undertaking many of the lending operations and other banking functions in which it had previously engaged. The law spells out which monetary instruments the PBC may use. It states that the PBC can lend to commercial banks, trade in government bonds and exercise full autonomy in the application of all of its monetary instruments.

The NPC passed amendments to the Central Bank Law in December 2003, which implemented relatively minor changes, including a provision that a special agency be set up to co-ordinate policies among the increasing number

10 China


of regulators. The amendments did not go as far as some local economists had expected in terms of strengthening the PBC�s independence.

The Ministry of Finance (MOF) manages central-government finances and prepares the state budget for approval by the NPC in March of every year. Through its subsidiary, the State Administration of Taxation, the MOF sets tax policy and co-ordinates tax collection to meet these budgetary needs. The ministry is responsible for financing any shortfalls, for which it issues foreign and domestic Treasury notes.

The State Administration of Foreign Exchange (SAFE) manages China�s foreign-exchange (forex) reserves. It is responsible for drafting regulations and authorising national and foreign financial institutions in conducting forex operations. It administers the complex set of regulations that China uses to keep its currency open on the current account (that is, for trade and other purposes) but closed on the capital account (for most types of investment). These systems shield the domestic economy and its unsteady banking system from global capital flows.

All foreign borrowings by wholly Chinese-funded institutions require SAFE�s approval. Banks should not lend hard currency to any local enterprise without such approval, nor should they accept assurances that SAFE approval is not necessary. Chinese firms that seek to borrow overseas must bid for forex quotas from SAFE, but a separate approval must be sought for every foreign-currency fundraising effort.

Management of the banking system is laid out in a set of regulations (the Interim Banking Control Regulations of the People�s Republic of China) promulgated by the State Council in 1986. These were refined in the General Rules on Lending of 1996 and supplemented by the Law on Banking Regulation and Supervision, effective February 1st 2004, which outlined the responsibilities of the CBRC.

Banks must meet required levels of capital. The minimum registered paid-up capital to set up a standard commercial bank is Rmb1bn. Urban and rural co-operative commercial banks need only Rmb100m and Rmb50m, respectively. Investors purchasing more than 10% of the equity of a domestic commercial bank must obtain PBC approval. Liquid bank assets, under PBC regulations, must equal at least 25% of liquid liabilities. Loans to a single borrower must not exceed 10% of a bank�s capital. The PBC has the authority to set other asset-liability ratios, as it deems necessary.

Commercial banks have also begun using asset-liability controls based on ratios set by the CBRC, with stricter internal audits and proper credit-risk management. At the same time, the CBRC has tightened up the supervisory role formerly held by the PBC on issues such as market entry, capitalisation requirements, asset quality, liquidity and profitability, marking a bold distinction between the banking and securities industries.

On May 5th 2011 the CBRC announced that stricter capital-adequacy ratio rules for banks, based on the Basel II and III standards, would be introduced on January 1st 2012. The new rules will set the required leverage ratio (core capital

China 11


as a percentage of total assets) at 4%, while demanding that an amount of money equivalent to 2.5% of total outstanding loans be set aside to cover NPLs. Meanwhile, in July 2011 the CBRC was preparing a list of banks and financial institutions that were systemically important, or �too big to fail�, and intends to issue the list in the third quarter of the year. The group is likely to include at a minimum the five major state-owned commercial banks. The systemically important institutions must implement the new ratios by the end of 2013, while other institutions have until the end of 2016. As of end-July 2011, it was too early to say if this deadline could be met; previous attempts to introduce the less-ambitious Basel II standards met numerous delays.

In September 2002 the PBC published new Guidelines on the Internal Controls of Commercial Banks, in an attempt to improve the lending of all banks and, in particular, that of the large state-owned commercial banks. The new framework requires the banks to adopt a three-tiered structure to conduct effective management and supervision. Senior management is in charge of day-to-day operations and internal-control mechanisms. The board of directors appoints senior management and also supervises internal controls. Finally, the board of supervisors ensures that the bank operates in accordance with existing legislation and oversees both the board of directors and senior management.

Perhaps more importantly, the 2002 guidelines were particularly focused on the crucial issue of the big state-owned banks� lingering high levels of NPLs. The guidelines state that banks must improve their procedures when granting credits and become better at pinpointing risks associated with providing new loans.

Under the more detailed provisions in the 1996 General Rules on Lending, loans must be made against collateral. The bank must strictly examine the borrower�s collateral quality, credit record and repayment capability, and the feasibility of realising the mortgaged or pledged assets. A written contract must cover all aspects of a loan.

The law specifically bans interference in banking operations by any nonbank individual or organisation. Commercial banks may not give unsecured loans to related parties or provide secured loans on preferential terms. Under Articles 40 and 41 of the law, no organisation or individual may force a commercial bank to provide a loan or guarantee. These provisions aim to correct the widespread abuses that took place in earlier years, when military and Communist Party officials used their political clout to extract concessionary loans from local bank branches.

The PBC issued its Guidelines on Loan-Loss Provisions in April 2002. The PBC introduced a five-tier loan-classification system to be used by all banks alongside the four-tier system that was already in place. In the new system, loans are classified as �pass�, �special mention�, �substandard�, �doubtful� or �loss�. Loans are classified according to various criteria, including the borrower�s credit history and the value of the collateral. Certain loans, such as those that have been restructured, can be classified as no higher than substandard. This marks a certain degree of sophistication compared with the

12 China


older four-tier system, which was based more mechanically on the number of days that loans had been overdue.

According to the most recent figures from the CBRC, the overall NPL ratio as of end-March 2011 was 1.1% (compared with 1.4% a year earlier); including 0.4% characterised as �substandard�, 0.5% as �doubtful�, and 0.2 as �loss�. The NPL ratio of the top five banks, according to the CBRC, also stood at 1.1% at end-March 2011. This compared with 1.6% at end-March 2010. The CBRC said in its annual report published in June 2011 that efforts had paid off to curb the risk of bad loans especially to local government-sponsored financing schemes, which had been seen as one of the biggest dangers.

Analysts also warn that the decline in the NPL ratio likely reflects a rapid increase in the stock of outstanding loans, rather than an actual resolution of the problem. This increase has become especially pronounced since late 2008 as the big state-controlled commercial banks have extended credit in massive amounts to accommodate an Rmb4trn spending package organised by the government to lift economic growth during the financial crisis. This means, by implication, that NPLs are currently being merely �diluted� among the larger amount of outstanding loans, and that, in future, the NPL ratio will again rise as some of the loans now being extended turn bad.

The five state-owned commercial banks have historically been burdened by high levels of NPLs, primarily because of their previous role as policy lenders. Many state-owned enterprises (SOEs) cannot service their debts because they must deal with difficult markets, increased competition and selective restructuring. Often, for example, they face local government-imposed restrictions on laying off workers and selling assets.

The PBC and the MOF now allow all banks to make loan-loss provisions based on asset quality, rather than on the basis of their consumer-loan balances. In addition, since 2001, provisions have ranged from 1% to 100%, which is a considerable improvement over previous practice, when the MOF capped all provisioning at 1% of loan balances. One remaining shortcoming of the system is that the banks themselves, not the regulators, determine specific loan-loss reserves. The Guidelines on Loan-Loss Provisions merely set benchmarks for provisions for different classes of loans: 2% for �special mention� loans, 25% for �substandard�, 50% for �doubtful� and 100% for �loss�.

Since 2002, banks have not been able to book overdue interest payments beyond 90 days as accrued income (the previous time limit was 180 days). The measure had a negative effect on the bottom lines of those banks with high levels of NPLs�that is, the large state commercial banks. The rule is important in that it recognises overdue interest income in line with international accounting rules.

Banks were previously expected to stick to banking and to avoid speculation. China still bars banks from investing in real estate and stocks, but it is now encouraging banks to acquire trusts. However, the Chinese government�s attitude to diversification has changed as local banks are facing growing competition following the opening up of the banking sector to foreign rivals, as required by the World Trade Organisation. Banks have branched out into

China 13


numerous sectors, including the insurance and financial leasing segments (see the Insurance and Financial leasing sections below).

The central government has taken other significant steps to chart a new, more market-oriented direction for the country�s banking system. The initiatives include the following:

• A willingness to allow foreign institutions to invest in local banks. In March 2010 Deutsche Bank (Germany) became the single largest shareholder in Huaxia Bank, a medium-sized lender, after it acquired Sal Oppenheim Jr (also of Germany). This boosted Deutsche Bank�s holdings in the Chinese lender to 17.12%, up from 13.69%, ahead of Chinese steelmaker Shougang�s 13.98% stake in the Chinese bank. In February 2009 Banco Bilbao Vizcaya Argentaria (Spain) raised its stake in China CITIC Bank from 4.80% to 10.07%, paying �800m; the agreement was reached in June 2008. Also in February 2009, Hong Kong�s Hang Seng Bank acquired 20% in Yantai City Commercial Bank for Rmb800m.

The CBRC raised the 15% cap on individual foreign investment in local banks to 20%, with a 25% maximum on total foreign holdings, in late 2003. However, foreign banks have been more interested in weathering the global financial crisis of 2008�09 by selling off their stakes in Chinese banks as opposed to increasing their holdings. This sell-off trend was further reinforced by the completion of many investors� three-year �lockup period�, during which foreign banks were contractually barred from reducing their stakes in Chinese banks. A prime example is Bank of America�s investment in China Construction Bank (CCB). In November 2008 Bank of America (US) spent US$7bn to raise its stake in CCB to 19.15% from 10.75%. However, in January 2009 it reduced its stake to 16.6% by selling US$2.8bn worth of shares, followed by a further reduction to about 11% with a US$7.3bn sale in May 2009.

• A more permissive attitude towards allowing Chinese banks to list their shares. Everbright Bank, the latest major Chinese lender to go public, raised Rmb18.9bn in an initial public offering (IPO) on the Shanghai Stock Exchange on August 11th 2010; on September 16th, it increased the size of the offering to Rmb21.7bn. This followed the Agricultural Bank of China�s (ABC) massive US$19.2bn IPO in both Shanghai and Hong Kong in July 2010. Prior to the planned share sale by ABC, the most eye-catching IPOs were by China�s other major state-owned commercial banks�in October 2006 Industrial and Commercial Bank of China raised US$21.9bn in a dual listing in Hong Kong and Shanghai. In September 2007 CCB raised Rmb58.1bn on the Shanghai Stock Exchange, shortly after Bank of Beijing raised Rmb15bn in Shanghai. In November 2009 China Minsheng Banking Corp, China�s largest semi-private lender, raised HK$30.1bn on the Hong Kong Stock Exchange.

• An overhaul of the nation�s international trust and investment corporations (Itics), vehicles set up in the early years of reform to channel foreign and domestic funds to local investment projects. The failure of Guangdong Itic in 1998 lent a certain urgency to this task, and the PBC is now closing down or eliminating inefficient Itics, via mergers and acquisitions. According to the CBRC, only 63 Itics remained as of end-July 2011, from 239 at their peak. China is now seeking foreign investment into Itics. In September

14 China


2009 the Macquarie Group (Australia) bought 19.99% in a joint venture (JV) resulting from a reorganisation of Kunming International Trust and Investment. The JV had initial registered capital of Rmb300m. On July 26th 2011 the Shenzhen Daily newspaper reported that China International Capital Corp (CICC) bought 35% of Zheshang Trust, becoming the first local financial institution to gain control of an Itic. Following the acquisition, CICC is the second-largest investor in the company, after state-owned Zhejiang International Business Group, which holds 56%.

• Official support for the development of capital markets. The PBC is also pushing for the active development of direct capital-markets financing to substitute for bank credit. This will minimise the risk shouldered by the banking sector as the main provider of funds to the SOEs. In particular, the PBC wishes to see the rapid development of securities markets that could channel savers� money into efficient enterprises.

Regulatory watchlist

• The China Banking Regulatory Commission (CBRC�the main industry watchdog) said in May 2011 that it was preparing a list of lenders considered �too big to fail�, or in other words, seen as �systemically important�. The CBRC said the list was likely to be completed in the third quarter of 2011. Observers considered it likely that at least the five major state-owned commercial banks would be included on the list.

• The CBRC also said in May 2011 that it was preparing new stricter regulations on banks� capital and leverage ratios, aimed at bringing China in line with the Basel III requirements. The rules, which are expected to take effect from January 1st 2012, are expected to impose an 11.5% capital-adequacy ratio on big banks and a required leverage ratio (core capital as a percentage of total assets) of 4%.

• Among the innovations that the Chinese authorities are considering is the establishment of a deposit-insurance system financed by the banks themselves. As early as May 2005, the People�s Bank of China (PBC�the central bank) set up a special Deposit Insurance Department to oversee the system, but implementation slowed down afterwards. However, with the onset of the global financial crisis, new momentum seems to have built for establishing such a system. In November 2008 Zhang Jianhua, the head of the PBC�s research department, told a gathering in Beijing that a plan for implementation of a system had been handed over to the State Council, or cabinet, for approval. It was expected that the plan would cover 98% of personal and corporate accounts nationwide, Zhang said. In January 2011 the PBC confirmed in a statement that a deposit-insurance system remained a priority for the future.

• The Financial and Economic Committee of the National People�s Congress (legislature) in May 2010 handed over a draft Telecommunications Law to the State Council, or cabinet, for review. A draft, which has circulated since October 2009, states that the Chinese government �actively promotes network convergence�. It also sets limits for foreign investment, with a cap of 49% on foreign holdings in basic telecommunications services (public network infrastructure, public data transmission and basic voice communication). For value-added telecommunications services (defined as everything else), the cap on foreign investment is 50%, according to the draft. As of end-July 2011, the law was still being reviewed by the State Council.

China 15


Top ten domestic banks Ranked by assets at end-2010�US$ m

Market

Bank Pretax profit a Assets share (%) b

Industrial and Commercial Bank of Chinac 24,944 2,022,029 14.0

China Construction Bankc 26,316 1,624,146 11.2

Bank of Chinac 21,356 1,571,494 10.9

Agricultural Bank of Chinac 5,187 1,553,096 10.8

China Development Bankd n.a. 751,202 5.2

Bank of Communicationse 7,505 593,689 4.1

China Merchants Banke 5,009 360,954 2.5

China CITIC Banke 4,311 312,697 2.2

China Minsheng Banking Corpe 3,452 273,999 1.9

Industrial Banke 3,607 277,895 1.9

Total market n.a. 14,440,200 100.0

(a) After nonperforming loans provisions. (b) Calculations by the Economist Intelligence Unit (EIU) based on total assets recorded by the China Banking Regulatory Commission (CBRC). (c) State-owned banks. (d) State-owned development bank. (e) Joint-stock commercial banks.

Source: The Asian Banker; CBRC; and EIU.

China�s domestic banking system is made up of five state-owned commercial banks, two private banks, two development banks, 12 joint-stock commercial banks, and urban and rural co-operative banks as of end-July 2011. The five state-owned commercial banks dominate the sector, accounting for 47.9% of total assets of Rmb99.9trn of all financial-sector assets as well as 47.9% of all deposits of Rmb93.6trn at end-April 2011, according to the China Banking Regulatory Commission (CBRC). These five are Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), Agricultural Bank of China (ABC) and the Bank of Communications (BoCom). According to The Asian Banker, these banks� returns on assets ranged from 0.99% (for ABC) to 1.32% (for both ICBC and CCB) in 2010.

The special status of state commercial banks stems from the period of 1949�78, when the ABC was primarily responsible for supporting the farm sector, the BOC for dealing with foreign-exchange needs, ICBC for �technical transformation� loans, CCB for construction projects, and BoCom for telecommunications and transport projects. These distinctions have blurred in recent years as the five banks came to offer commercial- and international-banking products. They have long been the principal financiers of the state-owned enterprises (SOEs). They fund themselves largely through deposits and central-government allocations.

The state commercial banks have had to cope with large provisioning requirements, operational inefficiencies and a high cost base. Capital levels of the big state-owned commercial banks are comparatively low, and they had been deteriorating as a result of massive lending in 2009. However, in 2010 they strove to raise the ratios, with some success.

CCB�s capital-adequacy ratio was 12.68% at end-2010, up from 11.70% at end-2009, after strengthening its capital base via a Rmb62bn share rights issue in Shanghai and Hong Kong in November 2010. Similarly, BOC�s capital-adequacy

Domestic banks

16 China


ratio was 12.58% at end-2010, up from 11.14% a year earlier, as a result of a Rmb40bn convertible bond issue in May 2010 followed by a Rmb60bn rights issue in November 2010. The ICBC raised Rmb70bn in 2010, and BoCom raised Rmb32.7bn, both also in a bid to improve their capital bases.

The state commercial banks will require continuous recapitalisation as provisioning requirements steadily eat away at their base capital. This pattern was also obvious in previous years, when the banks received capital injections in preparations for listings abroad. In the most recent example of this, ABC, the weakest of the five, received a US$19bn capital injection in November 2008, prior to a share sale at home and abroad.

Industrial and Commercial Bank of China was incorporated in 1984 to take over the central bank�s branch network, budgetary allocations and loans to SOEs. It finances industry and is the main supplier of credit to the urban economy, mainly through short-term working-capital loans to a wide range of industrial sectors. It does business with about 80% of China�s small and medium-sized SOEs and claims to be the country�s biggest mortgage lender.

ICBC is China�s largest bank, with assets of US$2.02trn at the end of 2010, up from US$1.73trn at end-2009, according to The Asian Banker. Its pretax profit reached US$24.9bn in 2010, up 1.6% from a year earlier. The bank cut its nonperforming loan (NPL) ratio to 1.08% at end-2010, down from 1.54% a year earlier and 21.16% at the end of 2004. ICBC raised US$21.9bn in a massive public offering in Hong Kong and Shanghai in October 2006. As of end-2010, the largest shareholder was Central Huijin Investment�the central bank�s investment arm�holding a 35.4% share, followed by the Ministry of Finance (MOF) with 35.3%. Foreign shareholders include Goldman Sachs of the US, which reduced its share in the bank from 3.9% to 2.96% after it sold 23% of its Hong Kong-listed shares in ICBC in September 2010. American Express of the US held 0.2% of the shares in ICBC as of end-2010.

Internationally, ICBC has branches in Almaty, Busan, Doha, Frankfurt, Hong Kong, London, Luxembourg, Macau, New York, Seoul, Singapore, Sydney and Tokyo, as well as offices in Dubai, Jakarta and Moscow. It is actively involved in overseas acquisitions. In January 2011 it acquired 80% in the US subsidiary of Bank of East Asia (Hong Kong) for US$140m, the first Chinese takeover of an American retail bank. In the same month, ICBC said it had completed the purchase of 70% in Bank of East Asia�s Canadian operations for C$80.25m. In April 2010 it bought 97.24% of Thailand�s ACL bank for US$550m. In March 2008, ICBC bought 20% of South Africa�s Standard Bank, Africa�s largest lender, for US$5.4bn.

Through its 1998 purchase, with Bank of East Asia, of Hong Kong�based NatWest Securities Asia (since renamed ICEA Finance), ICBC set itself up to offer traditional investment-banking services. In January 2010, however, Bank of East Asia bought out ICBC, acquiring its 75% stake in ICEA Finance, the owner of ICEA Securities and ICEA Capital, for HK$372m. ICBC has also created ICBC Asia as its Hong Kong�based arm. In December 2010 ICBC bought all ICBC Asia�s Hong Kong-listed shares, taking the bank private; ICBC said the decision was made partly to facilitate the transfer of funds from ICBC to ICBC

China 17


Asia. ICBC Asia reported a 19% rise in operating profits from 2009, to HK$3.003bn, in 2010. ICBC Asia�s NPLs stood at 0.54% of total loans at end-2010, down from 0.92% at end-2009, and down from 23.2% at end-2000.

China Construction Bank was set up in 1954 to provide medium- and long-term finance for capital-construction projects and urban housing development. The bank�s main strengths are evaluating and managing large-scale projects. CCB was the first bank to introduce Western-style asset-liability management. Although CCB has engaged in international business since 1986, it is principally a domestic player.

CCB had assets of US$1.62trn at end-2010 (up from US$1.41trn at end-2009), making it China�s second-largest bank, according to The Asian Banker. It earned pretax profits of US$26.3bn in 2010, up 29.6% from a year earlier, and cut its NPL rate to 1.14% from 1.50% over the same period. CCB has important subsidiaries, such as the wholly owned China Investment Bank, Hong Kong�incorporated Jian Sing Bank (40% stake) and China International Capital Corp (42.5% stake), China�s first investment bank. In December 2006, CCB acquired 100% of Bank of America Asia (the Hong Kong subsidiary of the US bank), for HK$9.71bn. The deal pushed CCB from 16th to 9th place in the Hong Kong banking industry in terms of outstanding loans.

Central Huijin Investment Co is the largest shareholder of CCB with 57.03% of the bank�s shares. Bank of America (US) holds a 10.23% stake. Fullerton Financial Holdings (formerly Asia Financial Holdings), a wholly owned subsidiary of Singapore�s Temasek, holds a 5.65% share in the bank.

Bank of China is the oldest of the five main banks. It handles deposits, overseas remittances and other transactions of foreign-invested companies in China. Although other domestic and foreign banks have expanded their businesses to include these activities, BOC maintains a powerful lead in this area. It was also the first Chinese bank to issue a credit card, the Great Wall Card.

BOC reported assets of US$1.57trn at the end of 2010, up from US$1.28trn at the end of 2009, The Asian Banker data showed. Pretax profits for 2010 totalled US$21.4bn, an increase of 31.3% from 2009, and the bank cut its NPL rate to 1.10% from 1.52% over the same period, according to The Asian Banker. BOC raised US$9.7bn in a massive initial public offering (IPO) in May 2006.

BOC has the largest overseas network among the domestic banks and operates in many countries, including Brazil, Japan, Panama, Singapore, South Africa, South Korea, the UK, the US and Zambia. The BOC Group is the second-largest bank in Hong Kong, after HSBC (UK). It is also one of only three note-issuing banks there (the other two are HSBC and Standard Chartered Bank, also of the UK). In Hong Kong, the group offers all traditional retail and corporate-banking services, including consumer-banking and corporate services to small and medium-sized companies. It also operates the largest brokerage business.

BOC entered investment banking through its unit Bank of China International (BOCI), which it created in 2000. In August 2004 BOC International Investment Managers, a joint venture between BOCI and Merrill Lynch (US), began

18 China


operations. In the same month, BOC was transformed into a company limited by shares in preparation for its overseas listing in Hong Kong in May 2006.

The top shareholder of BOC is Central Huijin Investment Co, which holds 67.55% of the shares. The National Social Security Fund holds 3.81%. The main foreign investor, after recent sell-offs, is Temasek with 4.06%.

Agricultural Bank of China was established and abolished several times until 1979, but it has operated continuously since then. ABC was incorporated to provide finance and working capital to farming through the rural credit co-operatives from which it also receives the majority of its deposit base. ABC offers traditional wholesale and retail-banking services.

Among the five banks, ABC has the largest network, with 23,486 branches nationwide as of end-July 2011. Its overseas network comprises branches in Hong Kong and Singapore as well as representative offices in Frankfurt, London, New York, Seoul, Sydney and Tokyo. ABC�s assets totalled US$1.55trn at end-2010, an increase of 19.2% from the end of 2009, while its pretax profits in 2010 reached US$5.2bn, down from US$10.8bn in 2009, according to The Asian Banker. Its NPL rate stood at 2.51% at the end of 2010, down from 2.91% a year earlier.

ABC was the last of the four state-owned commercial banks to list its shares. The bank�s IPO was launched in Shanghai and Hong Kong in early July 2010, initially raising US$19.2bn. The ABC had worked for years to prepare the IPO. In November 2008 it received a US$19bn fund injection from the government, accounting for an abrupt decline in NPLs, and in January 2009 it transformed itself into a shareholding company. In May 2009 it issued Rmb50bn in financial bonds, China�s biggest corporate bond issue ever. The bond was in three tranches: Rmb20bn of 10-year bonds with a 3.3% coupon rate, Rmb25bn of 15-year bonds with a 4% coupon and Rmb5bn of floating-rate bonds with a coupon of 0.6 percentage points above the one-year deposit rate.

As of end-2010, the top shareholder of ABC is Central Huijin Investment Co, which holds 40.03% of the shares, followed by the MOF with 39.21%. The main foreign investor is Standard Chartered Bank with 0.37%.

China Development Bank (CDB) is one of China�s two developments banks (see below). It was set up in 1994 as a tool of industrial policy, directing government funds to sectors whose rapid development was considered key to the national economy as a whole. The CDB is supposed to be in charge of industrial lending, but often acts in close coordination with the large state-owned commercial banks, using the same branch networks for its operations.

The CDB reported assets of US$751.2bn at the end of 2010, up from US$665.0bn at end-2009 according to The Asian Banker. NPLs amounted to 0.68% at the end of 2010, down from 0.94% at end-2009.

Bank of Communications was established in Beijing in 1908 as a financier for the telecommunications and transport sectors. Following the establishment of the People�s Republic of China in 1949, the bank�s operations in China were absorbed into the People�s Bank of China (PBC�the central bank). Its Hong Kong operations, however, continued to function virtually autonomously.

China 19


(BoCom regained full control in 1998.) BoCom was re-established in 1986 in Beijing and subsequently moved to Shanghai, where it re-opened for business in 1987 as a retail/commercial bank. In January 2010 BoCom took over China Life�s 51% stake in China Life CMG, a joint venture with Commonwealth Bank of Australia. After the transaction, the cost of which was not disclosed, the joint venture was renamed BocomLife Insurance Co.

BoCom reported assets of US$593.7bn at the end of 2010, up from US$484.6bn at end-2009, while pretax profits in 2010 totalled US$7.5bn, an increase of 33.9% from 2009, according to The Asian Banker. The NPL rate amounted to 1.12% at the end of 2008, down from 1.36% at end-2009.

BoCom is owned by the MOF (27.41%), HSBC (17.26%) and better-performing SOEs such as Capital Airports Holdings with 2.15%. The bank�s articles of association permit any individual to hold up to 10% in BoCom; however, no shares have ever been issued to the public. HSBC paid US$1.7bn in August 2004 for its 19.9% stake in BoCom. The deal represented the largest single foreign investment ever in a mainland Chinese bank, and it ensured HSBC�s position as BoCom�s second-largest shareholder. Since involving HSBC as a strategic investor, it has significantly improved its NPL ratio. Since August 2008, HSBC has had an option in its contract to increase its share to 40%, but remains barred by local regulations from exercising that option, since no single foreign shareholder is permitted to hold more than 20% in a Chinese bank.

China also has a number of second-tier commercial banks. Most have been turned into shareholding banks, and they will likely be listed in the future on the Shanghai A-share market. They are much smaller than the big state commercial banks. According to the CBRC, at end-April 2011 they accounted for 16.0% of total financial-sector assets and 16.1% of deposits.

These banks are better managed than their state-owned commercial counterparts, and they have generally stayed away from policy lending, a practice that has often led to high NPL ratios in the past. Reflecting this, China Minsheng Banking Corp, for example, had an NPL ratio of just 0.69% at end-December 2010, down from 0.84% a year earlier, according to the bank�s annual report.

In a bid to compete more effectively against the big state-owned commercial banks, ten second-tier commercial banks agreed to link their branch networks in 2001; this allows their retail customers to deposit and withdraw money at the branches of any other alliance member. Ultimately, the alliance will be extended to include syndicated lending, which would let these banks attract larger companies.

The most important second-tier commercial banks include the following:

China Merchants Bank, established in 1987, was the country�s first joint-stock commercial bank. It is indirectly controlled by the Chinese government via state-owned China Merchants Group, which holds 18.01% of the company�s shares, as well as China Merchants Steam Navigation Co (12.40%) and China Ocean Shipping Group (5.95%), both state owned. It was the seventh largest bank in terms of assets in China at end-2010.

20 China


China CITIC Bank (formerly CITIC Industrial Bank�CIB), established in 1987, is a typical retail and wholesale bank, with interests in lending, foreign exchange, trade finance, securities and private banking. China CITIC Bank still exclusively services the corporate sector, though it is keen to enter the consumer-banking market by expanding into credit-card services. The main shareholders are CITIC Group (61.78%) and Spain�s Banco Bilbao Vizcaya Argentaria (15.00%). In April 2010 Banco Bilbao entered into an auto-financing joint venture with China CITIC Bank.

China Minsheng Banking Corp, incorporated in 1995, was the country�s first private bank. It was organised by the All-China Federation of Industry and Commerce, made up of 60 shareholder companies from the private sector. Its largest shareholders are Hope Corp (5.9%), a feed-grain producer based in Sichuan, and insurers China Life (5.1%) and Ping An (4.9%). Hope is one of China�s largest privately owned conglomerates. Strictly speaking, however, even Minsheng is not a private bank since the majority of the shareholders are state owned. It made its debut on the Shanghai Stock Exchange in November 2000, issuing 350m A-shares and raising Rmb4.1bn. The International Finance Corp, a branch of the World Bank, bought a 1.08% stake in Minsheng in July 2004. The bank wants retail banking eventually to rise to 30% of its total business, from about 10% at present. In November 2009 the bank raised HK$30.1bn on the Hong Kong Stock Exchange in its first overseas listing.

City commercial banks. The 147 city commercial banks had a combined share of 7.1% of total assets in the banking system and 7.0% of deposits as of end-March 2010 (latest available figures). Their NPL ratio at end-March 2010 was 1.19%, down from 2.17% a year earlier.

The best-known city commercial banks are the Shenzhen Urban Credit Co-operative Bank and the Shanghai City United Bank. Their mandate remains the servicing of small and medium-sized enterprises, but increasingly, they also do business with large SOEs, on a strictly commercial basis. But the financial viability of most of these banks is questionable, because of continued weak management and low staff quality. Nevertheless, they are regarded as a way to soak up surplus banking employees and thus will probably receive support from the PBC.

Rural credit co-operatives (RCCs). There were 2,646 RCCs, with assets totalling Rmb6.39trn at the end of 2010 (up from Rmb5.49trn a year earlier), according to the CBRC. The number of RCCs was down from 3,056 at the end of 2009, from as high as 19,348 at the end of 2006, reflecting consolidation of the industry and restructuring of some of them into rural co-operative banks and rural commercial banks. Their NPL ratio stood at 2.47% at end-March 2010, compared with 3.59% a year earlier, according to the latest data available. The PBC admits that the sector has high NPL ratios, although they are falling. The CBRC has increased its focus on the institutions, stepping up on-site examinations and emphasising the need for training.

The CBRC had stated that one of its top tasks in banking reform was �to clarify the co-operatives� ownership structure and improve their management capacity�. In March 2005 it vowed to push ahead with reform of the RCCs into

China 21


rural co-operative banks and rural commercial banks. At the end of 2010, 223 rural co-operative banks and 85 rural commercial banks had been established through RCC restructuring, in addition to the 2,646 RCCs, according to the CBRC.

Top ten foreign banksa Ranked by assets at end-2010�Rmb m

NonperformingBank Assets Pretax profit loans (%)HSBC (UK) 256,960 b 1,456 n.a

Standard Chartered Bank (UK) 207,912 b 482 0.32

Bank of East Asia (Hong Kong) 191,760 1,243 0.19

Bank of Tokyo-Mitsubishi UFJ (Japan) 123,108 b 1,724 b n.a.

DBS (Singapore) 62,459 347 0.78

BNP Paribas (France) 45,182 b 253 b n.a.

The Royal Bank of Scotland (UK) 44,843 b 56 b n.a.

OCBC Bank (Singapore) 34,000 b 61 b 0.20

JP Morgan Chase (US) 25,562 b 259 b n.a.

United Overseas Bank (Singapore) 22,762 126 2.88

(a) Figures unavailable for Citibank China. (b) Figures estimated.

Source: The Asian Banker.

Traditionally, China did not provide a particularly friendly environment for foreign banks. This was largely a result of efforts by the People�s Bank of China (PBC�the central bank) to reap the benefits of allowing foreign banks market access without permitting them to disrupt the domestic banking system. Despite the difficult operating environment, foreign banks kept coming, lured by the vast potential market, and now especially by the considerable market-opening measures that have ensued from the country�s entry into the World Trade Organisation (WTO) in December 2001. As the market has opened up progressively in the years since WTO entry, allowing foreign banks to incorporate locally and compete on a more even playing field with local rivals, business opportunities have increased markedly.

According to the latest data available from the China Banking Regulatory Commission (CBRC), 74 foreign banks, representing 25 different countries, had opened 90 branches and sub-branches by the end of 2010; while 185 foreign banks, from 45 countries, had opened up 216 representative offices. A total of 40 foreign banks, with 223 branches and sub-branches, had incorporated locally. In addition, there were two joint-venture banks with seven branches and sub-branches and one wholly foreign-funded finance company.

The foreign banks had total assets of Rmb1.74trn at the end of 2010, up 29.1% from a year earlier. While they represented 1.71% of total assets in the Chinese banking sector at the end of 2009, this figure had risen to 1.85% at the end of 2010, according to the CBRC. This reflected a bullish attitude towards China. Foreign banks that report their holdings to the Bank of International Settlements poured a total of US$77bn into China in 2010, up 86% from a year earlier, according to the Wall Street Journal in May 2011. Foreign banks reported after-tax profits of Rmb7.79bn for all of 2010, up 20.8% from a year earlier, and

Foreign banks

22 China


posted a nonperforming loan (NPL) ratio of 0.53% at end-2010, down from 0.85% a year earlier.

Also at the end of 2010, 35 locally incorporated banks and 44 foreign bank branches had been granted licences to carry out business in the local currency, the renminbi. Another 56 foreign-bank institutions had been given permission to carry out derivatives services.

The larger banks with bases outside the mainland include HSBC (mainly through Hang Seng Bank, its subsidiary based in Hong Kong), Citibank (US), Standard Chartered (UK) and Bank of East Asia (Hong Kong), all of which have a long relationship with China. Foreign banks operating in the country generally do not disclose to the public the size of their operations, their profitability, their balance sheets or their loan quality.

Legal requirements. The Regulation on the Administration of Foreign-invested Financial Institutions took effect on February 1st 2002 (when the related Implementing Regulations also took effect). The regulations specify requirements for foreign-bank branches, wholly foreign-owned banks and joint-venture banks:

• Foreign banks with head offices outside China that wish to establish branches in the country must have total assets of US$20bn and a capital-adequacy ratio of 8% or higher. The bank must also have operated a representative office in China for at least two years prior to setting up the branch.

• Wholly foreign-owned banks and finance companies that have their head offices in China must have total assets of at least US$10bn and must also have operated a representative office in China two years prior to establishment.

• Sino-foreign joint-venture banks and finance companies must have assets of at least US$10bn, and the foreign party must already operate a representative office in China. There is no requirement for how long that office must have been in business.

• In order to engage in renminbi business, a foreign-invested banking institution must have had operations in China for at least three years and have been profitable in the two last years before application. Capital requirements used to vary depending on the business scope of the banking institution, but new rules effective September 1st 2004 apply to foreign-bank branches, wholly foreign-owned banks and Sino-foreign joint-venture banks, and wholly foreign-owned and Sino-foreign joint-venture finance companies. Capital requirements for all these institutions are Rmb300m for renminbi transactions with Chinese companies and Rmb500m for renminbi transactions with Chinese individuals.

• In late 2006 China issued new regulations encouraging foreign banks to incorporate locally. These included the Regulation of the People�s Republic of China on the Administration of Foreign-funded Banks, issued by the State Council on November 11th 2006, and the Rules for Implementing the Regulation of the People�s Republic of China on the Administration of Foreign-funded Banks, issued by the CBRC on November 24th 2006. While banks that do not incorporate locally will be barred from accepting individual deposits of less than Rmb1m�severely limiting the scope of their business�banks that do will face no

China 23


such restrictions, giving them in principle the same access to the Chinese market as local competitors.

• Guidelines for the Consolidated Supervision of Banks, released by the CBRC on February 18th 2008, require banks to ensure that rules on corporate governance, risk management and internal controls are extended to their nonbanking subsidiaries.

Foreign acquisitions and joint ventures. The PBC has relaxed its policy on foreign investors taking stakes in Chinese banks, though it remains unwilling to permit them to take control. The CBRC announced in December 2003 that the maximum share a single foreign investor may take in a local bank had been raised to 20%, from 15%. The overall maximum foreign shareholding was set at 25%.

The services foreign banks may now offer include the following:

• Basic services. Foreign banks are permitted to carry out basic services, including deposits and loans in local currency to corporate and private clients, with the rules encouraging banks to incorporate locally to take full advantage of these opportunities (see above).

• Foreign-currency transactions. Both foreign and domestic banks may take foreign-exchange deposits from foreign-invested enterprises (FIEs). The number of accounts that may be opened is restricted by the State Administration of Foreign Exchange (SAFE). Accounts may be opened to settle day-to-day transactions; special-function transactions; capital injections; special-function accounts, such as dispersing money borrowed from the bank; or bank and/or payment services, such as declaring dividends or making interest payments on debt.

• Foreign banks are the primary source of foreign-currency loans for FIEs. Cheques may be used to settle accounts and are becoming increasingly common, although the absence of computerised clearing systems can cause delays, especially in remote locations.

• Banking consultancy. Most foreign banks offer advisory services related to doing business in China. Though not engaged in the business directly, they can organise credit checks on potential clients and joint-venture partners.

• Underwriting and trading of B-shares. With the growth of China�s capital markets, some foreign banks began to underwrite B-shares, offer custody services to clients and advise on the flotation of B-shares and H-shares (those listed in Hong Kong). Crédit Lyonnais Securities Asia (France), for example, has seats on both the Shanghai and the Shenzhen exchanges for trading B-shares. Foreigners were originally excluded from the more lucrative A-share market (those reserved for Chinese investors), but qualified foreign institutional investors were given permission to buy A-shares in December 2002.

• Trade financing. This service consists mainly of opening or negotiating letters of credit (L/Cs). Although the use of L/Cs is standard for trading purposes, L/Cs are not as reliable in China as in other countries. Many Chinese banks have refused to honour L/Cs when contractual disputes have arisen between the local importer and the supplier.

24 China


Top ten brokerage firms Ranked by trading on the Shanghai Stock Exchange in 2010-Rmb bn

Member Trading Market share (%) China Guotai & Jun An Securities 4,137.77 5.65

Shenyin & Wanguo Securities 4,035.17 5.51

China Galaxy Securities 3,886.02 5.31

Haitong Securities 3,347.27 4.57

Guosen Securities 3,059.94 4.18

China Merchants Securities 2,738.11 3.74

GF Securities 2,698.32 3.68

China Securities 2,584.25 3.53

Huatai Securities 2,471.34 3.37

CITIC Securities 2,190.29 2.99

Total market 73,234.22 100.00

Source: Shanghai Stock Exchange.

Investment banks. The first half of 2011 saw a rekindling of foreign activity in the Chinese investment banking market. In June 2011 Morgan Stanley (US) launched Morgan Stanley Huaxin Securities, a brokerage joint venture with China Fortune Securities; the US partner holds 33%. This followed the opening in May 2011 of Huaying Securities, a joint venture between Royal Bank of Scotland (UK) and Guolian Securities; here, too, the foreign partner held 33%. In June 2011 JP Morgan Chase (US) received permission to launch a joint venture with First Capital Securities, called JP Morgan First Capital Securities; JP Morgan Chase will hold 33% in the venture. Also in June 2011, Citigroup (US) and Orient Securities signed an agreement to set up a joint venture, called Citi Orient Securities (with the US partner taking 33%); as of July 2011, it was still awaiting regulatory approval.

China had announced the green light for Morgan Stanley�s and JP Morgan Chase�s proposed ventures in January 2011, prior to a US trip by Chinese President Hu Jintao. It marked the end of a lengthy wait for the two banks, and a re-entry into the sector for Morgan Stanley after recently abandoning another venture (see below). The foreign banks will be allowed to underwrite stocks and bonds via their ventures, although they can only enter into brokerage business after five years of operation.

Foreigners are currently allowed to hold 33% in brokerage joint ventures; new rules promulgated by the China Securities Regulatory Commission (CSRC) on December 28th 2007 did not raise this to 49% as had been hoped. However, the 2007 regulations allow foreign investors to obtain ownership in a Chinese brokerage by buying its shares listed on the stockmarket; previously the only allowable method was to become a strategic investor in an unlisted brokerage.

Domestic investment banks are governed by the Rules on the Administration of Securities Companies issued by the CSRC and in force since March 2002. They stipulate that a securities company, in order to engage in investment banking, must have registered capital of no less than Rmb500m and have no less than ten professionals with qualifications for engaging in investment banking�related securities business.

Investment banks andbrokerages

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Foreign investment-banking firms may operate in China via joint ventures with Chinese partners. The Provisional Measures for the Administration of Chinese�Foreign Equity Joint Venture Investment Banking Institutions, in effect since 1995, define foreign investment-banking institutions to include foreign investment banks, merchant banks and securities companies that are engaged in investment-banking business and are administered by the financial or securities regulatory authorities. The measures specify a minimum registered-capital requirement for joint-venture investment banks of Rmb500m in foreign exchange. Principal partners to the investment bank must contribute at least 25% of the registered capital; nonprincipal partners are limited to 10% of the registered capital.

Under China�s World Trade Organisation agreements, minority-foreign-owned joint ventures were allowed to underwrite domestic securities issues and underwrite and trade in foreign-currency-denominated debt and equity securities immediately upon China�s accession to the trade body.

China�s first international investment bank, China International Capital Corp (CICC), was launched in Beijing in 1995. CICC�s shareholders are China Construction Bank, Morgan Stanley (US), the Government of Singapore Investment Corp and Mingly (Hong Kong). CICC is allowed to underwrite domestic equities in the local market, take equity stakes in foreign direct investments in China, assist local enterprises in mergers and acquisitions, organise project finance and handle foreign exchange (though not renminbi). Its mandate also includes assisting domestic and joint-venture firms to raise capital on the international market, advising the loss-making state sector on restructuring and assisting foreign direct investors. The CSRC issued the first joint-venture A-share brokerage licence to CICC in 2002. In order to gain this authorisation, the foreign partners had to reduce their combined stake to 49%.

In December 2010 Morgan Stanley received permission from the Chinese government to sell its 34.4% stake in CICC to US private-equity firms Kohlberg Kravis Roberts and TPG Capital as well as the Government of Singapore Investment Corp and Great Eastern Holdings, an insurance firm controlled by Singapore-based Overseas Chinese Banking Corp. In March 2011 Dow Jones Newswires reported the price of the stake was US$1bn.

CICC has established itself as the vehicle of choice for major state-owned enterprises to restructure and list overseas. It was the underwriter for the December 2009 initial public offerings (IPOs) for China Shipbuilding Industry Corp, which raised Rmb14.7bn, and China North Locomotive and Rolling Stock Co, which raised Rmb13.9bn, both on the Shanghai Stock Exchange. In Hong Kong, CICC helped underwrite Sinopharm Holding�s HK$8.7bn IPO in September 2009, as well as CPIC Life�s HK$24.1bn IPO in December 2009.

Goldman Sachs and Merrill Lynch (both of the US) have representative offices in Shanghai and Beijing; Nomura (Japan) is represented in Beijing; and ING Baring (the Netherlands) is in Shanghai. Other banks that have substantial business in China include ABN AMRO (Netherlands), BZW Securities (UK), Crédit Lyonnais Securities Asia, HSBC Investment Bank (UK), Rothschild (UK/France) and UBS (Switzerland). They typically offer assistance with issuing

26 China


bonds, underwriting share offerings and arranging syndicated loans in the international market.

Other Asian financial companies have been seeking access to the Chinese market. Seapower Financial Services Group (based in Hong Kong) has won more than ten advisory mandates for Chinese companies since setting up in Shanghai in late 1996.

On July 20th 2006 the CSRC published new rules on the domestic brokerage industry aimed at improving their risk-management capabilities. The rules set the capital requirement for broking-only companies at Rmb20m; depending on the variety of services the securities firms wish to add, such as securities underwriting and asset management, they must increase their capital to as much as Rmb200m. The rules also specify other risk-management levels that must be kept, including a ratio between net capital and debt of no less than 8%. The rules, which followed draft regulations issued in 2001, took effect on November 1st 2006.

China�s largest brokerage house is China Guotai & Jun An Securities, with trading turnover on the Shanghai Stock Exchange in 2010 of Rmb4.14trn. Other leading brokers included Shenyin & Wanguo Securities, China Galaxy Securities, Haitong Securities and Guosen Securities.

China has two development banks: China Development Bank (CDB) and Agricultural Development Bank of China (ADBC). They were set up in 1994 (along with the Export-Import Bank of China) to take over the policy-lending functions of the state-owned commercial banks and to channel government financing to priority sectors.

In theory, the CDB and ADBC are responsible for industrial and agricultural lending, and also infrastructure construction projects. In practice, the two banks are so closely associated with the state commercial banks that they often operate from the same locations and rely on the same branch networks to conduct loan business. The two policy banks finance themselves largely through the issue of bonds (which are guaranteed by the Ministry of Finance as their main shareholder) to the five state commercial banks.

CDB also issues bonds independently and has opened an office in Hong Kong to increase its international profile. Following a deal signed in July 2007, CDB invested �2.2bn in Barclays (UK), acquiring 201m new shares (representing 3.1% of the company). The Chinese government on January 1st 2008 announced a US$20bn capital injection as part of a restructuring effort that could eventually turn it into a state-owned commercial bank operating for profit. However, there had been no reported developments on this proposed transformation as of end-July 2011.

The CDB and ADBC seem to have failed in their original mission, in that they are very reluctant to become involved in policy lending because credit risks involved are less than satisfactory. However, both banks have recently supported government policies to accelerate economic development in the western parts of China by matching, renminbi for renminbi, an Rmb100bn infrastructure programme sponsored by the government.

Development and postal banks

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China Postal Savings Bank is a wholly owned subsidiary under the China Postal Group. At end-2010, the bank had a deposit base of Rmb3.03trn, and about 37,000 outlets. The purpose of the bank, according to the China Banking Regulatory Commission, is to provide basic financial services to town and village communities and to rural residents.

The Green Card�a bank card issued by the China Postal Savings Bank�can be used in a number of ways. First, cardholders can go to switching centres and transfer funds or settle bills in (selected) other cities and provinces (including Beijing, where the national switching centre is located). Second, cardholders can go to processing centres to manage deposit accounts. Meanwhile, frontline applications allow cardholders to make cash deposits, withdrawals and remittances, as well as supporting all traditional methods, such as the passbook and report printer.

In June 2002 the People�s Bank of China (PBC�the central bank) allowed Bank of Communications, China Merchants Bank, Shanghai Pudong Development Bank and Shenzhen Development Bank to provide offshore banking services. However, these banks have seen only limited growth in this segment. They blamed problems such as an inability�caused by PBC regulations�to guarantee their offshore banking units with their domestic assets for their slow growth.

Hong Kong is a special administrative region (SAR) of China, with its own mini-constitution (the Basic Law), guaranteeing a �high degree of autonomy� until 2047. Foreign affairs and defence fall within the ambit of the central government in China. The SAR has autonomy in other matters. Hong Kong is a major international offshore finance centre. For further information, see the most recent Economist Intelligence Unit report Country Finance Hong Kong.

The Macau SAR returned to Chinese sovereignty on December 19th 1999, having been a Portuguese trading post from 1557. Cohabitation with China is based on a Basic Law similar to Hong Kong�s. It ensures Macau�s financial independence and its own fiscal system until 2049. A new banking ordinance was passed in July 1992, opening the sector to foreign competition and allowing the establishment of development banks. There were 28 banks at end-July 2011. Of these banks, 12 were locally incorporated and 16 were branches of foreign banks. Other financial institutions include two cash-remittance companies, one financial intermediary and one representative office of a credit-card company.

Offshore banks

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Top ten domestic insurance companies Ranked by premium income in 2010�Rmb bn

Life insurance Company Premium income Market share (%)China Life 333.0 31.7

Ping An 159.1 15.2

New China Life 93.6 8.9

CPIC Life 92.0 8.8

Tai Kang Life 86.8 8.3

PICC Life 82.4 7.8

Tai Ping Life 33.0 3.1

Sino Life 15.3 1.5

PICC Health 9.2 0.9

Minsheng Life 8.1 0.8

Total life insurance market 1,050.1 100.0Property insurance Company Premium income Market share (%)PICC 153.9 38.2

Ping An (Property) 62.1 15.4

CPIC Property 51.5 12.8

China United Property 19.3 4.8

China Continent 13.8 3.4

China Life Property 11.3 2.8

Sunshine Property and Casualty 10.6 2.6

Sinosure 8.9 2.2

Tianan Insurance 8.0 2.0

Anbang Insurance 7.0 1.7

Total property insurance market 402.7 100.0

Source: China Insurance Regulatory Commission.

Despite China�s huge population, its insurance market remains relatively small. According to the China Insurance Regulatory Commission (CIRC), total insurance premiums, including both foreign and domestic firms, stood at Rmb1.45trn at the end of 2010; as a percentage of GDP this amounted to a meagre 3.6%, up from 3.3% a year earlier. Total assets of insurers grew to Rmb5.05trn by the end of 2010, an increase of 23.2% from 2009; by end of March 2011, assets had risen to Rmb5.41trn. Market participants should not expect explosive growth, but rather a gradual increase on the back of rising national levels of wealth. Insurance coverage is expected to expand in the coming years as the state rolls back the communist social-security system and the market expands to include those companies and their employees who were previously uninsured.

China had 70 local insurance companies (34 life, 36 non-life) and 46 foreign-invested insurance companies (26 life and 20 non-life) as of end-July 2011. However, the industry continues to be heavily concentrated in a handful of key players. China Life, the largest life insurer, commanded a market share, based on premium income, of 31.7% in 2010, according to the CIRC (down from 36.2% in 2009). Life insurance premiums of local and foreign insurers expanded by 28.9% to Rmb1.05trn in 2010, and property premiums grew by 34.5% to Rmb402.7bn.

Insurance companies

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The CIRC estimated the combined market share (of premium income) of foreign and joint-venture companies at 4.2% in 2010, up slightly from 4.1% the previous year. Foreign firms have generally been taking a larger share of the market over the past several years. Domestic companies have responded to increased competition from foreign firms by issuing shares to increase their capital bases.

Until 1992, when American Insurance Group (AIG) gained permission to enter the Shanghai market on an experimental basis, foreign participation in the sector was prohibited. Even now, entry by overseas firms is much more tightly controlled than in the banking industry. Foreign insurance companies continue to queue to enter the market, and their ardour has strengthened since China�s entry into the World Trade Organisation (WTO) in December 2001.

In August 2009 Nipponkoa Insurance, Japan�s fourth-largest property insurer, began operations at a fully owned subsidiary in the south Chinese city of Shenzhen. The company, which has registered capital of Rmb200m, targets Japanese companies located in Shenzhen.

China Construction Bank�one of four banks given the preliminary go-ahead to invest in insurance companies in 2008�in June 2011 completed the acquisition of a 51% stake in Pacific-Antai Life Insurance, a 50-50 joint venture between ING (Netherlands) and China Pacific Insurance Co; the a price was Rmb950m, according to the Global Times newspaper. The Industrial and Commercial Bank of China�another of the four�bought 60% of Axa-Minmetals Assurance, a joint venture between Axa (France) and China Minmetals Corp, in October 2010. The cost of the acquisition was Rmb1.2bn. In July 2011 Axa SA of France said it would start offering variable annuities on a trial basis, via the joint venture. This followed a decision by the CIRC in May to allow such annuities, as a hedge for policyholders against inflation, in Shanghai, Beijing and three other cities.

Two other banks given the preliminary go-ahead in late 2008 to invest in insurance firms�Bank of Communications and Bank of Beijing�had been active slightly earlier. In January 2010 Bank of Communications bought China Life Insurance�s 51% stake in China Life�CMG Life Assurance, a joint venture with Commonwealth Bank of Australia. In July 2010 Bank of Beijing bought Beijing Capital Group�s 50% stake in ING Capital Life Insurance, a 50-50 joint venture with ING Group (the Netherlands).

CIRC keeps a close eye on foreign insurers and is especially concerned by pull-outs. In September 2009 Manulife of Canada sold its 50% stake in Hancock Tian An Life Insurance, a joint venture with Tian An Life, which it had acquired when buying John Hancock Financial Services in 2004. Manulife said it was not downsizing its China engagement, as it would concentrate on its existing insurance joint venture with Sinochem.

Regulation. China�s insurance market is governed by the National Insurance Law, which came into effect in 1995; new amendments to the law became effective on October 1st 2009. The amendments broaden the scope for insurance companies� investments. The law previously had allowed insurers to only place their money in bank deposits, government bonds and other

30 China


instruments �as stipulated by the State Council�. The new law explicitly allows insurers to invest in bonds, stocks and securities investment fund shares, as well as immovable property. While the old law, via the reference to State Council discretion, made some investment possible, the new amendments are expected to dramatically increase the leeway for insurers. For example, the new regulations allow insurers to buy bonds backed by infrastructure projects; life insurers can invest up to 6% of their assets in such bonds, and non-life insurers up to 4%.

In August 2010 the CIRC issued detailed regulations about investments permitted by insurance companies, and specified certain ratios that insurers must obey. These include maximum investment in unsecured corporate bonds (20% of the insurer�s total assets); maximum investment in shares and equity funds (20% of total assets); in unlisted enterprises (5%); and in property (10%).

Since July 2007 Chinese insurers can invest 15% of their assets overseas, up from 5% previously, according to rules published by the CIRC, the People�s Bank of China (PBC�the central bank) and the State Administration of Foreign Exchange (SAFE). In April 2006 SAFE permitted insurance firms to buy foreign exchange as part of their assets for investment in fixed-income products in overseas markets. In February 2005 the CIRC, the China Securities Regulatory Commission and the China Banking Regulatory Commission jointly issued detailed rules on asset custody and settlement. In December 2005 the CIRC issued Temporary Measures on Overseas Use of Foreign Exchange Insurance Funds, allowing insurers to invest up to 80% of their foreign-exchange holdings in foreign bank deposits, bonds and money-market products, as well as �other investment objects� (a category analysts say includes shares by Chinese companies listed on foreign stock exchanges).

Chinese insurance companies booked Rmb182.4bn in returns on investments, equivalent to a rate of return of 4.4%, in the first 11 months of 2010, according to the latest information from the CIRC. This compared with Rmb214.2bn in returns on investments in all of 2009, a rate of return of 6.4%.

The 2009 amendments to the National Insurance Law removed a previous requirement ordering insurers to only use local reinsurance companies; this change is in accordance with China�s concessions made in order to enter the WTO in late 2001. The amendments also improve policyholders� rights by limiting the conditions under which insurers can cancel an insurance contract. If an insurer discovers that the policyholder has withheld crucial information, the company is permitted to cancel the contract, but must do so within 30 days; previously, there was no such time limit.

Companies now merely have to report rates and terms to the CIRC after they have set them themselves, as opposed to prior CIRC approval of the rates and terms. The amendments also widened the scope for insurers� use of funds to include investments in insurance-related enterprises.

Earlier amendments in 2003 relaxed the requirement for firms to set up separate operations for property insurance (such as for property loss, liability and credit insurance) and personal insurance (such as for life, health and

China 31


accident insurance). Following the amendments, property insurers were allowed to sell accident and short-term health insurance. But the scope of each insurer�s operations still needs the CIRC�s approval.

The CIRC grants licences to foreign insurance firms. The original 1995 law covers the operations of foreign insurance companies and agents. The regulations permitted the establishment of joint ventures in the form of joint-stock insurers. A series of supplementary regulations implementing the law were published in 1996. The Administrative Regulations for Foreign-Invested Insurance Companies took effect on February 1st 2002, stating the entry requirements for foreign insurers, based on China�s concessions for gaining entry to the WTO.

Foreign insurers wishing to do business in China must have at least 30 years of experience abroad, the operation of a representative office inside China for at least two years and total assets of more than US$5bn at the end of the year prior to application. The regulations also set a minimum capital requirement of Rmb200m, applicable to wholly foreign-owned insurers, joint-venture insurers and branches of foreign insurers with headquarters overseas.

Foreign insurers have been permitted to do business anywhere in China since December 2004. Foreign insurance companies were allowed up to 50% ownership in life-sector joint ventures immediately upon China�s accession to the WTO in December 2001. A special provision also allowed the foreign joint-venture partner to negotiate management control.

For non-life businesses, China allowed 51% ownership or branching immediately upon WTO accession, and wholly owned subsidiaries were allowed by December 2003. Brokers for insurance of large-scale commercial risks, for reinsurance and for international marine, aviation and transport insurance and reinsurance were allowed up to 50% ownership immediately upon accession. This rose to 51% in December 2004 and reached 100% by December 2005. In the non-life insurance business, foreign companies were initially allowed to provide �large-policy� business only to foreign-invested companies. They have been allowed to deal with Chinese clients only since January 2004.

In life insurance, foreign companies were allowed to provide services to Chinese and resident foreign nationals upon WTO accession. This was expanded to include group, health and pension insurance beginning in December 2004. In reinsurance, foreign firms were allowed to provide services through branch offices, joint ventures or wholly owned subsidiaries immediately upon WTO accession.

Revisions to the Administrative Regulations on the Representative Offices of Foreign-Invested Insurance Institutions took effect March 1st 2004. The rules require the CIRC to reply to an application for establishing a representative office within 20 days (30 days in certain circumstances) of receiving it. The rules also specify that representative offices must submit annual reports to the CIRC within six months of the end of the fiscal year. Representative offices can be fined up to Rmb300,000 if they engage in profit-seeking, non-insurance-related business.

32 China


Top ten foreign insurance companies (wholly owned and joint ventures) Ranked by premium income in 2010�Rmb m

Life insurance Company Premium income Market share (%)AIA (US) 8,470.3 0.8

Generali China Life Insurance (Italy) 6,146.1 0.6

Huatai (US) 6,064.1 0.6

CITIC Prudential (US) 5,414.2 0.5

Sun Life Everbright (Canada) 5,106.0 0.5

Aviva-Cofco Life Insurance (Britain) 4,925.5 0.5

Cigna-CMC (US) 3,235.6 0.3

Metlife (US) 2,539.7 0.2

Manulife Sinochem (US) 2,007.0 0.2

Aegon CNOOC Life (Netherlands) 1,719.7 0.2

Total life insurance market 1,050,100.0 100.0Property insurance Company Premium income Market share (%)AIU (US) 1,021.1 0.3

Tokio Marine and Fire (Japan) 413.8 0.1

Mitsui Sumitomo (Japan) 405.3 0.1

Liberty Mutual (US) 382.5 0.1

Samsung Fire and Marine Insurance (South Korea) 362.1 0.1

Allianz (Germany) 302.4 0.1

Generali Property (Italy) 192.8 0.0

Zurich (Switzerland) 187.5 0.0

Japan Property Insurance (Japan) 183.6 0.0

AXA (France) 175.2 0.0

Total property insurance market 402,700.0 100.0

Source: China Insurance Regulatory Commission.

Before the move away from a planned economy, beginning in 1978, China did not require pension funds (or indeed a social-security system). Workers received lifelong employment and pension payments from their employers, whether work units or state-owned enterprises (SOEs). This practice continues to some extent, with SOEs paying pensions directly out of revenues. With the �iron rice bowl� system coming to an end, China is now struggling to introduce a uniform pension-fund system that is compatible with commercial enterprises and flexible labour markets.

In 1997 the State Council issued the Decision on the Establishment of a Unified Basic Old Age System for Enterprise Staff and Workers, instructing the more than 800 pension-fund schemes in operation throughout China to unify by 2000. Under the unified system, employers pay 20% of employees� annual salary into a Social Security Fund and an individual pension account. The employees pay 8% of their salaries into the individual account, and the personal account is portable if an employee changes jobs. The scrapping of the old system has helped some SOEs become profitable since pension payments no longer come out of operating costs.

The State Council�s Decision on the Establishment of a Basic Medical Insurance System for Urban Staff and Workers, effective in 1998, created a healthcare

Pension funds

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system to which employers contribute 6% of a worker�s salary, and employees, 2%. The final piece of legislation completing China�s social-security reform, the Unemployment Insurance Regulations, with effect from 1999, requires employers to pay the equivalent of 2% of their total payroll to unemployment funds.

The Social Security Fund, established in 2000, had assets of Rmb856.7bn at the end of 2010, up 10.3% from a year earlier, when total assets were Rmb776.5bn. A previously announced target of reaching Rmb1trn by the end of 2010 was missed, but the fund�s chairman, Dai Xianglong, said May 2011 that he expected that level to be reached by the end of 2011 instead.

Regulations introduced in 2001 allowed the fund to invest up to 40% in equities and an additional 10% in corporate bonds. Previously, investment was limited to bank deposits or government bonds. The revised rules also allocate at least 10% of the funds to bank deposits and no less than 50% to bank deposits and government bonds. In 2010 the fund reported investment gains of Rmb32.1bn, representing a return on investment of 4.23%. This compared with total gains of Rmb42.8bn in 2009, resulting in a return on investment of 8.39%.

The Social Security Fund is a major shareholder in some companies, such as Tsingtao Beer in which it owns 12.5% of the shares. As of May 1st 2006, it was allowed to invest a small part of its funds overseas.

In December 2002 the government picked six fund-management companies to manage the Social Security Fund: Boshi Fund Management, Changsheng Fund Management, China Asset Management, China Southern Fund Management, Harvest Fund Management and Penghua Fund Management. The six fund-management companies began investing in Chinese equities in June 2003.

Local governments control a number of smaller pension funds. The Social Security Fund on December 20th 2006 signed an agreement with nine provincial-level governments (Heilongjiang, Henan, Hubei, Hunan, Jilin, Shandong, Shanxi, Tianjin and Xinjiang) to manage a new Rmb10bn fund, made up of contributions from the nine local pension funds. The fund will focus mostly on domestic markets, investing in bank deposits, bonds and stocks.

In November 2007 the China Insurance Regulatory Commission issued administrative measures for pension insurance business conducted by insurance firms, which took effect on January 1st 2008. The measures cover individual and group insurance schemes, as well as corporate annuity management. They mainly are aimed at protecting the rights of insurance clients, preventing insurers from recommending high-risk products. They also spell out the right of an individual to withdraw his part of a group insurance scheme when leaving a company.

34 China


Top ten mutual-fund managers Ranked by value of funds under management as of end-May 2011�Rmb bn

No. of No. of Total funds Market share open-end closed-end Total no.Company under mgt (%) funds funds of fundsChina Asset Mgt 241.0 7.5 27 2 29

China Southern Fund Mgt 156.5 4.9 30 2 32

E Fund Mgt 152.7 4.8 27 1 28

Boshi Fund Mgt 144.8 4.5 27 2 29

Harvest Fund Mgt 143.3 4.5 26 2 28

GF Fund Mgt 141.3 4.4 17 0 17

Da Cheng Fund Mgt 138.9 4.3 24 3 27

Hua�an Fund Mgt 119.5 3.7 24 2 26

Bank of Communications Schroder Fund Mgt 101.5 3.2 16 0 11

Yinhua Fund Mgt 101.2 3.1 25 0 12

Total market 3,213.8 100.0 798 43 841

Source: www.66fund.com.

China has a small mutual-fund (unit-trust) sector that has grown rapidly in recent years. There were 43 closed-end and 798 open-end mutual funds in operation in June 2011. They held Rmb3.21trn in funds under management as of end-May 2011, according to www.66fund.com.

China�s largest fund managers are China Asset Management, China Southern Fund Management, E Fund Management, Boshi Fund Management and Harvest Fund Management, according to 66fund.com, an online service tracking the fund market. Large, well-known funds include the Jintai Fund, the Kaiyuan Fund and the Xinghua Fund.

In February 2005 the People�s Bank of China (PBC�the central bank), China Banking Regulatory Commission (CBRC) and China Securities Regulatory Commission (CSRC) jointly issued the Administrative Rules for Pilot Incorporation of Fund Management Companies by Commercial Banks. The rules seek to ensure segregation of commercial banks� banking business and their fund-management business.

The Securities Investment Fund Law took effect on June 1st 2004. The law lays out detailed rules on the establishment of funds. They must have a minimum registered capital of Rmb100m, which must be paid up in cash. The major shareholder in the fund must be a company specialised in the securities business, with no record of law infringement over the previous three years and with capital of at least Rmb300m. The fund must designate a custodian in the form of a commercial bank approved by the CSRC; the tasks of the custodian include keeping the fund assets in safe custody, establishing accounts, maintaining records and handling settlement and delivery.

In order to enter into operation, the fund-management company must be able to sell at least 80% of the units approved by the CSRC within the fundraising term; for the open-end funds, sales to the public must exceed a number of units predetermined by the CSRC for the fund to be able to enter into operation.

Mutual funds and asset-management firms

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Closed-end funds can be traded on the stock exchange if the fund contract has a duration of at least five years, if the amount of money raised by the fund exceeds Rmb200m and if there are at least 1,000 unit-holders.

The law requires that the funds be controlled by the shareholders themselves and cannot be owned by single individuals. No more than 10% of a fund may be invested in any one company, and no more than 10% of a company�s shares may be held by the fund. Furthermore, 80% of assets held by the funds must be invested in the equity and bond markets, and at least 20% must be invested in Treasury bonds. The law seeks to remove the risk of conflict of interest by barring the funds from investing in either the principal shareholder or the fund custodian.

In 1998 the CSRC introduced rules allowing funds to subscribe to initial public offerings (IPOs) of 50m shares or more and to buy a combined 10% of any new issue of up to 200m shares, and 20% of IPOs of 200m shares and more. Moreover, no single fund may subscribe to more than 5% of any IPO. Shares bought in IPOs must be held for at least two months, during which they must be placed into the custody of the stock exchange. Lastly, each fund must keep its total annual investment in IPOs to no more than 15% of its capital.

In 1999 the China Insurance Regulatory Commission (CIRC) permitted foreign-funded insurance companies in China to buy units in mutual funds, thereby indirectly investing in the otherwise closed A-share market. However, any such purchase must be approved by the CIRC, with the total investment not exceeding 15% of the insurer�s total assets. The rules apply exclusively to closed-end funds.

Effective from July 5th 2007, the CSRC allowed domestic fund-management companies and securities companies to invest in overseas securities via the qualified domestic institutional investor (QDII) scheme. Fund-management companies with net assets of at least Rmb200m and a minimum of two years of operational experience can apply for QDII status. As of July 2011, a total of 250 QDII products were available. Among these is the Yinhua Anti-Inflation Theme Fund, which was launched by Yinhua Fund Management Co in December 2010, raising Rmb691m; it focuses on commodities. Another recent example is the Fullgoal Global Bond Fund, which concentrates on bonds; the fund was launched by Fullgoal Fund Management in October 2010, raising Rmb828m.

Closed-end funds can be established once monies under management exceed Rmb200m and the number of investors reaches at least 100. There are no limits on fund size. However, the rules do not specify where precisely the money may be invested. Another problem is that if there is only one day per week when units can be traded, investors may have to wait up to ten days to withdraw their funds.

All fund managers of open-end funds must be pre-approved. In the early stages of funds, the CSRC allows an authorised period during which investments may be paid into the fund, but withdrawals are not permitted. Fund managers can charge investors a joining fee of up to 5% of the investment. Buyback fees�that is, fees levied if an investor withdraws�may not exceed 3% of the amount

36 China


withdrawn. Otherwise, fees collected on both investment and buyback are at the fund�s discretion. In addition, fund managers must set aside at least one day per week for trading units of the fund. An updated account needs to be published the following day. Open-end funds outstrip closed-end funds in assets and include about 70% of the sectors� monies under management.

Foreign fund-management companies. Foreign fund managers have rushed to form joint ventures in China since late 2002. Recent fund-management joint ventures include the following:

• In April 2011 Taiwan�s SinoPac Financial Holdings approved a plan by its subsidiary SinoPac Securities Investment Trust to establish a fund-management joint venture with China Huarong Asset Management Corp. There was no immediate information available on the percentage shares that the partners would hold.

• In March 2009 United Overseas Bank of Singapore established a fund-management joint venture with Ping An, China�s second-largest insurer. The Singaporean bank holds 25% and Ping An holds the rest.

• Royal Bank of Canada received approval in February 2007 to set up a fund-management joint venture. It holds 30%, while China Minsheng Banking Corp holds 60%, and the Three Gorges Finance holds 10%. The company, Minsheng Royal Fund Management Co, based in the southern city of Shenzhen, began operations in November 2008.

• In January 2007 AXA of France got the green light for a fund-management joint venture in which it holds 39%. Shanghai Pudong Development Bank holds 51% and Shanghai Dragon Investment 10%. The joint venture launched in August 2007.

• Crédit Agricole of France won approval from the China Banking Regulatory Commission to set up a fund-management joint venture in January 2007. Crédit Agricole owns 33.33% in the venture, while Agricultural Bank of China holds 51.67% and Chalco, 15%. The company launched in Shanghai in April 2008.

Several foreign companies have entered the market via acquisitions of shares in existing companies. In July 2011 Founder Fubon Fund Management was launched in Beijing; Taiwan�s Fubon Financial Holdings holds 33% in the Rmb200m joint venture, while Founder Holdings controls the rest. Ping An UOB Fund Management was launched in January 2011 as a Rmb300m joint venture between UOB Asset Management, an arm of Singaporean United Overseas Bank (which holds 25%), Ping An Trust (which holds 66%) and Sanya Yingwan Tourism (11%). In April 2010 Manulife (Canada) bought a 49% stake in ABN AMRO TEDA Fund Management; the venture, whose remaining 51% is owned by the Chinese firm, Northern International Trust, was renamed Manulife TEDA Fund Management. In August 2008 Morgan Stanley (US) bought 40% of Jutian Fund Management, which it renamed Morgan Stanley Huaxin Fund Management. In December 2008 La Compagnie Financière Edmond de Rothschild Banque (France) bought a 15.38% stake in China�s Zhonghai Fund Management from Xingyun Investment Joint Stock Co. The

China 37


Shanghai-based Zhonghai Fund was established in April 2004 as a joint venture between Zhonghai Trust Investment, Guolian Securities and Yunnan Tobacco with total registered capital of Rmb130m.

The growing inflow of foreign companies reflects the liberalisation mandated in China�s World Trade Organisation accession agreements. Accordingly, the CSRC initially allowed foreign companies to take stakes of up to 33% in local fund managers. The ceiling was raised to 49% in 2005, which is where it stood at end-July 2011. Under rules prepared by the CSRC and in force since July 1st 2002, the foreign fund-management company in any Sino-foreign joint venture must have paid-up capital of at least Rmb300m.

Other rules specify that the foreign company must have a securities-investment or fund-management licence in its home market and should not have been involved in illegal activities for three years prior to the application. Securities companies that are already involved in the B-share market must submit a report detailing how this activity would affect their planned joint venture. Foreign companies must also abide by China�s complex foreign-exchange (forex) regulations.

New rules on Sino-foreign fund-management joint ventures, published by the State Administration of Foreign Exchange (SAFE), took effect on May 1st 2003. The rules strengthen SAFE�s supervisory powers over the companies, requiring them to seek permission before setting up special forex capital accounts through which overseas investment funds are to be channelled.

The traditional activities of Western-style asset-management firms�segregated pension-fund management and sophisticated private banking�have not yet appeared in China. The government first outsourced management of its Social Security Fund to a consortium of fund managers in December 2002.

There are four official asset-management companies (AMCs), however. These were established in 1999 to deal with the state commercial banks� bad debts and to repackage and sell them. The four AMCs are the China Huarong Asset Management Corp, formed to clear the nonperforming loans (NPLs) of Industrial and Commercial Bank of China (ICBC); China Orient Asset Management Corp, for Bank of China (BOC); Cinda Asset Management Corp, for China Construction Bank (CCB); and Great Wall Asset Management Corp, for Agricultural Bank of China (ABC).

The four AMCs had taken over Rmb1.4trn in NPLs from the state commercial banks as of end-July 2011�an amount essentially unchanged since their inception�and an additional Rmb100bn from China Investment Bank. Partly as a result of the transfers, asset quality has improved, according to official statistics. According to the CBRC, the NPL ratio of the top five banks, according to the five-category classification system, stood at 1.1% at end-March 2011. This compared with 1.6% at end-March 2010.

The four AMCs were initially supposed to turn these assumed debts into revenues, with a completion date of 2005; however, official Chinese statistics have shown this target was entirely unrealistic. Data from the CBRC indicate that at the end of 2006 (the latest statistics available), the four AMCs had

38 China


disposed of Rmb1.12trn of NPLs, out of the Rmb1.4trn total. Of this amount, Rmb222.3bn had been recovered in cash.

The CBRC, in its 2008 annual report, suggested that new business opportunities will be explored for the four AMCs, saying they were amid a �commercialised transformation. . .which aims to enable such companies� engagement in innovation and diversified operation, as well as help them further strengthen their internal controls and improve their risk-management capability�. The intention appears to be to transform the AMCs into financial holdings firms. To this end, in August 2010 Cinda Asset Management Corp completed a restructuring that left the Ministry of Finance (MOF) the sole owner; the MOF�s intention was to bring in strategic investors and eventually allow Cinda to go public.

In September 2009 Great Wall Asset Management acquired China-based SVA Group�s 50% stake in Nissay-SVA Life Insurance, a joint venture with Japan�s Nippon Life Insurance. Following the transaction, the venture was renamed Nissay-Greatwall Life Insurance. In April 2010 Huarong Asset Management announced it had received CBRC approval to set up Huarong Xiangjiang Bank, which will become the first Chinese bank to be controlled by an AMC. At the same time, Huarong said it might invite ICBC to become a strategic investor in the AMC.

China initially intended to sell a large amount of the nonperforming debts to foreign investors. According to rules published in the China Securities Bulletin in 2001, the four AMCs can directly sell or transfer equity and creditors� rights in nonlisted Chinese companies to foreign investors. The AMCs are also allowed to transfer, tender or auction tangible assets held as collateral for loans or use equity holdings and tangible assets under their control to form joint ventures with foreign partners. The guidelines bar the disposal to foreign investors of assets in the cultural, financial and insurance sectors and in other industries off-limits to foreigners. However, the market has been losing steam in recent years. In a report issued in May 2011, PricewaterhouseCoopers (UK) characterised the Chinese NPL market as �extremely quiet�, with �few if any� transactions involving foreign investors over the previous two years.

In December 2002 the Ministry of Foreign Trade and Economic Co-operation (since March 2003, the Ministry of Commerce, or MOFCOM) approved two Sino-foreign joint ventures charged with selling a total of Rmb12.8bn of bad loans. They are allowed a range of operations, including collecting, managing and selling debt.

The bigger of the two ventures, First United Asset Management, is 35% owned by China Huarong Asset Management; the remaining stake is held by a consortium of US investors including Morgan Stanley and KTH Investments. It was established to resolve the Rmb10.8bn in bad loans the investors had purchased the previous year. The smaller of the two ventures, Rongsheng Asset Management, is a joint venture between Huarong and Goldman Sachs (US) and is charged with the disposal of Rmb2bn in bad loans owed by 44 companies.

China 39


Top ten venture-capital firms Ranked by investment valuea as of end-2010�US$ m

Company Investment valueSequoia Capital (US) 361

GSR Ventures (US) 247

DCM (US) 230

Qiming Venture Partners (US) 211

Northern Light Venture Capital (China) 153

China Science & Merchants Venture Capital Management (China) 149

VantagePoint (US) 99

Ceyuan Ventures (China) 96

Yunfeng Capital (China) 94

Tsing Capital (China) 67

Ranked by number of deals in 2010b

Company Number of disclosed dealsShenzhen Capital Group (China) 61Fortune Venture Capital (China) 23

Sequoia Capital (US) 22

DCM (US) 14

Zhejiang Silicon Paradise Venture Group (China) 14

Qiming Venture Partners (US) 12

GSR Ventures (US) 10

Tiantu Capital (China) 10

Northern Light Venture Capital (China) 8

Ceyuan Ventures (China) 6

(a) Investment value is based on the total for each investment transaction, not individualcontribution. (b) Deals disclosed to the public.

Source: Asian Venture Capital Journal.

The year 2010 saw a rebound in Chinese venture capital investment, following a steep slowdown the year before in reaction to the global financial crisis. The total amount invested during the year reached US$5.4bn, a doubling of the figure from the previous year, while the total number of investment deals increased 71.3% to 817, according to Zero2IPO, a Beijing-based research firm. The majority of the funds, 13.3%, were invested in Internet business, followed by 9.4% in clean technologies and 8.5% in biotechnology. Most of the investment, 61.5%, was denominated in renminbi, while 38.5% was in foreign currencies. This was roughly in line with the situation in 2009�60.9% and 39.1%, respectively�but in sharp contrast to 2008, when 68.0% had been denominated in foreign currencies and 32.0% in the renminbi. This reflected the drop in global US dollar liquidity since the worldwide economic woes in 2009.

Expectations in the sector for 2011 were high. A survey by the China Venture Capital and Private Equity Association released in December 2010 showed that 90.9% of the 35 respondents planned to increase their investments in China in 2011. The most popular (18.8%) planned investment outlets were retail businesses, while 17.3% expected to invest in biomedicine, and 15.8% in clean technologies.

Venture-capital and private-equity firms

40 China


US-based Sequoia Capital is the largest venture-capital firm in China, marking a strong presence since it launched its first US$250m fund in China in 2005. The stock of its total investments made in China at end-2010 was US$361m, according to Asian Venture Capital Journal. GSR Ventures (US), the second-largest venture-capital firm in China, had invested US$247m in China by the end of 2010. These were followed by DCM (US), with a stock of total investments at end-2010 of US$230m; Qiming Venture Partners (US) with US$211m; and Northern Light Venture Capital with US$153m.

A growing number of venture-capital funds bypass listed shares entirely and seek business opportunities in unlisted companies. In addition, Western investment banks and brokerage houses have set up funds (many listed on the London or New York stock exchanges) to invest in companies that derive most of their revenue in China and red chips (the highest-rated shares of mainland companies listed on the Hong Kong Stock Exchange). These direct investment funds effectively serve as venture-capital funds for joint ventures.

The Ministry of Foreign Trade and Economic Co-operation (now the Ministry of Commerce�MOFCOM) issued regulations allowing foreign-invested venture-capital companies, with effect from September 2001. New rules amending these regulations, the Rules on Administration of Foreign-Invested Venture Capital Investment Enterprises (FIVCIE), took effect on March 1st 2003. Among other things, the revised regulations reduced the capital requirement for foreign investors to US$10m and relaxed requirements on the organisational structure of FIVCIEs.

The new rules make it easier for foreign firms to invest. However, there is so far no proper exit mechanism because of the stockmarkets� inability to attract and serve high-technology companies, although this may be set to change by the establishment of a Nasdaq-style exchange in Shenzhen in October 2009 (see below). Consequently, venture capitalists exit their investments by listing them on an overseas exchange or by transferring shares to other investors. Another problem is that venture capitalists have to use their own capital in their investments; they are not allowed to borrow the funds.

In June 2002 the government announced the creation of the China Venture Capital Association, the first national entity dealing with the sector. The association, renamed China Venture Capital and Private Equity Association in November 2010, brings together both venture-capital and private-equity firms, including many affiliates of international banks and technology companies.

Foreign fund managers or commercial banks typically undertake private-equity investments. About 300 private-equity firms, often dominated by just one single investor, have been established in China as of end-July 2011. Typically their investments take the form of acquisition of minority stakes.

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Top private-equity deals, 2010 Ranked by private-equity funds invested�US$ m

Investee Funds

invested Industry Announcement date Investor(s)

360buy.com/JingDong Online 150.0 InformationTechnology January 2010

Tiger Global Management (China/US),undisclosed venture capital firm(s)

Vancl.com 125.0 InformationTechnology December 2010 Tiger Global Management (China/US)

Nobao Renewable Energy 100.0 Electronics October 2010 Silver Lake (US)

Live By Touch 75.4 Electronics December 2010

CDH Investments Management (China),China International Capital Corp. (China),

Legend Capital (China)

Ethicar 70.0 Transportation/

Distribution August 2010

CDH Investments Management (China),Goldman Sachs (US), Ignition Partners (US),

JAFCO (Japan), New Access Capital (China), Qiming Venture (US)

iSoftStone Information Service Corp 65.0 Computer-related January 2010

AsiaVest Partners (Taiwan), CEL Venture Capital (China),

Fidelity Asia Ventures (Hong Kong), Infotech Pacific Ventures (China),MVC Corp (US)

Moonbasa.com 60.0 Informationtechnology December 2010

Tiger Global Management (China/US),undisclosed investor(s)

Lattice Power (JiangXi) Corp 55.5 Computer-related December 2010

Ajia Partners (China), GSR Ventures (China),Hydepark Capital Partners (US),

International Finance Corp.

Qiyi.com 50.0 InformationTechnology February 2010 Providence Equity Partners (US)

Youku.com 50.0 InformationTechnology September 2010

Brookside Capital (US), Chengwei Ventures (China), Farallon Capital Management (US),

Maverick Capital (US),Morgan Stanley Investment Management (US),

T. Rowe Price (US)

Source: Asian Venture Capital Journal.

The use of receivables as a basis for short-term financing has traditionally been little used in China; after a period of rapid growth, it has now seen some weakening. Factoring volume reached �154.6bn in 2010, up 129.7% from the year before, according to Factors Chain International, an international alliance of factoring firms. Of this, �120.0bn was in domestic transactions and �34.6bn in crossborder deals. There were 23 financial institutions providing factoring services as of end-July 2011, including the Agricultural Bank of China, Bank of China, the China Construction Bank and the Industrial and Commercial Bank of China, according to Factors Chain International. Coface, owned by French bank Natixis, said in June 2008 it had started offering export factoring services in China via its Hong Kong�based unit Coface Greater China Finance. This marked the first entry of a foreign company into the nation�s factoring business. In January 2010 IBM set up IBM Factoring Co to provide factoring services for companies operating in China.

To penetrate overseas markets, many companies�Chinese and Western�have to sell on open account, which lends itself to factoring. Two costs are related to such transactions: the factoring fee and interest. The exporter often pays these two fees, which together can amount for 1.25�1.5% of the overall transaction value.

Factoring firms

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The extension of credit against the sale or transfer of receivables is relatively rare in China. However, the Bank of China and the Bank of Communications offer this service for both domestic and foreign-trade transactions. The Bank of China has a factoring department that operates in 35 of its main branches. The bank uses a two-tiered, two-factor system, rather than a single-factor deal with both the seller and the buyer. Both export and import factors work together on a transaction. If a Chinese manufacturer wishes to export to a US customer on open-account terms, for example, the Bank of China brings in a US factor to perform an overseas credit check, to take the risk of the sale and to collect any debts. For its part, the Chinese bank collects the money owed and provides financing as needed. This arrangement can also work in reverse for foreign exports to China.

Top ten financial leasing companies Ranked by registered capital as of end-2010�Rmb bn Company Registered capital Year establishedCDB Leasing 7.49 1984

Bohai Leasing 6.25 2008

Kunlun Financial Leasing 6.00 2010

ICBC Leasing 5.00 2007

CCB Leasing 4.50 2007

Bank of Communications Finance Leasing 4.00 2007

Minsheng Financial Leasing 3.20 2007

Changjiang Leasing 2.80 2004

CMB Financial Leasing 2.00 2007

Xinjiang Leasing 2.00 1984

Source: China Leasing Alliance.

The financial leasing business has been in a period of stagnation for several years, but is now likely to become more active with the entry of new participants. As of end-July 2011 China had 17 financial leasing companies, including seven with some foreign participation. The companies had combined assets of Rmb350bn at the end of 2010, an increase of 106% from a year earlier, according to the China Leasing Alliance; by the end of March 2011, the assets had risen to Rmb364bn, according to the China Banking Regulatory Commission (CBRC�the banking watchdog). The CBRC said in its annual report in May 2011 that financial leasing companies had �made significant progress in product innovation, with some companies having launched tailor-made products for small enterprise customers.�

In April 2011 Shin Kong Venture Capital International, a subsidiary of Shin Kong Financial Holding (Taiwan), announced a decision to set up a financial leasing operation in either Shanghai or Suzhou, both areas of east China where Taiwanese entrepreneurs are particularly numerous; further news on the plans were not available as of end-July 2011. In June 2010 China Everbright Bank opened China Everbright Financial Leasing, based in the central city of Wuhan. Everbright holds 90% of the shares in the Rmb800m venture, with Wuhan Xingang Investment Development Group and Wuhan Rail Transit Construction sharing the rest.

Financial leasing companies

China 43


In the 1990s China had a first go at developing a financial leasing industry, with a total of 12 companies in the market, but in the course of the following decade, this number was reduced to six. At that time, banks were ordered to leave the financial leasing business after they had been found raising funds illegally and engaging in speculative investments, especially in the stockmarkets. This changed in January 2007 when the CBRC issued new Management Rules for Financial Leasing Companies. The rules, which took effect on March 1st 2007, replaced earlier rules published in 2000 and lowered the minimum required registered capital for financial leasing companies to Rmb100m from Rmb500m. The rules also permitted local and overseas commercial banks to set up financial leasing companies, provided they complied with a set of requirements, including a capital-adequacy ratio of no less than 8% and being profitable for two consecutive years.

Industrial and Commercial Bank of China and the Bank of Communications set up financial leasing firms in November 2007. The following month, the China Construction Bank (CCB) launched CCB Financial Leasing Corp, a joint venture with Rmb4.5bn in registered capital, with CCB holding 75.1% and Bank of America (US) holding the rest. China Minsheng Banking Corp established an Rmb3.2bn leasing firm in April 2008, holding an 81.25% share, while the investment unit of the Tianjin Free Trade Zone in the northern port city of Tianjin held the rest in the company. Also in April 2008, China Merchants Bank established an Rmb2bn leasing company in Shanghai. In June 2008 China Development Bank set up an Rmb7.5bn financial leasing company in Shenzhen, the largest player in the field so far.

The Ministry of Foreign Trade and Economic Co-operation (now the Ministry of Commerce�MOFCOM) issued regulations for foreign-invested leasing companies in 2005. Under these rules, all foreign-funded leasing concerns must be set up as businesses carrying limited liability and classified as financial leasing companies or nonfinancial leasing companies. A foreign financial leasing company must have registered capital of at least US$10m (lowered from US$20m in new rules that also made it possible for foreigners to set up wholly owned financial leasing companies).

In joint efforts to form foreign-funded companies, the Chinese partner must have had total assets valued at no less than Rmb400m one year prior to its application. The foreign partner must have assets valued at a minimum of US$400m and must have been engaged in the business for at least five years. In addition, a Chinese partner must contribute no less than 20% of the new venture�s registered capital. For nonfinancial leasing firms, the minimum amount of registered capital allowed is US$5m, 20% of which should come from its Chinese founder. The Chinese partner must have had assets worth no less than Rmb100m one year before it applies to set up the company. The foreign partner should have total assets of no less than US$50m and three years� experience in the leasing business.

Some of the foreign joint ventures involved in leasing include China International Leasing (owned jointly by Mitsui Bussan of Japan and China Investment Bank); China Universal Leasing (co-owned by Bank of China�s China Orient Trust & Investment Corp, UFJ of Japan and Dresdner Bank of

44 China


Germany); and China International Non-Ferrous Metals Leasing (a joint venture between Industrial and Commercial Bank of China and several European banks). Caterpillar of the US said in April 2004 that it had set up a leasing arm in China, 75% owned by Caterpillar Financial Services and 25% owned by Caterpillar (China) Investment.

Financial leases involving foreign currencies or those where the lessor is a foreign or foreign-invested enterprise are treated as foreign-currency lending and require approval from the State Administration of Foreign Exchange.

International trust and investment corporations (Itics) began to emerge in 1978 as nonbank finance vehicles to channel foreign capital and technology into their respective areas of operation and incorporation. By 1988 there were more than 700 Itics owned by provincial governments, government departments and ministries, and state-owned enterprises. Itics have entered into a merger and reorganisation process since then�by end-July 2011 there were just 63 Itics in operation in China, up from 58 a year earlier.

The 1998 bankruptcy of Guangdong International Trust & Investment Corp (Gitic), the investment arm of the Guangdong provincial government, highlighted both foreign lenders� naivety and the end of the Itics as a force in China�s financial sector. Gitic was the first high-level casualty in the sector, but its bankruptcy exposed the nonviability of many other Itics, which were subsequently unable to repay their debts.

Recent attempts to reinvigorate the sector appear to be bearing fruit. The China Banking Regulatory Commission (CBRC�the main banking regulator) issued new management rules for Itics on February 1st 2007, aimed at improving the sector�s performance and protecting investors� interests. In addition, the rules allowed Itics to broaden their scope to areas such as securitisation, infrastructure finance and qualified domestic institutional-investor funding. At end-2010, Itics had total assets of Rmb3.04trn, an increase of 47.6% from a year earlier, according to the CBRC.

China is considering raising the limit on foreign investment in the Itics to 49% from the current 25%, but had not done so as of end-July 2011. However, the government will seek to ensure professional management of the Itics by barring nonfinancial companies from investing.

In a new development, and as part of official efforts to encourage banks to diversify, the Bank of Communications (BoCom) set up Bank of Communications International Trust and Investment Co in June 2008, following official approval in December 2007. BoCom holds 85% in the Rmb1.2bn company, while Hubei International Trust and Investment Co holds the remainder. BoCom�s aim was to diversify its revenue sources, with the new company expected to eventually branch from traditional trust operations into areas such as financial consulting and private-equity business. The Hubei Itic was bailed out by the government of Rmb2.06bn in bad debt at end-2006.

Consumer-credit companies. China has traditionally been a nation of great savers, and buying on credit has generally been avoided. Thirty years into reform, the culture of buying on credit remains a weakly developed part of the

Other institutions

China 45


Chinese economy. However, a great deal of interest has been generated by new rules issued by the CBRC in August 2009 permitting the establishment of consumer-credit companies in four cities, Beijing, Chengdu, Shanghai and Tianjin. The interest appears not to have been impacted by a cautious approach reflected in the rules, which require that consumer credit is capped at five times the individual client�s monthly income.

To qualify as a lender for the project, a company must meet several requirements, including minimum asset levels and at least five years of experience in providing consumer loans. As of end-July 2011, four pilot projects had been allowed to go ahead. Bank of Beijing operates Beiyin Consumer Finance Co, a wholly owned venture designed to service the Beijing area with Rmb300m in registered capital. In Chengdu, Bank of Chengdu runs Sichuan Jincheng Consumer Finance Co, with registered capital of Rmb320m, holding 51% itself, and with 49% controlled by Hong Leong Bank of Malaysia. In Shanghai, Bank of China has set up Zhongyin Consumer Finance Co, with registered capital of Rmb500m, in which it would hold 51%, with 30% held by Bailian Group and 19% held by Liujiazui Finance and Trade Zone Development. In Tianjin near Beijing, PPF Group of the Czech Republic has established Hope Credit China, a wholly owned company with an investment of Rmb300m. At the end of 2010, the four companies had extended a total of Rmb58.7m in consumer credit.

First overseas initial public offering denominated in renminbi

The second quarter of 2011 saw the first-ever renminbi-denominated initial public offering (IPO) outside China�s borders. Hui Xian Real Estate Investment Trust, controlled by Hong Kong�s richest man, Li Ka-shing, raised Rmb10.48bn on April 24th 2011 in Hong Kong�s first-ever renminbi-denominated IPO. The sale of 40% of the company�s total assets, in the form of the rights to revenues from Beijing�s iconic Oriental Plaza complex, was divided into two tranches, with 80% going to institutional investors and 20% to retail investors. BOC International, CITIC Securities and HSBC acted as bookrunners for the transaction. The IPO was seen as yet another step towards the gradual internationalisation of the Chinese currency, following earlier issues of renminbi-denominated bonds and trading in the Chinese currency in the Hong Kong markets. A successful IPO could potentially mean access to a previously entirely untapped reservoir of funds in the form of renminbi deposits held by Hong Kong citizens. At the end of February 2011, renminbi deposits in Hong Kong totaled Rmb407.7bn, a quadrupling from a year earlier. Despite these underlying factors, the offering did relatively poorly, with the retail tranche subscribed a mere 2.5 times, which is low by local standards. The offering was also priced at the low end of the range. Even so, the share performed poorly on the first day of trading, April 29th, 2011, declining 9.4% to Rmb4.75. There were several explanations for the lackluster performance, including the fact that the company�s rights to profits generated by the Oriental Plaza expire in 2049, meaning that it will have no clear revenue stream beyond that date. Other analysts also pointed to the fact that the limited circulation of the Chinese currency in Hong Kong made the stock relatively illiquid and, therefore, less attractive as an investment.

46 China


Monetary and currency policies/regulations

China is slowly moving towards a more market-oriented monetary system, in which individual banks have greater scope to set their own interest rates based on the creditworthiness of their clients. The central government has been pushing that development by gradually lowering the lending rate floor and raising the deposit rate ceiling; however, the People�s Bank of China (PBC�the central bank) still maintains the floor and the ceiling in a bid to ensure that state-run commercial banks remain profitable and also sets benchmark rates.

John Lipsky, deputy managing director of the International Monetary Fund, in May 2011 during a visit to Beijing said that �the entire term structure of interest rates is distorted when key interest rates are not market-determined,� urging China to consider �de-regulating loan and deposit rates to allow these and other key interest rates to be determined by market forces.� Even as pressure builds on China to allow interest-rate reform, signs of domestic resistance have also emerged. Also in May 2011, Li Lihui, president of the Bank of China, warned that reform would likely severely erode margins for Chinese lenders, who depend overwhelmingly on interest income for their revenues.

On June 19th 2010 China announced that the renminbi's fixed peg to the US dollar would be replaced by a more flexible currency regime. From end-June 2010 to end-July 2011, the renminbi appreciated 5.08% against the US dollar, to stand at Rmb6.44:US$1 at end-July 2011. Since July 2008, and the onset of the global economic crisis, the PBC had maintained a de facto peg to the US dollar by setting the mid-point of the exchange-rate band at Rmb6.8275:US$1. However, the authorities are still adopting a highly cautious approach to the liberalisation process. There has been no one-off revaluation of the currency, and major appreciation has been ruled out. The central bank emphasised "stability" rather than flexibility, indicating that the value of the renminbi against the US dollar would continue to be heavily managed.

Although the government maintains relatively strict exchange controls, the general trend over the past decade has been towards gradual liberalisation of China�s foreign-exchange (forex) market. The country reached its most significant milestone in December 1996 when it officially made the renminbi convertible on the current account. Convertibility on the capital account is not expected in the near future.

China hopes to gradually raise the global profile of its currency. In July 2009 a trial began allowing a limited number of companies in Shanghai and the southern province of Guangdong to carry out settlement in the renminbi when conducting trade with select companies in Hong Kong and Macao. In another bid to strengthen acceptance of the renminbi abroad, the PBC began signing currency-swap agreements with counterparts in other countries and territories beginning in November 2008. As of June 2011, it had signed swap agreements with Argentina, Belarus, Hong Kong, Iceland, Indonesia, Malaysia, Mongolia, New Zealand, Singapore, South Korea and Uzbekistan. In the latest such agreement, it signed an Rmb5bn swap deal with Mongolia in May 2011. In the

Overview

China 47


year since June 2010, an active offshore market in the renminbi has developed in Hong Kong (see Currency spot market).

On May 1st 2006, the government introduced new rules allowing Chinese institutional investors to invest in overseas markets, making it easier for domestic companies and individuals to buy foreign exchange. According to PBC rules, banks can now invest in foreign fixed-income products on behalf of their clients; fund-management companies can invest in foreign securities products for their clients; and insurance firms can invest in fixed-income and money-market products overseas. The authorities have also gradually relaxed curbs preventing Chinese citizens from channelling money abroad. The State Administration of Foreign Exchange (SAFE) allows individuals to buy up to US$20,000 every year.

The interbank market consists of designated state forex banks and approved foreign banks. They operate as members of the China Foreign Exchange Trade System (CFETS) in Shanghai, a national forex-trading centre linked by computer to regional forex-trading centres. The CFETS allows daily fluctuations in the renminbi�s forex rate and oversees trading of US and Hong Kong dollars and Japanese yen.

The PBC provides daily quotes of unified rates for the US dollar and other major currencies, based on the previous day�s closing prices in the interbank market. Should the rate fluctuate during the day outside a narrow set band of 0.5% on either side, the PBC maintains a special hard-currency account for intervention.

All forex receipts and disbursements must flow through the �basic� and specialised forex accounts. China allows foreign-invested enterprises (FIEs) to set up a range of different forex accounts, depending on their purpose. Although the exact types of accounts on offer vary among the banks, basically they can be classified as follows:

• accounts for receiving investment into the enterprise�funds on this account are for purposes previously approved by SAFE;

• accounts for receiving proceeds of forex loans�again, SAFE is involved in approving the project for which the loan is intended, and the financial institutions must deny withdrawal if it is for purposes not covered by the loan agreement;

• accounts to repay forex loans�for debt repayment to take place via this channel, the lender must submit a request to SAFE for approval; and

• accounts for proceeds from the disposal of assets.

The system allows a certain degree of flexibility since companies may be allotted a higher cap or allowed to open more than one account�denominated in either US dollars or another foreign currency�if the nature of their business requires it.

Inflation control has emerged as China�s top priority in recent months, with the People�s Bank of China (PBC�central bank) raising the lending rate five times in

Base lending rates

48 China


the period from September 2010 to July 2011; as of end-July 2011, the one-year lending rate stood at 6.56%, while the one-year deposit rate was 3.5%. In its monetary-policy report published in May 2011, the PBC warned that �stabilising prices and managing inflation expectations are critical.� It also said there was �no limit� in how far it might raise the required reserve ratio to achieve its objectives. On June 15th 2011, the PBC raised the required reserve ratio by 50 basis points to a record high of 21.5%; it was the sixth time the ratio was hiked since the start of 2011. Inflation is mainly reflected in movements in the consumer price index (CPI). Consumer price inflation reached a three-year high of 6.5% year on year in July 2011.

The PBC, with approval from the State Council, sets base interest rates for the entire banking system, including nonbank financial institutions. It also defines the corridors under which commercial banks may offer loans. For all financial institutions, the floor on lending rates is 90% of the PBC benchmark; a 230% ceiling applies to rural and urban credit co-operatives. Financial institutions are subject to deposit rate ceilings, set by the PBC in a bid to ensure their profitability.

The PBC�s official interest-rate structure is quite complicated; originally, up to 200 different rates applied at any given time. But the PBC has gradually simplified the rate structure, and it now determines 34 categories of rates. Preferential rates are available to state-owned enterprises and vary by sector and purpose. These highly subsidised interest rates�some of which are half the standard rates�are charged on policy loans granted for certain types of agricultural production, as well as heavy-industry infrastructure, export industries and funding for the underdeveloped, low-income regions that lag behind fast-growing coastal provinces.

Since 1996 the PBC has sought to move closer to a market-driven system. In April 1996 it abolished the use of fixed, inflation-proof interest rates on long-term deposits and Treasury bonds. In June 1996 it removed the cap on rates offered on the domestic-currency money market, leaving market forces to determine the cost of capital.

In September 2000 the PBC allowed domestic banks to set their own foreign-currency deposit and lending rates on amounts up to US$3m. It said at the time that this was part of an ambitious three-year plan to liberalise interest rates, beginning in rural areas and then moving to the cities, with curbs on lending rates being loosened ahead of those on deposit rates. However, the timetable met with opposition from the big state-owned commercial banks, on fears that it would exacerbate their bad-loan problems, since more expensive credit would add to the burdens of clients already struggling to repay past debt.

The Shanghai interbank offered rate (SHIBOR) is the Chinese version of the London interbank offered rate (LIBOR). It was published for the first time in October 2006, and after a one-month trial run, the PBC made it the nation�s official benchmark rate on January 4th 2007. It offers a more market-sensitive alternative to the benchmark rates used by the PBC when adjusting interest rates and performing other monetary-policy actions. The introduction of

China 49


SHIBOR was considered a major step towards the eventual liberalisation of interest rates in China.

SHIBOR is divided into different maturities, ranging from overnight to one week; two weeks; three, six and nine months; and one year. In each case, it is the average of the prime rates offered by 16 foreign and local banks, including the five large state-owned commercial lenders, as well as Deutsche Bank (Germany) and HSBC and Standard Chartered (both UK). When establishing the SHIBOR, the National Interbank Funding Centre removes the two highest and two lowest rates quoted by the banks and calculates the average of the remaining 12. The three-month SHIBOR stood at 6.0% at end-July 2011, up from 2.45% a year earlier, while the six-month SHIBOR increased to 5.26%, up from 2.51%, and the one-year SHIBOR increased to 5.23%, up from 2.61%.

The PBC is encouraging the use of the SHIBOR as a reference for setting the price of a number of instruments, including floating-rate debt, and derivatives such as forwards, options and swaps. In November 2010 the Agricultural Development Bank of China issued Rmb12bn in three-year bonds with a coupon based on the three-month SHIBOR. When Bank of Tokyo Mitsubishi UFJ (the Chinese arm of the Japanese bank) issued Rmb1bn in two-year renminbi-denominated notes in May 2010, it set the coupon at 48 basis points above the three-month SHIBOR.

The introduction of SHIBOR followed the 1996 launch of the China interbank offered rate (CHIBOR), which never took off as a benchmark due to thin interbank trading. The National Interbank Funding Centre publishes the SHIBOR every day at 11.30 am on the website www.shibor.org, which also contains a list of the 16 banks contributing to the compilation of the SHIBOR as well as historical rate data.

Base lending rates(Jul 2006 to Jul 2011; %; month-end)

Source: Bloomberg.

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.01- to 3-year12-month6-month

JMMJ11

NSJMMJ10

NSJMMJ09

NSJMMJ08

NSJMMJ07

NSJ2006

The People�s Bank of China (PBC�the central bank) has a wide array of monetary tools on which to draw, as laid out in the Central Bank Law of 1995. These include mandating reserve deposits for financial institutions, fixing interest rates on lending and deposits, rediscounting operations for financial institutions that have current accounts with the PBC, lending to commercial banks, and conducting open-market operations in state and other government bonds and foreign exchange. The PBC looks at a variety of economic factors in

Monetary policy

50 China


determining its monetary policy and does not adhere to any single variable, such as inflation, money supply or the value of the currency.

In 2010 the broad money supply (M2)�including currency in circulation, corporate deposits and savings deposits�rose 19.7% year-on-year, down from 27.7% the year before. Narrow money (M1)�currency in circulation plus business deposits�grew 21.2%, down from 32.4%. Cash in circulation (M0) increased 16.7%, up from 11.8%.

Over the course of 12 months, the renminbi appreciated by 4.98% against the US dollar by end-July 2011, to stand at Rmb6.44:US$1. The Economist Intelligence Unit expects the renminbi will strengthen further against the dollar, by an average of 3.6% a year in 2011�15, partly reflecting higher productivity growth in China than in the US. Its appreciation will be fastest during the early part of this period as the government seeks to curb imported inflationary pressures. Meanwhile, higher price inflation in China than in OECD markets will also help to rebalance the real exchange rate. China's efforts to make the renminbi an international currency may lead it to ease capital controls further, and this too could put upward pressure on the renminbi's external value.

The official currency of China is the renminbi, which is denominated in units of renminbi, jiao and fen (one renminbi equals ten jiao, or 100 fen). From January 1994 to July 2005 the People�s Bank of China (PBC�the central bank) fixed the value of the currency in a �managed float� that allowed it to fluctuate in a very narrow range around Rmb8.278:US$1. On July 21st 2005, Chinese authorities re-valued the currency by 2.1%, maintaining the managed-float system around a new target of Rmb8.11:US$1. In July 2008, at the height of the global financial crisis, the PBC established a de facto peg to the US dollar by setting the mid-point of the exchange-rate band at Rmb6.8275:US$1. On June 19th 2010, the PBC announced a shift to a more flexible exchange rate, ending the 23-month peg to the US dollar that had led to considerable criticism from Western governments that claimed the renminbi was undervalued.

Beginning in July 2005 (and again since June 2010) when the renminbi was de-pegged from the US dollar, China has attempted to set its currency against a basket of major world currencies. On August 10th 2005, the PBC disclosed the basket�s composition, saying that it �mainly� includes the US dollar, euro, yen and won. The pound sterling, rouble, Malaysian ringgit, Thai baht and the Australian, Canadian and Singapore dollars are also factored in, although the central bank has not detailed precise weightings of each currency. However, managing the basket has proved difficult, and China has tended to carry out its exchange-rate policies with reference to the renminbi�s value against the US dollar.

The currency is allowed to fluctuate only within a daily band of 0.5% up or down from a reference rate announced by the PBC at the start of each trading day�continuing the �managed float� policy in place since 1994. The State Administration of Foreign Exchange said in its annual report released in June 2011 that greater flexibility of the exchange rate would gradually be allowed; this was seen by some as a signal that the trading band could be widened. Until May 2007 the band had been 0.3%. It was not until Beijing�s formal adoption of

Currency

China 51


International Monetary Fund Article VIII in December 1996 that the renminbi was officially convertible on the current account, although it had been, in effect, convertible since July 1996. The current account includes daily recurring business transactions. Examples are trading receipts and payments; service receipts and payments; unilateral transfers, such as payment of royalties; repatriation of after-tax profits and dividends; remittance of after-tax wages and other legal income of foreign employees of foreign-invested enterprises; and payment of interest on foreign debts.

The renminbi remains nonconvertible on the capital account. This account deals with import and export capital, direct investment, loans and securities investment (such as repayment of principal of foreign debts), overseas investment, investment in foreign-invested enterprises (FIEs) and remittance of capital by FIEs following liquidation. Since 1993 the government has promised to move gradually to convertibility of the renminbi on the capital account. However, the authorities lost their ardour for rapid liberalisation after the Asian financial crisis of 1997�98 and the subsequent depreciation of a number of Asian currencies. The global financial crisis that erupted in 2008 is likely to have made the government even more reluctant, and it has given no timetable for convertibility on the capital account.

The circulation of foreign currencies within China has been banned since January 1994. The interbank market and banks authorised to deal in foreign exchange�where individuals and enterprises may set up foreign-exchange (forex) accounts�are the only legal avenues for retaining and transferring foreign currency. To keep forex out of the market, the government has banned the setting of prices or settling of accounts in hard currency, including the Hong Kong dollar. But the authorities have been unable to prevent the use of the Hong Kong dollar in cash transactions, and it remains a widely used currency in southern China.

Month-end rates of the renminbi against the dollar, euro and yen(Jul 2006 to Jul 2011)

Source: Bloomberg.

12

11

10

9

8

7

6

5Rmb:¥100Rmb:€1Rmb:US$1

JMMJ11

NSJMMJ10

NSJMMJ09

NSJMMJ08

NSJMMJ07

NSJ2006

External borrowing by Chinese financial institutions or enterprises falls under the annual credit plan and is subject to stringent controls. All such loans must be approved by and registered with the State Administration of Foreign Exchange (SAFE). Rules apply to any foreign currency borrowed by national enterprises with terms of 365 days or more. Also, foreign banks cannot engage

Loan inflows and repayment

52 China


in any lending without SAFE approval. The Chinese authorities will not acknowledge unregistered debt. The SAFE issued a circular in March 2011 announcing a quota of US$32.4bn for domestic financial institutions� short-term debt, the same level as in 2010. This was in an effort to control the risks of crossborder capital flows.

The Administrative Measures on Domestic Institutions Borrowing International Commercial Loans, from 1998, made international borrowing more difficult for domestic nonfinancial institutions. Before being considered eligible to borrow from abroad, domestic firms must overcome the following hurdles: (1) have been profitable in the preceding three-year period; (2) have permission to carry on an import/export business; (3) be in an economic sector encouraged by the state; (4) have well-established financial-control systems in place; (5) have net assets not less than 15% of total assets for a trading business, or net assets of not less than 30% of total assets for a nontrading business; (6) have an aggregate balance of international commercial obligations and foreign-related security obligations of no more than 50% of net assets expressed in foreign exchange (forex); and (7) have an aggregate balance of international commercial loans plus foreign-related security obligations of not more than the forex revenue for the previous year.

Foreign-invested joint ventures may borrow hard currency for their projects under Article 78 of the Implementing Regulations of the Law on Equity Joint Ventures, amended in July 2001. The loans must be reported to, but need not be approved by, the SAFE or one of its branches.

To ensure that joint ventures are not too highly leveraged, however, guidelines governing permissible debt/equity ratios were set out in the Interim Provisions of the State Administration for Industry and Commerce (SAIC) Concerning the Ratio Between Registered Capital and Total Amount of Investment of Chinese-Foreign Equity Joint Ventures of March 1987. The rules are meant to inhibit investors who put in a comparatively small amount of their own cash.

Under the rules, where the total amount of the investment (or total project cost) is less than US$3m, the registered capital (or actual equity contributions of the partners) must be at least 70% of the project cost (that is, 30% may be borrowed). For projects valued at US$3m�10m, 50% may be borrowed; for those valued at US$10m�30m, 60% may be borrowed; and for those worth more than US$30m, 66.6% may be borrowed.

In 1998 the People�s Bank of China (PBC�the central bank) and SAFE introduced new forex regulations for foreign-invested enterprises (FIEs). First, the Administrative Provisions on Foreign-Exchange Accounts Outside of China require FIEs that seek to establish overseas accounts to submit to SAFE a capital-verification certificate (verifying that the FIE�s registered capital has been contributed) prepared by a previously approved accounting firm. Second, the Administrative Measures for the Borrowing of International Commercial Loans by Domestic Organisations require FIEs�which had not been considered domestic organisations in the past�to comply with foreign-debt registration procedures. This regulation also requires domestic and foreign enterprises to

China 53


obtain approval from SAFE to deposit borrowed funds overseas or to convert borrowed funds into renminbi.

Borrowing rules for FIEs were relaxed by Circular 223, issued by the PBC, from 1999. Its major provisions are the following: FIEs may finance fixed-asset investment with forex-backed renminbi loans; forex-backed renminbi loan terms may be extended up to five years; FIEs may pledge forex equity contributions and current-account receivables to obtain renminbi financing; and in the event of default, forex guarantees or collateral are to be realised at the exchange rate on the date of default.

Special loan accounts. The 1996 forex reforms require the establishment of special accounts to service foreign loans or forex loans from domestic financial institutions. The rules reiterate the need for strict control over foreign borrowing and call for the establishment of �debt repayment funds�. Should forex be insufficient to service these loans, the debtors have recourse to the designated forex banks to convert renminbi for that purpose. But the banks must obtain proof that the foreign debt has been registered, and the payment of principal and interest in renminbi must be approved. The account-holding bank must use a specialised account for repayment of loans when the period for repayment specified in the agreement has expired.

Loan guarantees. Measures for Control of the Provision of Security to Foreign Parties by Organisations within the People�s Republic of China, in effect since 1996, stipulate that security provided to foreign-invested financial institutions inside the country is deemed security to foreign parties. The measures apply to domestic banks (but not foreign-invested banks) and to domestic enterprises and FIEs that are legal entities and have the ability to repay debts in place of debtors. They require that, after the provision of security to a foreign party, the security provider must register with the local SAFE branch.

The government itself does not guarantee commercial loans and has also restricted the number of financial institutions able to issue guarantees to foreign lenders. Similarly, provincial governments and authorities are not permitted to guarantee loan facilities. Any such guarantees given, both verbally or in writing, are illegal and cannot be honoured.

For FIEs, no restrictions apply on payments on foreign loans. But such transactions must be channelled through a venture�s forex account designated for this purpose. FIEs have access to the designated forex banks to convert renminbi.

Tax consequences. The basic withholding tax on interest remitted abroad is 10%.

For equity joint ventures and wholly foreign-owned companies, capital can be repatriated only at the end of the joint-venture contract period or upon liquidation. In co-operative joint ventures, partners can repatriate their part of the capital while the joint venture is still operating, provided the other partners agree. Repatriation is allowed only upon approval from the State Administration of Foreign Exchange (SAFE). Funds are convertible at the exchange rate at the time of repatriation or transfer.

Repatriation and remittance ofcapital

54 China


Foreign investors may remit dividends and profits from joint ventures after they pay Chinese income taxes and meet all reserve-fund and labour-fund allocations. Funds are convertible at the exchange rate at the time of repatriation or transfer.

For joint ventures, the board of directors normally establishes dividend policies. Profits may not be distributed until losses from previous years have been made up. Dividends must be distributed according to the equity shares of the investing parties, and no cap is imposed on their amount.

Foreign-invested enterprises (FIEs) may freely remit their after-tax profits and dividends. No prior SAFE approval is required. Funds may be drawn either from foreign-exchange (forex) accounts or by conversion and payment at designated forex banks, on the strength of an appropriate corporate board resolution concerning profit distribution and proof from the appropriate authorities of tax payment.

Tax consequences. Any foreign company that does not have an establishment in China but does derive profits, interest, rental, royalty, capital gains or other income from sources in the country must pay a 10% tax on that income. This also applies to foreign companies established in China that collect the same types of income not effectively connected with their Chinese enterprises.

Dividends remitted abroad from an FIE to its parent are exempt from withholding tax. However, dividend income earned on investment in a publicly traded mainland enterprise (A-shares) is subject to a 10% withholding tax.

Foreign-portfolio investors that receive dividends from China�s B-share, H-share and N-share companies are exempt from withholding tax on dividends.

Special tax treatment applies to profits directly reinvested by the foreign partner of an FIE into the same�or a new�enterprise, for a period of at least five years. Under the unified tax law, such FIEs may generally obtain a 40% refund of the enterprise tax already paid if they reinvest the earnings in the same or a new project. If the profits are invested in technologically advanced or export-oriented enterprises, the tax paid on the reinvested amount will be refunded completely.

The Ministry of Commerce, or one of its regional counterparts, must approve all licensing agreements. For joint ventures in which the foreign parent is providing technology, approval comes along with that for the Chinese investment. The 1996 forex reforms provide that once the authorities have approved a licensing agreement, payments or fees arising from it may be remitted without prior SAFE approval. Forex may be drawn either from the basic forex account or by conversion of renminbi at designated forex banks on the strength of supporting documentation.

A basic 10% withholding tax applies to royalties remitted abroad. It can be lowered or waived altogether for high-priority projects or when technology is provided on preferential terms.

The foreign-exchange (forex) reforms of 1996, amended in 2002, specifically authorise foreign-invested enterprises (FIEs) to retain the proceeds from exports

Restrictions on trade-relatedpayments

China 55


(or other earnings) in a basic forex account, up to a specified maximum, with one of the designated forex banks. However, all export receipts received beyond the limit must be sold off in the local forex market within five days. FIEs requiring additional forex for current-account needs, such as payment of goods and services, may obtain funds from the designated banks upon presentation of supporting documentation. (See Cash management section below for further details.)

Since July 14th 2008, the State Administration of Foreign Exchange (SAFE) has embarked on a campaign to scrutinise more carefully forex settlements by local exporters in a bid to prevent the inflow of short-term speculative funds, or �hot money�. It launched a renewed crackdown in February 2010 and announced that by end-October 2010, it had uncovered 197 cases of falsified export contracts aimed at bringing a total of US$7.34bn in hot money into China for speculation in stocks and property.

Importers may buy forex upon presentation of documents, such as import contracts and payment notes, issued by a financial institution outside of China. For imports subject to quotas or licence requirements, forex may be bought upon presentation of relevant contracts and approvals. Starting April 1st 2003, the SAFE liberalised its rules, abolishing the need to report the use of forex for three categories of trade-related payments: imports for re-export trade; imports of materials for overseas projects; and repayment of excessive parts of advance payments.

Foreign-trade corporations received digital identification cards in 1999 to communicate with customs offices via a computer link. All corporations authorised to engage in foreign trade have their licences checked annually. Certain categories of imports continue to be strictly controlled via quotas or licensing requirements administered by the Ministry of Commerce.

Deliberate, arranged leading and lagging of payments is not a common practice in China. There are no legal restrictions; however, in the government�s clampdown on illegal forex transactions in 1998, SAFE adopted the cash-after-delivery rule�imported goods could not be paid for until they physically arrived at their destination. There was never a legal basis for this rule, and SAFE soon abandoned it.

Tax consequences. China offers value-added tax rebates for a range of exported products. These rebates have been the subject of some criticism from abroad, and China is gradually reducing the list of eligible products. In June 2010 it cut 406 items, including some steel and non-ferrous metals products, from the list. In November 2010 it removed another 44 types of processed goods, including polysilicon and broken glass.

Short-term instruments/regulations

The People�s Bank of China (PBC�the central bank) sets the interest rates payable on renminbi deposits. These rates, like almost all others, are set as an element of the government�s economic policy.

Overview

56 China


The most common type of credit facility in China remains the one-year short-term loan. Borrowing for more than one year remains difficult and is normally permitted only when an official government plan or a project of national priority is involved. Most short-term financing for foreign-invested enterprises (FIEs)�whether in renminbi or in hard currency�is obtained from the Bank of China (BOC) or one of the other specialised banks.

The five large state-owned commercial banks continue to dominate the lending market, with a combined market share of over 50%. Despite official orders to transform themselves into truly �commercial� banks, they continue to lend much of their portfolios to the state-owned enterprises (SOEs). In fact, a fair portion of their nonperforming loans results from the restriction on short-term lending. Banks often grant one-year facilities even if that does not make commercial sense (for instance, a one-year facility for a large construction project). Any loan not repaid on the due date is then classified as nonperforming.

The five banks have significantly expanded their product range. With the abolition of free housing, markets have emerged for residential mortgages and retail lending. Competition among foreign banks for creditworthy domestic and foreign-invested clients is already strong and will intensify as more foreign banks enter the market. In this environment, foreign companies should have room to shop around for the best deals for renminbi borrowing.

Multinational companies generally have little trouble finding working-capital loans, but obtaining funds for smaller FIEs is difficult without ties to individual branch managers or loan officers. Hence, a potential partner�s understanding of the banking system is an important consideration when contemplating a joint-venture contract. Many foreign investors establish banking relationships with several Chinese banks. One reason is for easier access to money in times of tight credit. Another is to facilitate collecting payments from Chinese customers who may have accounts with these banks.

Despite a central-bank crackdown on illegal and grey-market financial activities, including underground fundraising, these practices continue. The central bank has prosecuted a number of �bankers� engaged in illegal lending�at higher-than-official rates of 20�80% per year (on one- to three-year facilities). This credit remains one of the main sources of funds for private enterprises. Lenders in the grey market include the five large banks and even SOEs.

Cash contributions to capital by foreign investors (when they initially establish a venture) are often used to tide a project over for the first few difficult years of foreign-exchange (forex) generation. This money can be converted into local currency as needed for working capital, though most foreign investors are reluctant to turn hard currency into soft unless absolutely necessary.

The Securities Law of 1999 provides a basic framework for the capital markets, but more sophisticated financial services, such as derivatives, are not mentioned. The beginning of a regulatory foundation was created with the release in March 2007 of rules on financial futures and options.

China 57


China�s derivatives markets are far less sophisticated than those in developed economies. However, some innovation is allowed, such as the introduction of forward contracts in ten different foreign currencies. The market for commodities futures may also gradually expand in terms of product range and market participants.

The payment system outside major cities remains somewhat antiquated and not entirely able to deal with the volume of transactions demanded by a modern commercial system. Fund transfers in some parts of China are still done through telegraph, telephone and mail.

Cheques and cash. Cheques, which are valid for only ten days, present a problem when those drawn on out-of-town bank accounts take longer than ten days to clear. However, a new cheque-imaging system introduced in August 2007 has alleviated this problem somewhat. Nonlocal purchasers sometimes avoid this problem by using banker�s drafts, for which the funds have already been cleared.

The Negotiable Instruments Law clarified the terms for cheques and other negotiable instruments (such as bills of exchange, promissory notes and banker�s acceptances). The law, which went into effect in 1996, defines the nature of such instruments and the rights and responsibilities of the various parties involved in issuing such paper, including the holder, maker, drawer, drawee, acceptor and guarantor. The law contains some restrictive provisions designed to limit opportunities for abuse and fraud, including a ban on post-dated cheques and the ten-day limit on their validity.

Certain provisions of the Commercial Bank Law of 1995 helped alleviate mistrust of negotiable instruments. They state that no commercial bank may enquire into, freeze or deduct depositors� savings without proper authorisation. Timely payment of interest and principal must be guaranteed.

The People�s Bank of China (PBC�the central bank) is trying to improve payments by promoting the use of secured instruments to settle accounts and also by creating secondary markets in which banks can discount accounts receivable. The introduction and gradual expansion of the China National Advanced Payment System is a step in that direction (see Payment-clearing systems below). This lets suppliers receive prompt payment and prevents arrears from accumulating. The PBC�s intention is to prevent the delivery of goods without payment by secured instrument or to customers with existing arrears. It initiated this policy in 1996 in troubled state industries, such as coal, and later expanded it to other areas.

When locals travel for business or pleasure, they often carry a large amount of cash. There remains a general mistrust of noncash methods of payment, and using cash is also a way to escape regulation. Even large deals are occasionally transacted in cash. The government has attempted to crack down on this practice by instituting a ceiling on the amount of cash that enterprises can have on hand or use in transactions. However, there was no public information regarding the government�s movements in this regard as of July 2011.

Cash management

58 China


Payment orders. Instead of receiving cheques, a company selling in China is often paid directly by the bank from the buyer�s account through a cheque-like system of payment orders. The buyer�s bank issues a payment order and shifts the money from the buyer�s account into its own reserve account; the bank receiving the order first clears it through the payments system to ensure that the money is available. To speed up the process, when a sales contract is signed, it often includes the buyer�s account number. The seller can collect by taking the contract to the buyer�s bank or, if buyer and seller have accounts at the same bank, by having the bank credit the seller�s account directly when the deal is done.

Such bank transfers do not necessarily move quickly if payment is originating from inland regions or from a less efficient state bank branch. Transfers exceeding Rmb500,000 must ordinarily pass through the PBC�s clearance system, which can add to processing time. In 1996 the PBC imposed minimum standards on the speed of settlements, with a two-day limit for transactions within the same city and a seven-day limit for transfers by mail. Foreign financial managers report, however, that these limits are not always observed. Transfers between Beijing and Shanghai can take up to a week; transfers between companies can take even longer.

Letters of credit. The publication of the Measures for the Settlement of Letters of Credit in China, effective August 1997, encouraged the use of letters of credit (L/Cs) to settle domestic accounts. The measures stipulate that only PBC-approved commercial banks and their branches may undertake this business. However, L/Cs are still uncommon in domestic transactions.

Even in foreign-trade transactions, L/Cs are not always a reliable form of payment. A Chinese buyer sometimes prefers to add riders to an L/C, specifying that the bank may release payment only once goods have cleared customs. If the purchaser is short of funds when the goods arrive, it may refuse to clear the goods, in effect, blocking payment. In other instances, Chinese banks have refused to honour L/Cs where contractual disputes exist between the local importer and the supplier.

Electronic commerce. Thanks to the widespread acceptance of the Internet, progress in establishing electronic commerce in China is pushing ahead rapidly. Internet service providers have begun developing payment and authentication systems to enable Internet-based transactions, using credit cards issued by large commercial banks. There is clearly a demand for online banking in China, and all major institutions and even some rural credit co-operatives offer services in the field.

The authorities have begun to feel a need for increased control. The PBC issued a notice in April 2002 requiring all banks to file reports on their online operations within ten days of the end of each quarter and to file additional reports if their systems had experienced hacker attacks or if vital information had leaked.

The PBC also attempted to establish a legal framework in the field with its Provisional Measures for the Administration of Online Banking Services of July 2001. An important objective of the measures appears to be the extension of

China 59


PBC influence to all kinds of banking institutions, regardless of ownership or location, that serve Chinese customers. According to the rules, in effect at June 2011, even banks registered outside Chinese borders must apply to the PBC if they wish to serve online banking customers inside China. The measures also make stringent demands on online security, requiring applicants to file a report describing their online security systems.

Credit cards. An overarching project guiding China�s modernisation of financial-data communications infrastructure is known as the Gold Card project. It aims to provide an interbank, inter-region card-clearing network. The Gold Card project ensures that debit cards issued by a Chinese bank in one province can be immediately verified and used for cashless payment in another province.

China is making strides towards a �cashless economy� on several fronts. The government has been promoting the use of credit cards and automated teller machines. For example, China UnionPay said that as end-2009, the latest date for which figures are available, holders of its UnionPay cards could withdraw cash from 215,000 automatic teller machines across China and carry out purchases through nearly 2.41m point-of-sales machines.

China issued 230m credit cards in 2010, up 23.96% from 2009, according to the China Bank Association. Distribution of true credit cards is tightly controlled, and there are required guarantees. For example, the Industrial and Commercial Bank of China requires documentation of financial assets of at least Rmb200,000 when issuing the Peony Visa International Credit Card.

All the major Chinese banks have issued their own debit cards: Peony, Great Wall, Pacific and Golden Spike. They also have arrangements with international credit-card issuers such as Visa and MasterCard. In addition to individual cardholders, businesses increasingly use cards to cover large purchases and to keep track of employees� business expenses.

The PBC on January 13th 2011 issued Measures for the Supervision and Administration of Commercial Banks� Credit Card Business, the first comprehensive rules for the protection of credit-card user confidentiality. The rules prohibit banks from using clients� credit-card information for any other purposes than their own credit-card businesses. It also specifies that banks are not allowed to print entire credit-card numbers on receipts and transaction statements.

Cash pooling in the traditional Western sense is not possible in China since the government does not allow the free flow of foreign exchange in and out of the country. But the pooling of cash between different operations in China is possible. Domestic cash pooling is possible only where foreign companies establish all their operations under a single holding company. The holding company cannot, under Chinese law, issue invoices or collect money. Similarly, the holding company cannot collect money, but it can organise the necessary telegraphic transfer payment to the relevant joint venture. Under this arrangement, the holding company effectively controls cashflow and receivables.

60 China


Foreign currency held locally by resident individuals. Chinese citizens may set up personal foreign-currency savings accounts; indeed, the central government encourages this as a way to keep these funds off the black market. Many Chinese bring back hard currency from abroad or receive it as gifts. They may open such accounts with designated foreign-exchange (forex) banks.

Foreign currency held locally by domestic companies. The use of foreign-currency accounts is limited to defined purposes. Following rules promulgated in 2002, Chinese companies may hold a limited amount of their forex earnings in special accounts.

Foreign currency held locally by foreign companies. The State Administration of Foreign Exchange (SAFE) requires each licensed foreign-invested enterprise (FIE) to take out a Foreign-Exchange Registration Certificate (FERC) to open foreign-currency accounts. FIEs must maintain a cumbersome administrative segregation of their hard-currency bank balances in order to respect the distinction between current- and capital-account transfers. Hence, most FIEs have three separate hard-currency accounts: (1) a base account, for trade and other current-account transactions; (2) a capital account, for injections and repatriation of capital; and (3) a loan account, for receipt and repayment of hard-currency loans.

A base account (more than one can be held with SAFE�s approval) must be used for current-account transactions. Account size is capped based on a company�s export volume. All forex earned above the limit must be sold off to the local market within five days. The account is capped at 20% of the enterprises� trade-related forex receipts of the previous year. For companies that had no trade-related forex receipts the previous year, the cap is set at US$100,000.

Local currency held abroad. In 1999 the Bank of China stopped accepting renminbi transfers and closed its renminbi accounts with all foreign banks, forcing all payments to be remitted into China in hard currency, rather than being exchanged into renminbi before remittance. However, renminbi deposits are allowed at Hong Kong banks.

Local currency held locally. No restrictions apply. All entities and private individuals that seek to convert money from forex accounts into renminbi for local expenses must do so via designated forex banks. However, the re-emergence of black markets for foreign currency in major cities has provided an illegal yet viable venue for domestic holders of hard currency to change funds.

Loans from the Bank of China (BOC), the primary Chinese commercial bank serving the needs of the foreign-investment community, are governed by the Procedures of the Bank of China for Loans to Enterprises with Foreign Investment of 1987. The BOC authorises a range of loans, including those to buy fixed assets and for working capital. Borrowers may negotiate interest rates with the bank on hard-currency loans.

Qualifications for loans are fairly restrictive: a joint venture must have paid its registered capital in full, and loans for capital construction projects must have

China 61


government approval. Priority is given to technologically advanced and export-oriented joint ventures.

Foreign-invested enterprises have access to other state-owned banks on similar terms, to foreign and joint-venture banks and to certain other Chinese financial institutions for their credit needs. A domestic bank will usually demand foreign-parent guarantees, but this may be negotiated. Joint ventures that borrow from the banking system are subject to a borrowing limit equal to 70% of assets (not including the value of land).

There are no restrictions on bilateral or multilateral netting between Chinese import and export companies and their counterparties. But this is not common practice. Continued restrictions on capital-account transactions preclude any use of netting with such payments.

Settlement between companies and their banks in China has traditionally been largely paper based, and poor communication between parties has made the verification of transactions difficult. Insufficient flows of information and poor standards of record-keeping�money often appears without any indication of its origins�has led to a high rate of failed transactions, or, perhaps more frustrating, a situation in which payments sit indefinitely, awaiting reconciliation.

The People�s Bank of China (PBC�the central bank) operates a national clearing system, the Electronic National Interbank Settlement System, or E-Link, which expanded rapidly to cover virtually the entire country by July 2006. The system is based on the central bank�s infrastructure, with all of its 2,153 sub-branches acting as relay stations for payments among banks in different parts of the country. The system is gradually being phased out and replaced with the more sophisticated China National Advanced Payment System (CNAPS). However, the PBC has not disclosed an official timeframe for completion.

In recent years, the PBC has made great strides in setting up CNAPS, which consists of two components, the Bulk-Entry Payment System (BEPS) and High-Value Payment System (HVPS). Under the BEPS system, the bank that sends the amount is debited the same day, while the bank that receives the amount is credited on the following business day. The BEPS supports various payment types, such as credit transfer, debit transfer and direct debit. CNAPS is served by a host computer in Beijing and a backup in the east Chinese city of Wuxi.

In August 2010 the PBC launched the Online Payment Interbank Clearing System, serving as a clearing system for online payments nationwide; among other things, it allows customers to log on just once and manage their accounts at different banks, including immediate transfer from one account to another. It is geared for transactions up to Rmb50,000; above this limit, HVPS will handle all transactions. As of June 2011, 129 financial institutions participated in the new system.

Branches of China�s large state-owned commercial banks often prefer to use their own electronic-funds-transfer systems. These facilitate payments between companies that are clients of the same bank but are of little help to those who use different banks. The domestic banks� extensive networks are a major

Payment-clearing systems

62 China


competitive advantage that foreign banks have sought to use to speed up payments. For example, HSBC (UK) reached agreements with all five state-owned commercial banks in 2000 to allow payments to its clients to be made from any of the Chinese banks� branches.

In October 2002 the PBC set up a national clearing centre connecting 96 of China�s 111 city commercial banks, helping the banks to link up with one another�s payment systems. The measure was beneficial to the city commercial banks, which frequently serve only customers in their specific localities and were at a disadvantage compared with the large state-owned commercial banks. China also has independent clearing systems for payments between companies in the same city, run by local PBC settlement offices.

Under normal conditions, sellers extend terms of 15�90 days net. Buyers and sellers are free to negotiate suitable terms, and companies producing a scarce or highly desired product are usually able to extract better conditions.

It is still the practice in China for a vendor to supply a customer and then present the bill or contract to the customer�s bank. Cashier orders, demand drafts and telex remittances from town to town also are used, as well as payment by cheque. Progress in establishing a system that would enable electronic payments is pushing ahead.

Following a number of foreign-exchange (forex) regulations introduced by the State Administration of Foreign Exchange (SAFE) during 1998, credit terms beyond 90 days on international transactions are now considered to be foreign debt and must be registered with SAFE. Hence, foreign-invested enterprises (FIEs) are keen to limit terms to fewer than 90 days.

FIEs increasingly make enquiries with local banks and suppliers, or employ local credit agencies to research customers� payment histories, thereby minimising the risk of nonpayment. Sinotrust and Huaxia are among the larger Chinese credit agencies offering credit information on domestic companies.

FIEs have only limited recourse to legal action. Although Chinese law permits foreign companies to file suits in local courts, many prefer arbitration because of concerns about the speed and impartiality of the courts. There is also a weak tradition of implementation of court rulings, especially if they favour foreigners over locals. This lack of confidence in the Chinese judicial system is not confined to foreign entities; it is shared by broad sections of Chinese society as well. The main reason is the absence of a clear-cut division of powers, with the court acting in close co-operation with politicians and officials. The spread of corruption in post-reform China has also affected the courts. Whereas judicial staff in the largest cities�such as Beijing and Shanghai�improved considerably during the reform years, the problem of graft is grave in many of the provinces.

Payment delays to suppliers are common, particularly in periods of credit tightening. Triangular debt has been a recurrent problem in the country. It occurs when indebted Chinese companies are cut off from access to credit, making them unable to pay their creditors, who in turn simply pass their cashflow problem down the line to their suppliers.

Receivables management

Payables management

China 63


Inefficient state-owned enterprises (SOEs), which are highly dependent on the state-owned banking system to keep them afloat, are the first to feel the effect when banks tighten the supply of credit. Firms doing business with SOEs also experience the effect of triangular debt, as do foreign-invested enterprises (FIEs). Collecting receivables has become a serious problem for many of these firms since some customers simply cannot pay their bills within the promised time.

There are no extraordinary techniques used by firms to delay payments.

China continues to retain strict controls on moving and holding its national currency, the renminbi, and foreign currencies. The renminbi is convertible on the current account (that is, for trade, services and other similar payments) but remains nonconvertible on the capital account (that is, for investments, borrowing and the like). It may not legally be used overseas. Chinese authorities require that all enterprises that operate locally, Chinese and foreign, sell foreign currency in excess of specified amounts to �designated foreign-exchange (forex) banks�. Officials tightened these restrictions in the late 1990s but have relaxed them somewhat in recent years.

Over the past year, an offshore market for the Chinese currency in Hong Kong has emerged to attain substantial size. As of June 2011, less than a year after China and Hong Kong decided to relax regulations on offshore trading of renminbi in the special administrative region, average daily turnover in Hong Kong�s offshore renminbi market exceeded US$1bn, rapidly catching up with renminbi nondeliverable forwards, for which the average daily transaction is between US$2bn and US$3bn. Trade in the market has been fuelled partly by foreign speculators betting on appreciation of the Chinese currency in the future.

China�s onshore forex market is composed of three parts:

Retail market. There is a retail market between designated forex banks (including foreign banks) and Chinese entities (domestic companies, foreign-invested enterprises and government organisations) for selling or buying forex. There are 21 Chinese designated forex banks, including Agricultural Bank of China, Agricultural Development Bank of China, Bank of China, China Construction Bank, China Development Bank, Export-Import Bank of China, and Industrial and Commercial Bank of China; and ten foreign-funded ones, including Bank of East Asia (Hong Kong), KBC Bank (Ireland), Mizuho Corporate Bank (Japan), Standard Chartered Bank (UK) and United Overseas Bank (Singapore).

Exchange-control regulations allow Chinese and foreign entities to keep forex earnings up to specific limits in special accounts; forex earnings above those limits must be sold on the retail market. Surrendered earnings include forex income derived from export or transit of goods and other trading activities, income generated through transport and tourism, net income of banks derived from forex transactions and profits derived from service-related activities. Under forex reforms in 1996, foreign-invested enterprises (FIEs) seeking hard currency for legitimate trade-related transactions can access the market via any designated forex bank.

Currency spot market

64 China


Interbank market. There also is an interbank market that comprises all designated forex banks, which are connected by a computer network in a trading, clearing and settlement system called the China Foreign Exchange Trade System (CFETS), based in Shanghai. Sub-branches of the CFETS, linked to Shanghai by computer, operate in Beijing, Chengdu, Chongqing, Dalian, Fuzhou, Guangzhou, Haikou, Nanjing, Ningbo, Qingdao, Shantou, Shenyang, Shenzhen, Tianjin, Wuhan, Xiamen, Xian and Zhuhai. The State Administration of Foreign Exchange is the market regulator.

The CFETS allows very small daily fluctuations in the renminbi exchange rate and oversees trading of Hong Kong and US dollars, euro and Japanese yen. Trading hours are 9.30 am to 3.30 pm, continuously; trading takes place Monday through Friday, except on national holidays.

Foreign and domestic banks and nonbank financial institutions participate in CFETS transactions as member-institutions. A unified rate for the US dollar and other major currencies is quoted daily by the People�s Bank of China (PBC�the central bank) based on the previous day�s closing prices in the interbank market. Should the rate fluctuate during the day outside the narrow set band, the PBC maintains a special hard-currency account for intervention.

Foreign banks obtain renminbi either by taking local-currency deposits from the few FIEs that generate large domestic revenues or by borrowing in the interbank market (where funding costs are substantially higher than those incurred by Chinese banks offering renminbi savings accounts).

Over-the-counter market. In January 2006 China permitted over-the-counter currency trading with banks acting as market-makers, obliged to cite both buying and selling prices. The market is characterised by bilateral credit authorisation and settlement between two parties. The CFETS carries out over-the-counter trade from 9:30 am to 5:30 pm.

Tax consequences. China at present does not levy a tax on currency transactions. However, Andrew Sheng, an adviser to the China Banking Regulatory Commission (the industry watchdog) indicated in an interview with the China Business News in March 2010 that a tax could be useful in deterring speculators. There had been no further developments in this area as of July 2011.

The market for currency and interest-rate futures has traditionally been extremely limited, mainly because the renminbi is convertible only on the current account. However, the situation is gradually changing, partly reflecting China�s growing investments overseas, which have resulted in a growing need for instruments to hedge against exchange rate risk.

On March 29th 2011, the state-controlled China Securities Journal newspaper reported that the government had started preparations for the reintroduction of bond futures to provide hedging for a rapidly growing Treasury bond market; bond futures trading had been stopped in 1995 due to excessive speculative behaviour. No timetable was reported. Previously, in May 2005 the People�s Bank of China (PBC�the central bank) issued rules permitting trades in bond forwards as a means of hedging interest-rate risk.

Futures and forward contracts

China 65


The State Council issued another set of rules on March 16th 2007, permitting companies to trade in financial futures and options, covering securities, interest rates, and foreign-exchange-rate and index-related derivatives. The new rules expanded the scope of regulations that had so far allowed trading in commodities-related futures and options. According to the rules, which took effect on April 15th 2007, both domestic and foreign companies can apply for licences to trade in financial futures and options, provided their registered capital amounts to at least Rmb30m. The new rules oblige the market to introduce various risk-control mechanisms, including a guarantee fund and an interest compensation system for futures investors. To this end, in February 2010 the China Financial Futures Exchange (see below) started charging its members a fee for a special settlement guarantee fund. The fee ranges from Rmb10m to Rmb30m depending on the type of membership.

The nation�s first financial futures exchange, the China Financial Futures Exchange, was inaugurated in Shanghai in September 2006. The following month it began simulation trading of stock index futures. On March 16th 2007 the State Council issued new rules that formally permitted companies to engage in financial futures trading. In April 2010 China launched its first financial futures product, the CSI 300 Index Futures, which covers the Shanghai and Shenzhen exchanges; as of end-July 2011, it was the only product of its kind available for trading on the financial futures exchange. Reflecting official concern about the risks involved, tough requirements are in force for investors who want to trade the products. They must place a deposit of Rmb500,000 in a special account, prove a record of trading in mock futures products and pay deposits in cash equivalent to 15�18% of the value of the futures contracts. In May 2011 the China Securities Regulatory Commission (CSRC) said it would allow qualified foreign institutions investors to invest in stock index futures, but for hedging purposes only; it gave no timetable.

Industrial and Commercial Bank of China, the country�s largest bank, started offering forward foreign-exchange (forex) contracts to local companies on April 1st 2003. The contracts, with terms ranging from one week to one year, are offered in US dollars, Japanese yen and eight other foreign currencies. The PBC said in August 2005 that more banks would be allowed to offer forward contracts, reflecting the need for easier access to hedging following the de-pegging of the renminbi from the US dollar in July of that year. Since then, several large foreign banks have been given permission to trade forwards, including Citigroup (US) and HSBC Holdings (UK).

Nonfinancial methods of forex hedging in China are broadly similar to those used in other markets (such as matching the currency denomination of assets and liabilities). Another option is for overseas ventures to denominate their initial investments in hard currency, rather than in renminbi. Some companies have converted their capital contributions into local currency up front, writing the renminbi equivalent into the joint-venture contract.

For the past few years, several international banks in Hong Kong and Singapore have offered a specialised hedging vehicle called the nondelivery forward (NDF) contract. NDFs differ from normal forward forex contracts in one respect: there is no consummation of the transaction. Normally, when a buyer and a

66 China


seller enter into a forward contract (for example, between Japanese yen and US dollars), they agree to exchange foreign currency at a specified rate on a future date. On this delivery date, called the value date, the two parties settle, actually exchanging currencies.

With an NDF, no delivery of currency actually takes place. Instead, at the time they enter into the arrangement, the parties agree upon a certain contract rate and a reference rate. The reference rate determines which party incurs a gain or loss. For China, that reference rate is normally the official closing renminbi rate posted each day. On the value date, the date the two parties settle, one of the parties will realise a gain based on the reference rate. This gain would be converted into and paid in US dollars; no renminbi actually changes hands.

Citibank now offers NDFs in a variety of amounts, typically US$5m�10m. For customers seeking to cover higher exposures, the bank will normally not assume the full risk. For the balance, it seeks counterparties willing to fund the other side of the transaction. Contract tenors run up to two years. Typically, however, the bank�s customers hedge for six months to a year, since higher costs are associated with longer contracts. At the end of the period, the contract can be rolled over, as needed.

NDFs are designed to overcome the barriers imposed by nonconvertible or only partially convertible currencies like the renminbi. Though NDF contracts have been around for several years, they have only recently become more widely available for renminbi operations.

China has a thriving futures and forwards market for commodities. There are three futures exchanges, in Dalian, Shanghai and Zhengzhou. As of end-July 2011 these exchanges traded futures contracts in aluminium, copper, corn, cotton, fuel oil, gold, linear low-density polyethylene, palm oil, pure terephthalic acid, rapeseed, rebar, rice, rubber, soybean, soybean meal, soybean oil, steel, sugar, wheat, wire and zinc. The combined turnover of the three exchanges was Rmb309.1trn in 2010, up 136.9% from the year before, making China the largest commodities futures market; the figure, provided by the China Futures Association, also included transactions in the stock index future.

The CSRC published a circular on January 23rd 2003 permitting foreign-invested companies to buy stakes in local futures brokerage firms. Foreign investors must have registered capital and net assets of at least Rmb10m and must have posted a profit for the preceding two fiscal years. The latter requirement does not apply to firms with more than Rmb50m in registered capital and net assets. On March 23rd 2004 the CSRC issued additional regulations on futures brokerage firms, clarifying standards of corporate structure, rights and liabilities of shareholders, and requirements for risk management and internal control of futures brokerage firms.

Overseas futures trading. Since January 2002 the CSRC has permitted some state-owned enterprises (SOEs) to trade futures on selected overseas exchanges. By end-July 2011 a total of 31 SOEs were engaged in active trading abroad. The firms are under strict obligations to use their access to overseas futures markets only to hedge trade risks and not engage in speculative activities. They must also file reports during the first ten days of each month on the previous

China 67


month�s activities. Non-SOEs and foreign firms are not permitted to conduct overseas futures trading. In February 2009 the State-owned Assets Supervision and Administration Commission (SASAC) assumed responsibility from the CSRC for oversight of overseas derivatives trading by local companies; in a sign of growing concern about risk, SASAC in July 2009 ordered companies engaged in overseas derivatives trading to file quarterly reports about their activities.

Tax consequences. Under the Foreign Income Tax Law, capital gains of foreign-invested enterprises and foreign companies in China are treated as normal income and taxed at 33% (though an 18% tax rebate often applies). Nonresident companies are subject to a 10% withholding tax. Gains or losses from currency transactions should be treated as normal income but may be amortised over five years.

With effect from April 1st 2011, China allowed trade in currency options involving the renminbi and foreign currencies. In a circular issued on February 14th 2011, the State Administration of Foreign Exchange (SAFE) explained detailed rules regarding the new instrument, making it clear that China is still wedded to a cautious approach. Only European-style vanilla options are allowed, meaning that they can only be exercised on their expiry date, not in the period before. Companies wishing to enter into options contracts must also provide documentation to demonstrate a need for hedging of currency transactions. Finally, companies are not allowed to sell options unless it is to square a position (ie, ensure that buy positions and sell positions are equal and cancel each other out).

Tax consequences. The 2011 SAFE rules did not specify how option trading would be taxed, but it is likely that a business tax of typically 3�5% will be levied on options premiums.

Beginning March 1st 2011, the State Administration of Foreign Exchange (SAFE) allowed qualified banks to trade in cross-currency swaps on behalf of their clients; previously they had been permitted to do so only in the interbank market and on their own behalf. In rules issued on February 14th 2011, the SAFE defined cross-currency swaps as the exchange not just of principal, but also of periodic payment of interest; previously, the most common swap agreement in China involved the exchange of the principal only. The new SAFE rules also marked a step towards liberalisation by not specifying which currencies are eligible for cross-currency swaps; earlier, only the renminbi, US dollar, the euro, the Japanese yen, the Hong Kong dollar and the British pound had been permitted.

On January 18th 2008 the People�s Bank of China (PBC�the central bank) issued new regulations that formally permitted renminbi-denominated interest-rate swaps. Previous rules from February 2006 had introduced the instruments merely on a trial basis. According to the rules, banks with derivatives licences can perform the transactions with each other or with their clients, but only for hedging purposes (that is, not in order to speculate). The opening is part of a broader effort to increase the availability of hedging tools to Chinese market

Options

Swaps

68 China


participants; the decision to increase the number of banks that can trade in forward contracts is generally seen as part of the same effort.

Tax consequences. Under the Foreign Income Tax Law, capital gains of foreign-invested enterprises and foreign companies in China are treated as normal income and taxed at 25%. Nonresident companies are subject to a 10% withholding tax. Gains or losses from currency transactions should be treated as normal income but may be amortised over five years.

Sophisticated derivatives instruments are not traded in China.

Bank loans fall into three categories: temporary loans for three months or less; short-term loans of more than three months but less than one year; and medium-term loans for one to three years. Interest rates on medium-term loans for operational funds are the same as those on loans for fixed assets.

Lending slowed in 2010, reaching Rmb7.95trn, a decline of 17.2% from a year earlier, but still higher than the Rmb7.5trn target set by the government. China�s monetary authorities have been struggling since 2009 to rein in lending, which saw a rapid expansion, mainly as banks accommodated a Rmb4trn stimulus package arranged by the government to ward off the worst effects of the global financial crisis. The slowdown in lending continued in 2011, with new loans in the first six months totalling Rmb4.17trn, a drop of 9.7% from the same period in 2010.

General Rules on Loans, in effect from 1996, apply to loans from Chinese banks extended to foreign-invested and domestic companies. (The general rules apply only to domestic banks. The General Rules on Loans lay out a host of �common sense� requirements for lending, such as that borrowers must prove the viability of their products in the marketplace and provide guarantees for loans. Borrowers must provide details on assets, liabilities, credit history, and other operational and management information in order to demonstrate creditworthiness.

Revolving credit lines with the Bank of China and other specialised banks are common. Interest rates on such loans are fixed to a central-bank reference rate.

The type of security demanded by Chinese lenders is based on a number of factors, the most obvious being the creditworthiness of the business. Typically, physical assets are used as collateral, but since 2006 some banks have also started accepting intellectual-property rights as security. The State Administration of Foreign Exchange (SAFE) prohibited loan security in the form of foreign bank guarantees or stand-by letters of credit in 1998.

In a bid to help companies meet their short-term financing needs, the People�s Bank of China (PBC�the central bank) announced in September 2001 that businesses could use their expected export-tax rebates as collateral for loans. The PBC said the loans should amount to no more than 70% of the expected rebates and be of a maximum one-year duration.

Foreign-invested enterprises (FIEs) are allowed to finance fixed-asset investment with foreign-exchange-backed renminbi loans. FIEs may pledge foreign-

Exotics

Bank loans

China 69


exchange equity contributions and current-account receivables to obtain renminbi financing. Loan terms may be extended up to five years.

Tax consequences. A withholding tax of 10% applies to all interest income, including short-, medium- or long-term loans. Since March 1998 the withholding tax also applies to fees received on guarantees on loans or contracts to any organisation, enterprise or individual. The purpose of this rule is to prevent banks from declaring interest income as fee income.

Interest income from certain loans made to the government or the five large state banks is exempt from tax. Moreover, tax exemption may also apply where the lender is in a country that has a tax treaty with China. However, local authorities occasionally charge arbitrary taxes (though the central government is trying to eliminate such practices).

Borrowers can deduct interest from taxable corporate income.

Indicative borrowing rates–Shanghai interbank offered rates(Oct 2006 to Jul 2011; %; month-end)

Source: Bloomberg.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.01-year6-month3-month

JAF11

DOAJAF10

DOAJAF09

DOAJAF08

DOAJAF07

DO2006

Fixed-term bank deposits are the most common instruments available to companies for placement of excess funds. Rates improve as the term of the deposit lengthens. However, renminbi-denominated savings have generally been made as unattractive as possible, since the government would like consumers to save less and spend more. The People�s Bank of China (PBC�the central bank) fixes all local-currency deposit rates.

Since late 2010, deposit rates have been rising as part of a general PBC effort to curb inflation via higher rates. In the period from October 2010 to July 2011, it hiked the one-year deposit rate five times; most recently in July 2011 it added 25 basis points to the benchmark rate, raising it to 3.5%.

PBC regulations define two types of foreign-currency deposits. One is a fixed deposit, in the form of a certificate, issued in the name of the depositor, which can be withdrawn only in a single lump sum, with a maturity of three months, six months, one year or two years. The deposit must be equivalent to at least Rmb10,000. The interest rate is fixed at the time of deposit. The other type is a current deposit, either by deposit book or current (demand) account. Withdrawals may be made at any time, but overdrafts are not permitted.

Time deposits

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Hard-currency deposits have become popular because of a lack of alternatives and the fact that interest income is not taxed. These can be made at state and foreign-bank branches in all major currencies, including Hong Kong and US dollars, European euros, Swiss francs, British pounds and Japanese yen. The rates offered are in line with Eurocurrency rates. The PBC liberalised US dollar deposits and lending in September 2000, in such a way that banks may set rates on amounts up to US$3m.

Tax consequences. There is a 5% withholding tax on interest earned from local-currency deposits. The tax rate was reduced from 20% with effect from August 15th 2007. Foreign-currency deposits are tax exempt.

Deposits(US$ bn)


0

5,000

10,000

15,000

20,000

Time and savingsCurrent-accountTotal

1211100908072006

China�s market for certificates of deposit (CDs) is tiny and nonliquid, and trading is extremely limited. Instead, money-market instruments consist mainly of interbank loans, commercial paper and bond repurchase agreements.

Indicative investment yields–savings deposit rates(Jul 2006 to Jul 2011; %; month-end)

Source: Bloomberg.

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.51-year6-month3-month

JMMJ11

NSJMMJ10

NSJMMJ09

NSJMMJ08

NSJMMJ07

NSJ2006

The government began issuing short-term Treasury bills (T-bills) in 1994. Foreign-invested enterprises may not at present invest in T-bills, though foreign banks granted the right to conduct limited renminbi business can participate in the primary and secondary Treasury bond (T-bond) markets. Although the trend up to 1996 had been towards a proliferation in both the number and variety of government issues, the Ministry of Finance has since taken a more traditional

Certificates of deposit

Treasury bills

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stance, focusing on bond sales to individual investors, rather than encouraging the development of an institutional bond market.

Tax consequences. Interest income from state-sponsored issues is exempt from withholding tax.

China had made substantial progress in developing a national market for investors to trade government bond repurchase agreement (repo) deals in the early and mid-1990s. Volume in the Treasury repo market fell sharply after 1997, however, after the central bank ordered the state banks gradually to pull out of the state-debt markets.

Tax consequences. Gains on repos are taxed as normal income.

A market for commercial paper (CP)�short-term, unsecured promissory notes sold on a discount basis�appeared in the Shenzhen Special Economic Zone in October 1996. The risks for investors are high, however, since no regular secondary market exists. Hence, issues also are rare. Issues are not available as an investment instrument to foreign-invested enterprises in China.

Tax consequences. Gains on CP are taxed as normal income.

Both Chinese and foreign bank branches offer overdraft facilities. Interest rates vary considerably, and rates of up to 20% are not unusual. Foreign companies prefer to raise overdraft facilities in Hong Kong since the rates are lower there. Raising an overdraft facility from a Chinese bank requires a considerable commitment to socialising with and entertaining the bank officials in question. Approval can take up to one week.

Tax consequences. A withholding tax of 10% applies to all interest income, regardless of whether it is derived from overdrafts, trade-finance facilities, or short-, medium- or long-term loans. Since March 1998 the withholding tax also applies to fees received on guarantees on loans or contracts to any organisation, enterprise or individual. The purpose of this rule is to prevent banks from declaring interest income as fee income.


Banker�s acceptances (BAs)�bills of exchange drawn on a bank�are not widely used in China.

Tax consequences. There are no special tax considerations for BAs. Gains are taxed as normal income.

The use of supplier credit depends on the relationship between buyer and seller. The ability of a foreign-invested enterprise in China to secure good terms depends largely on its bargaining position with the Chinese supplier. However, this business is not often entertained because of triangular debt and debt-collection difficulties.

Tax consequences. There are no special tax considerations for supplier credit. Gains are taxed as normal income.

Repurchase agreements

Commercial paper

Overdrafts

Banker�s acceptances

Supplier credit

72 China


Foreign-shareholder loans to their Chinese subsidiaries have occasionally been used to meet foreign-exchange shortfalls of joint ventures. Intercompany and intracompany borrowing within China have been outlawed since 1995, when the Commercial Bank Law came into effect. But the practice persists in the grey market.

The China Securities Regulatory Commission and the State-Owned Assets Supervision and Administration Commission issued Circular 56 in August 2003 on issues related to fund transfers between listed companies and related parties. It stipulated that listed companies are not allowed to provide capital to the controlling shareholder through so-called entrusted loans using banks or nonbanking financial institutions as intermediaries. This does not, however, appear to have inhibited the growth of entrusted loans.

Tax consequences. Because intercompany borrowing is prohibited, there are no special tax considerations for this practice. Engaging in such activity is not recommended, however.

Both Chinese and foreign bank branches discount trade bills in connection with foreign trade. The terms for discounting bills and other negotiable instruments were clarified by the Negotiable Instruments Law of January 1996.

Tax consequences. Gains on trade bill discounts are taxed as normal income.

Medium- and long-term instruments/regulations

It is often difficult for companies to obtain long-term credit in China. Instead, commercial banks lend local-currency funds at shorter terms and roll them over at maturity. They also lend local currency against solid collateral, such as accounts receivable and export tax rebates. Hard-currency loans are usually raised offshore, especially in Hong Kong. Leasing of vehicles, equipment and other goods is also possible. China has a rapidly growing bond market, but it is closed to foreign companies as both issuers and investors. Given the need for infrastructure development, the government is keen to involve private-sector capital for infrastructure financing.

Many of the same Chinese financial institutions that tap the syndicated-loan market also turn to the international bond markets. These funds are sometimes on loan for domestic projects and, occasionally, projects that have foreign participation. In an effort to contain outstanding foreign debt, the People�s Bank of China (the central bank) continues to keep a tight rein on the overseas borrowing and bond-issuing activities of the country�s banks and state enterprises.

The Shanghai and Shenzhen exchanges are China�s two designated stockmarkets. The Shanghai Stock Exchange has emerged as the more important of the two.

A-shares are denominated in renminbi and were exclusively reserved for domestic investors. But measures implemented in 2002 allowed entry to qualified foreign institutional investors (QFIIs). The opening of the market to

Intercompany borrowing

Discounting of trade bills

Overview

Securities markets

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QFIIs followed a previous move, from October 1999, to allow foreign investors to purchase A-shares indirectly by buying stakes in mutual funds that invest in A-shares. The Measures for the Administration of QFIIs� Investments in Domestic Securities, effective from September 1st 2006, replaced earlier rules released in November 2002. The 2006 regulations, published by the China Securities Regulatory Commission (CSRC), the State Administration of Foreign Exchange (SAFE) and the People�s Bank of China (PBC�the central bank), oblige applicants to meet a series of requirements, including the following.

• They must be categorised as fund-management companies, insurance firms, securities companies, commercial banks or other fund-management institutions, including pension funds and charitable foundations.

• Fund-management companies, insurance firms, pension funds and charitable foundations must have managed at least US$5bn in securities in the last fiscal year prior to approval; for securities companies and commercial banks, the minimum is US$10bn.

• Fund-management companies, insurance firms, pension funds and charitable foundations must have been in business for at least five years. Securities companies must have been in business for at least 30 years and must also have paid-up capital of at least US$1bn. Commercial banks must be among the 100 largest in the world.

• Applicants must be financially stable, have good credit standing, and have effective risk-control and governance systems.

• Applicants must be located in a country governed by a securities regulatory agency with which the CSRC has entered into an agreement on co-operation in the regulatory field. As of the end of July 2011, there are 45 such countries, including Japan and the US. Most recently added to the list was Israel in March 2011.

Such investors are allowed to invest in shares and bonds listed on local A-share markets, securities investment funds and warrants. No single foreign investor investing via a QFII may hold more than 10% in a listed company, and the total cap on QFII ownership of individual shares is 20%. The pool of investment quotas available to QFIIs was initially set at US$10bn. In December 2007, when US$9.95bn of the quotas had been used, China tripled the quotas to US$30bn. In October 2009 SAFE raised the maximum investment quota for an individual QFII from Rmb800m to Rmb1bn.

In addition, the 2006 rules, like the 2002 regulations they superseded, allow banks with a paid-in capital of at least Rmb8bn to act as custodians for QFIIs; this option was opened to foreign banks with a history of at least three years of operations in China. Custodians are charged with safekeeping all assets put under their custody by the QFIIs, and also with supervising the activities of the QFIIs and reporting violations of local laws and regulations to the CSRC and SAFE.

By end-July 2011 the PBC had approved applications from five foreign banks to act as custodians, including Citibank (US), DBS Bank (Singapore), Deutsche Bank (Germany), HSBC (UK) and Standard Chartered (UK); Citibank has quickly

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gained a dominant market share of about 50%. The PBC had also approved applications from eight Chinese banks: Agricultural Bank of China, Bank of China, Bank of Communications, China CITIC Bank, China Construction Bank, China Everbright Bank, China Merchants Bank and Industrial and Commercial Bank of China.

B-shares (traded in US dollars in Shanghai and Hong Kong dollars in Shenzhen) were originally reserved exclusively for foreigners, but the market opened in February 2001 to domestic investors with legitimate foreign-currency accounts. The B-share markets remain relatively illiquid, with few quality companies listed.

China has the second-largest equity market in Asia (after Japan), with total market capitalisation of Rmb26.4trn at end-July 2011. Shanghai had 907 A-share companies, worth Rmb17.7trn; and 54 B-share firms, worth Rmb91bn. Shenzhen had 1,320 A-share companies, worth Rmb8.5trn; and 54 B-share firms, worth Rmb101bn.

Companies raised Rmb1,263.59bn on the Shanghai and Shenzhen stockmarkets as well as overseas exchanges during 2010, a rise of 122.4% from 2009, according to the China Securities Regulatory Commission (CSRC). The funds raised included Rmb488.3bn in initial public offerings (IPOs) of A-shares (up from Rmb187.9bn in 2009); no B-share IPOs (as was also the case in 2009); and Rmb407.8bn in A-share rights offers (up from Rmb201.6bn in 2009). Also included in that total was US$17.8bn (about Rmb119.3bn) raised in issues of H-shares (Chinese companies listed in Hong Kong) and N-shares (Chinese companies that have issued American Depositary Receipts in New York), which was up from US$14.7bn in 2009; US$17.6bn (about Rmb117.9bn) in H- and N-share rights offers (compared with US$1.0bn in 2009); and finally Rmb132.0bn in corporate bonds (up from Rmb71.5bn in 2009).

In 2010 China (including Hong Kong) was the world�s most active IPO market. It saw US$131.8bn raised in 509 issues, accounting for 46% of global funds raised, according to Ernst & Young.

In the first four months of 2011, the most recent period for which data are available, a total of Rmb313.4bn was raised on the Shanghai and Shenzen stockmarkets as well as overseas exchanges, a rise of 36.3% from Rmb230.0bn in the same period in 2010. This included Rmb129.9bn in A-share IPOs (compared with Rmb151.7bn in the same period in 2010) and no B-share IPOs (likewise in the first four months of 2010). During the first four months of 2011, A-share rights issues amounted to Rmb93.5bn (up from Rmb58.2bn), and Rmb61.8bn in bond issues (compared with Rmb12.7bn in the first four months of 2010). There were no H- and N-share IPOs in the first four months of 2011, the same as one year earlier, while H- and N-share rights issues stood at US$768m (about Rmb5.1bn), down from US$1.1bn. Additional categories of issues are included in the CSRC�s total calculation but these have not been disclosed.

After the end of a moratorium on IPOs that had been in place since September 2008, new share issues started taking place in July 2009. These included a massive Rmb50.2bn listing by China State Construction Engineering Corp on July 29th 2009�marking the largest IPO anywhere in the world since March

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2008. An even larger IPO was a dual listing in Shanghai and Hong Kong by Agricultural Bank of China in July 2010 (see box on IPOs).

There are four separate indices for each of the markets: Shanghai A-shares and B-shares, and Shenzhen A-shares and B-shares. After performing strongly in 2009, they have seen a drop in the period from January 2010 to July 2011, mainly because investors have been concerned about macroeconomic issues such as the risk that the government will take steps to prevent overheating of the overall economy. The Shanghai A- and B-shares and Shenzen A- and B-shares indices stood at 2,829.5, 281.7, 1,234.1, 734.5, respectively, at end-July 2011, all higher than a year earlier.

The government has used the stamp tax as a means of lifting the stockmarkets in periods of decline. In April 2008 it cut the stamp tax on securities transactions to 0.1% from 0.3%, reversing a tripling of the tax rate that it carried out in May 2007. In September 2008 it removed the stamp tax entirely on stock purchases, but retained it for stock sales. As of July 2011, that tax remained in place.

On March 31st 2010, the government introduced margin trading and short selling on a trial basis. It indicated that for brokerages to perform the transactions they must have net capital of least Rmb5bn; initially it allowed six local brokerages to carry out the trades: Citic Securities, Everbright Securities, GF Securities, Guosen Securities, Guotai Junan Securities and Haitong Securities.

The Shenzhen exchange in October 2009 opened the Growth Enterprise Market (GEM) for smaller enterprises, with a total of 28 companies listed. This fulfilled an ambition the exchange had had since the beginning of the decade of operating an exchange akin to the US Nasdaq. Performance has been lacklustre, however, partly reflecting the overall state of the share market.

The most comprehensive information on the Shanghai and Shenzhen markets is online, at the website of the China Stock Markets Web. The Hong Kong Exchanges manage this site under an agreement between the three markets; the site offers information on listed companies, their announcements, share and index movements, and basic market data.

Regulation. The Securities Law of 1999 regulates China�s securities markets. It sets out standard practices for share issues and trading, codes of behaviour and penalties for violations for China�s listed companies, stock exchanges, brokerage firms, registration and settlement companies, self-regulatory associations and government regulatory bodies. The law mostly codifies existing practices to protect investors against unethical activity, such as insider trading, market manipulation and fraud. Its main provisions are as follows:

• establishment of the CSRC as the sole market regulator and delegation of certain powers to the exchanges to suspend and terminate listing of shares and corporate bonds;

• a continuing ban on the use of bank funds to speculate in shares;

• a ban on state-owned enterprises speculating in shares;

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• the establishment of a committee by regulators and external professionals to vet listing applications by voting;

• ranking of brokerage firms either as comprehensive securities houses (if they have registered capital of at least Rmb500m and a sound trading record) or as smaller firms (capital of at least Rmb50m), which are permitted to trade only on a client�s behalf;

• a requirement for stock exchanges, brokerage firms and the share-settlement company to set up compensation funds to protect clients and brokerage houses against default by exchange members and in the event brokerages have acted improperly; and

• a requirement that buyers of state shares must hold on to their acquisitions for at least one year, and subsequently they may only sell off shares equivalent to 5% of a listed company�s equity every 12 months.

The CSRC issued rules in 2000 requiring companies to disclose whether the assets they own in mainland firms are in fact genuine. Reports must also include an opinion on the legitimacy of claims to the ownership of shares in companies outside China by mainland-based institutions and individuals. In addition, they must include a statement as to whether these companies� activities are within the bounds of Chinese law, and general information on share issues, the assets to be listed, the underwriters, how the proceeds from the issue would be spent and the exchange on which the shares would be listed.

Since more financial institutions are listing on the A-share markets, the CSRC in 2000 also tightened disclosure rules for financial companies that intend to go public. The rules, effective January 1st 2001, were meant to prevent the problem of nonperforming loans (NPLs) among state-owned institutions from spilling into the capital markets. Prospective candidates must disclose information on asset quality and NPLs in their prospectuses and financial statements, as well as other sensitive information.

The CSRC changed reporting requirements so that, beginning in 2001, all listed companies must issue quarterly financial reports. The CSRC has pressed listed companies to undergo auditing by foreign accounting firms under international rules, in addition to audits by domestic accountants.

Monthly close of the Shanghai and Shenzhen A and B indices(Jul 2006 to Jul 2011)

Source: Bloomberg.

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Chinese companies offer their shares on stock exchanges in China, Hong Kong, London and New York. So-called A-shares, the renminbi-denominated equity that makes up most valuation and trading volume on the Shanghai and Shenzhen stockmarkets, were previously unavailable to foreigners. Under rules implemented in 2002, qualified foreign institutional investors (QFIIs) are now permitted to buy and sell them.

A separate set of national rules governs B-shares, the Hong Kong or US dollar�denominated stocks that have long been available to foreign investors on the two exchanges. Many funds based on B-shares from international fund managers have emerged since 1993. Since the supply of B-shares is limited and the markets remain illiquid, many investment funds are rounded out with related stock, H- or N-shares (mainland firms listed on the Hong Kong or New York stock exchanges) and American Depositary Receipts of B-share companies.

Some Chinese investment funds make placements directly in promising national ventures that are not listed on any exchange. Foreign investment funds, such as the Asian Infrastructure Fund, as well as the private-equity departments of large international commercial banks, also invest in these unlisted Chinese companies.

On April 13th 2006, China announced a long-expected financial liberalisation package giving the green light to overseas investments by Chinese institutions and individuals�qualified domestic institutional investors (QDIIs). The rules allow commercial banks to buy foreign exchange on behalf of Chinese companies and citizens for investment in overseas fixed-income instruments such as bonds, and also make it possible for insurance firms to invest part of their assets in fixed-income products in foreign markets. Fund-management companies also received the go-ahead to invest part of their assets overseas.

Banks and insurers considered the original range of potential investment options, limited to fixed-income products, somewhat restrictive. In May 2007 the government issued new rules allowing QDIIs to also invest in overseas equities. Analysts believe that the move was aimed in part at providing an outlet for the nation�s massive foreign-exchange reserves and forming part of a broader effort to allow more funds to exit China in a controlled manner in order to ease some of the pressure on the Chinese currency.

The nature of the business called for crossborder co-operation among market participants, and several players in the field announced plans to this effect in the weeks after the rules were announced. Most prepared to utilise already-existing business relationships. As of end-July 2011, the State Administration of Foreign Exchange had issued quotas totalling US$72.6bn to 92 banks, securities companies, trust companies and insurers. Among the first to take advantage of the QDII scheme were Bank of China (BOC), Bank of East Asia (Hong Kong) and Industrial and Commercial Bank of China. The BOC launched its first overseas fund on July 28th 2007.

Tax consequences. China-sourced capital gains of foreign enterprises are subject to a basic withholding tax of 10%. However, net gains obtained by a foreign enterprise or foreign national from transfers of B-shares�or shares in a Chinese

Portfolio investment

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enterprise listed overseas that are not held by an establishment or site within China�are provisionally exempt from the withholding tax.

There is a stamp duty on share trading, which applies to trading, inheritance and equity rights. It has been through significant adjustments in recent years, reflecting the authorities� wish to prevent fluctuations in the stockmarket. In September 2008 the 0.1% tax on share purchases was removed. It remained in place at 0.1% for share sales. The move was meant to boost the weakening stockmarket. This followed an adjustment in April 2008, when the government reduced the rate to 0.1% from 0.3% for both purchases and sales. The stamp tax does not apply to investors in open-end funds performing purchase or redemption actions. There is also a 35% tax on commissions paid and a 1.5% tax on transaction fees.

For more information on corporate and personal taxation, see the most recent Economist Intelligence Unit publication, Country Commerce China.

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Both the Shanghai Stock Exchange and the Shenzhen Stock Exchange use paperless, computerised trading systems. The host computer of the Shanghai Stock Exchange automatically matches orders at a speed of 8,000 transactions per second. The exchange accepts orders both from the floor and from member-firms and is linked to about 5,000 trading terminals via a satellite and optical telecommunications network.

Trading hours are 9.30 am to 11.30 am and 1 pm to 3 pm; a ten-minute period from 9.15 am to 9.25 am ahead of the morning session is allotted for centralised competitive pricing. The markets are closed on weekends and public holidays.

Shares are limited to a daily fluctuation range of 10% above or below the closing price of the previous trading day. Transactions that take place outside of this range are automatically deemed invalid.

Shareholding companies in China can issue three types of shares: state-owned shares, corporate or �legal person� shares (defined as state-owned, collectively owned and domestic or joint-venture enterprises accorded such status), and individual or listed shares. Only individual shares are listed and tradeable on the stock exchange.

Trading, clearing andsettlement

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State-owned shares can legally be converted to individual shares, but the process requires approval, as does converting legal-person shares. The China Securities Regulatory Commission relaxed the rules on legal-person shares in 2000: legal persons may now invest in companies with share capitalisations of less than Rmb400m. Apart from that, companies issuing shares to legal persons can also independently determine the proportion of subscription between legal persons and individuals.

The China Securities Depository and Clearing Corp (CSDCC) is in charge of registration, custody and settlement of shares listed on the two exchanges; use of its system is mandatory. It was established in 2001 with a registered capital of Rmb600m and with each of the two exchanges holding a 50% stake. With effect from October 1st 2001, the CSDCC took over the assets and liabilities of Shanghai Securities Central Clearing and Registration and Shenzhen Securities Clearing, wholly owned subsidiaries of the Shanghai Stock Exchange and the Shenzhen Stock Exchange, respectively. The two entities subsequently became local branches of the CSDCC. For settlement procedures, the Shanghai branch of the CSDCC uses an electronic system known as PROP; the Shenzhen branch uses a similar system referred to as B-Com.

The A-share market has adopted the T+1 trading system, meaning that settlement takes place one day after the transaction date. For B-shares, the T+3 system is used. At the end of the trading day during which the B-share transaction has been performed, the custodian bank transmits the information to the CSDCC for pre-matching. The CSDCC informs the custodian bank of the pre-match status on the following day.

Tax consequences. There is a stamp duty on share trading, which applies to trading, inheritance and equity rights. It has been through significant adjustments in recent years, reflecting the authorities� wish to prevent fluctuations in the stockmarket. In September 2008 the 0.1% tax on share purchases was cancelled entirely, while it remained at 0.1% for share sales; the move was meant to boost the weakening stockmarket. This followed an adjustment in April 2008, when the government reduced the rate to 0.1% from 0.3% for both purchases and sales. The stamp tax does not apply to investors in open-end funds performing purchase or redemption actions. There is also a 35% tax on commissions paid and a 1.5% tax on transaction fees.

Corporate governance

Accounting and oversight. Beginning in January 2007, publicly listed companies in China have been obliged to adopt standard Chinese accounting practices�the Accounting Standard for Business Enterprises�which are fundamentally in line with the International Financial Reporting Standards. In October 2003 the China Securities Regulatory Commission (CSRC), the industry watchdog, published new rules requiring companies to change external auditors at least every five years. According to the Code of Corporate Governance, issued by the CSRC in December 2002, at least one-third of company boards must comprise independent members. This rule took effect in mid-2003. In January 2010 rural financial institutions and asset-management companies were also ordered to adopt standard accounting practices. Banking. In the period since July 2009, the China Banking Regulatory Commission (CBRC) has been stepping up its surveillance of the ways that bank loans for companies� fixed-asset investments and working capital were being used. The main purpose is to ensure that the funds were not channelled into speculation on stocks or real estate. In April 2010 the CBRC said it would increase its supervision of property loans, while urging banks to determine interest rates and down

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payments based on the borrower�s credit risk. The CBRC even encouraged banks to make visits to the current dwellings of loan applicants to check claims that the proposed home purchases would be for residence, not for speculation. The CBRC on February 18th 2008 issued Guidelines for the Consolidated Supervision of Banks in order to introduce more efficient supervision of domestic and foreign banks as they expand to new business areas. Banks have a growing number of subsidiaries engaged in nonbanking operations. Under the guidelines, the CBRC is responsible for supervising the operations of diversified banking groups and ensuring that the banks extend their rules on corporate governance, risk management and internal controls to their nonbanking subsidiaries. In March 2000 the State Council issued regulations forcing all financial institutions (including banks, nonbank financial institutions and state-owned enterprises) to introduce supervisory boards. Under the rules, the supervisory board members are to be appointed by the cabinet and must report to it, serve maximum terms of three years and may not be involved in the decision-making process of the company they supervise. They are charged with monitoring the company�s profits, cashflow and value of state-owned assets. They must also appraise the performance of senior management and recommend to the government whether to promote, demote or remove them. Guidelines on the Internal Controls of Commercial Banks, published by the People�s Bank of China (PBC�the central bank) in September 2002, aim in part to improve the governance of state-owned banks, some of which have suffered from high-profile cases of fraud in recent years. The guidelines require the banks to set up a three-tiered structure, with a board of supervisors forming the top tier and supervising the two tiers below, consisting of a board of directors and senior management. In 2009, the CBRC carried out on-site examination of 58,831 banks and other financial institutions, finding that 4,212 banking institutions were in breach of existing rules. As a result, 86 senior managers were disqualified, according to the CBRC�s annual report. On October 31st 2006, the National People�s Congress, China�s parliament, passed amendments to the Law of the People�s Republic of China on Banking Regulation and Supervision, following the recommendation of the CBRC. These amendments allow the CBRC to investigate enterprises and individuals outside the banking sector. �These investigations will provide important facts and figures for dealing with bank-related criminal cases, raise the efficiency of investigations into compliance and criminal cases in the banking industry, and also protect the interests of banks and customers,� the CBRC said in its annual report. Stockmarkets. On February 28th 2009 the National People�s Congress passed an amendment to the Criminal Law, enabling courts to sentence professionals at financial institutions to up to ten years in jail for insider trading. This followed a renewed effort to crack down on insider trading. In the period from January 2008 until March 2009, the CSRC referred 19 cases of securities malpractice to police authorities, according to a May 2009 report by Xinhua news agency. In January 2008 the Central Commission for Discipline Inspection warned officials within the Communist Party against using insider information to make money on the securities exchanges. China is also increasingly using the courts to curb illegal activities on the stock exchanges. On July 19th 2008, the former president of Guangfa Securities, China�s sixth-largest brokerage, went on trial in the southern city of Guangzhou, accused of having leaked sensitive information about his company to a younger brother and a former classmate. The CSRC issued trial regulations on December 15th 2003 concerning Corporate Governance of Securities Companies, aimed at ensuring the rights of shareholders and clients. The regulations set procedures for holding shareholders� meetings, set the qualifications to be met by directors and emphasised the need to appoint independent directors. In relation to their clients, securities companies must perform good-faith duties and establish special departments for communicating with customers.

A-shares. A company must meet the following conditions to issue A-shares.

• Its production and operations must conform to the government�s industrial policies.

• It must issue only one class of common shares (preference shares can be issued in different classes), and the rights of common shares must be the same for all holders of common shares.

Listing procedures

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• The sponsor of the shares must be committed to buying no less than 35% of the total stock that the company plans to issue.

• The value of stock the sponsor is committed to buy must generally be at least Rmb30m.

• The portion of the shares issued among the public shall be no less than 25% of the total shares that the company plans to issue; the portion that the workers are committed to buy must not exceed 10% of the issue to the public.

• The sponsor must not have a record of violating any major laws in the three preceding years.

Any subsequent issues of A-shares are permitted only if the proceeds from the previous offering have been used as stated in that prospectus. Furthermore, any subsequent issue must take place at least 12 months after the previous one.

A circular from the China Securities Regulatory Commission (CSRC) in July 1999 improved the rules for A-shares in two ways. First, companies with registered capital exceeding Rmb400m can now choose to conduct their share issues through a combination of public offerings to ordinary investors and private placements to Chinese legal persons. Second, the rules allow a listing candidate and its lead underwriter to set the issuing price within a scope confirmed by the CSRC through the book-building method.

All other regulations related to issues of A-shares remain those detailed under the 1993 Provisional Regulations on Share Issues and Trading.

Existing joint ventures that wish to list shares must seek approval from the Ministry of Commerce (MOFCOM) and from the authority (regional or national) that originally approved the formation of the joint venture. Under this structure, the company is liable for its debt only to the extent of its assets, and shareholders are liable only for the subscription price of the shares. This form dictates higher reserve requirements (35% compared with 15% for simple equity joint ventures), carries greater restrictions on a company�s ability to increase its capital and has certain disclosure requirements. Many Chinese companies are converting into companies limited by shares, which makes them potentially eligible for listing.

The ministry issued rules in August 2002 on foreign-invested enterprises transforming stock into tradeable B-shares. One requirement is that the company must have had profits for the previous two years.

A lottery system is used for the purchase of new shares. Would-be investors must submit applications in advance, and only some are selected. The Shanghai Stock Exchange has streamlined the system so that prospective investors are given one lottery number for each lot of 200 shares for which they apply. The minimum level of public ownership stands at 15%. Hence, entities other than the state could theoretically own 85% of a company�s shares.

B-shares. The State Council in 1996 issued a unified set of national rules that apply to the issue of B-shares. Under its terms, joint-stock companies wishing to issue B-shares must obtain the approval of the State Council Securities Policy Committee (SCSPC). The B-shares may be purchased by the following: foreign

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legal persons or institutions; individuals; legal persons and institutions in Hong Kong, Macau and Taiwan; Chinese citizens living outside China; and other persons approved by the SCSPC. Since February 2001 resident Chinese citizens have also been permitted to purchase them.

State companies that wish to issue B-shares must observe policies on fixed-asset investment and on the use of foreign capital and must use the proceeds of the issue in accordance with state industrial policies. The sponsor must underwrite at least 35% of the total amount and make at least 25% of the total shares available to the public, or 15%, if the total shares are Rmb400m or more. All B-share issues must be approved by the People�s Bank of China (PBC�the central bank). Issuing companies must open a foreign-exchange (forex) account at a Chinese bank authorised to deal in foreign currency. The face value of B-shares is denominated in renminbi but subscribed for and traded in dollars (US dollars in Shanghai and Hong Kong dollars in Shenzhen).

In order to receive approval to issue B-shares, a company must fulfil all conditions for the issuance of A-shares (see above) and must also have a stable and relatively adequate source of forex reserves�sufficient to pay annual dividends and bonuses. Dividends, which may be remitted abroad after paying taxes, are to be denominated in renminbi and paid in forex.

B-shares may be publicly issued or privately placed with a securities house acting on behalf of the issuer. Once listed, no single party can acquire more than 5% of the outstanding shares without the approval of the PBC. In 1999 the CSRC allowed share buybacks by B-share and H-share companies and permitted state-owned enterprises to list in order to sell down government stakes.

Though share sales to domestic investors are encouraged, issues to foreign firms and individuals through B-shares or H-shares (those that list in Hong Kong) are limited to minority stakes. Hence, B-shares or H-shares issued are always less than 50% of a company�s share capital to prevent foreign investors from taking over domestic companies.

Shenzhen Small and Medium-sized Enterprises Board. The Shenzhen Stock Exchange published listing requirements in May 2004 for its new secondary exchange board. Companies can list only if they meet the following conditions.

• It has been at least one year since they last issued shares.

• They have been in existence for at least three years and have recorded three consecutive years of profits prior to listing.

• They can show a record of no rule infringements for the previous three years.

• Their expected profit margin in the coming year is at least as high as the interest rate on one-year deposits.

In addition, all financial data must be audited. Although these regulations are less stringent than the existing rules of the Shanghai Stock Exchange, high-tech firms and dotcom companies will find them hard to meet. Shares, once listed, are allowed to fluctuate by 20% in either direction each trading day, compared with 10% on the existing markets.

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Growth Enterprise Market. For a company wishing to list on the Growth Enterprise Market (GEM), which aims to attract smaller companies, requirements are more lenient than the rules applying to the larger exchanges in Shanghai and Shenzhen. A firm wishing to list on the GEM should have profits totalling at least Rmb10m over the preceding two years (for the Shanghai and Shenzhen exchanges, the requirement is a total of Rmb30m in the preceding three years). Other requirements for listing on the GEM include annual revenue in the most recent year of no less than Rmb30m, growing at least 30% from the year before. A GEM candidate must also have a history of three consecutive years of operations within a clear-cut core business, and this should account for at least 50% of the company�s revenue.

Listing of foreign and joint-venture enterprises. In the wake of China�s entry into the World Trade Organisation, the MOFCOM announced that foreign companies would be allowed to issue shares on both the A-share and B-share markets. Any such opening would help foreign companies localise their operations and improve brand and company recognition among local consumers and investors. It would also improve Shanghai�s image as an international financial centre. However, as of July 2011, official regulations on this had not been issued.

Corporate disclosure and governance. Listed companies must publish quarterly accounts, including information on earnings and trading activities of major shareholders. They must also report to the regulatory authorities any development that might severely affect share prices.

To align disclosure rules with international standards, the CSRC issued rules in November 2000 on the way annual meetings are to be conducted, including how far in advance the company must notify its shareholders of the meeting, its agenda and the amount of information that must be disclosed. Companies must also reveal information on asset restructuring (that is, how and why it is taking place) and give ongoing reports on its progress.

Investors are limited to 0.5% of a new share issue, and institutions holding more than 5% must report to the authorities any intention to buy more shares. A company that desires to purchase 30% or more of a firm�s listed capital must make a general offer to all shareholders.

Although the CSRC�s rules are quite comprehensive, transparency among listed companies remains unsatisfactory because they do not follow the rules. The CSRC has been clamping down on noncompliance, censuring a number of listed firms and handing out fines.

Tax consequences. The costs incurred for listing shares are deductible from corporate income tax. However, the deduction is subject to approval by the local authorities.

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Recent initial public offerings

A-shares

Pangda Automobile Trade, a car dealer handlings brands such as Toyota and Honda, raised Rmb6.3bn in an initial public offering (IPO) in Shanghai on April 15th 2011. This was the second-largest IPO of 2011 as of end-July 2011. Proceeds would go primarily to expand the company�s network and replenish working capital. The stock plunged 23.2% in its first day of trading on April 28th 2011, due to a combination of overall weak market sentiment and a bearish outlook for the auto market. UBS acted as underwriter for the offering. Inner Mongolia Junzheng Energy and Chemical Industry, a company with businesses in coal, power and metallurgy, raised Rmb3bn in an IPO on the Shanghai Stock Exchange on February 22nd 2011. Guosen Securities acted as chief underwriter. Proceeds from the share sale were allocated towards building a thermoplastic polymer plant with an annual capacity of 400,000 tonnes. Sinovell Wind, a wind turbine maker, raised Rmb9.5bn in an IPO on the Shanghai Stock Exchange on January 6th 2011. It was the largest domestic IPO in the first seven months of 2011. The company said that it would spend the proceeds on expanding its installed wind-power capacity as well as for research and development. Zhongde Securities, a joint venture with participation by Deutsche Bank, was the lead underwriter.

H-shares and N-shares

Hui Xian Real Estate Investment Trust raised Rmb10.48bn in Hong Kong on April 24th 2011 in the first-ever renminbi-denominated IPO outside of China. China Hongqiao Group, the nation�s largest aluminum producer, raised HK$6.37bn in an IPO on the Hong Kong Stock Exchange on March 18th 2011. Proceeds will go to expansion of the company�s production capacity. JP Morgan (US) was the lead underwriter. The company had initially planned an IPO in January 2011, but later postponed the issue, citing volatile market conditions. Ningbo Port, China�s third-largest port operator, raised Rmb7.4bn in an IPO on the Shanghai Stock Exchange on September 16th 2010; this was short of the company�s initial target of Rmb13.3bn, reflecting sluggish demand amid fears of relatively weak export performance in the near term. Proceeds were meant for the construction of coal and container berths and to purchase port-related machinery. China International Capital Corp served as the lead underwriter. Everbright Bank, the last major Chinese lender to go public, raised Rmb18.9bn in an IPO on the Shanghai Stock Exchange on August 11th 2010; on September 16th, it exercised an overallotment option, increasing the size of the offering to Rmb21.7bn. This was the second-largest Chinese IPO of 2010. The proceeds were aimed to fund expansion of the bank�s network, with plans to add up to 100 branches annually for the next three years. China International Capital Corp, Shenyin and Wanguo, and China Jianyin Investment Securities acted as lead underwriters for the offering.

The China Securities Regulatory Commission (CSRC) introduced regulations in 1995 charging underwriters with responsibility for ensuring that their clients conform to listing and issuing rules and fulfil their obligations to shareholders for a full year after coming to the market. These rules specify that a formal contract covering the content of a �guidance period� supervised by the underwriter must be signed at the same time as the underwriting contract.

Before an issue is offered to the public, underwriters should provide senior managers with relevant legal knowledge, help companies adopt new accounting standards and plan how shareholders� money will be used. After a listing, underwriters should ensure that companies release information according to the rules and adhere to their spending programme. Underwriters should oversee publication of both interim and annual results and ensure the fair treatment of minority shareholders.

Underwriters send their �guidance plans� for listing companies to local securities regulatory departments or enterprise-management offices at the

Underwritten offerings

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central-government level. The authorities concerned should provide a written assessment of the plans, to be included in listing applications by companies submitted to the CSRC. During the guidance period, representatives of the underwriters have the right to attend shareholder and board meetings and should have access to their minutes.

Underwriters cannot charge companies an extra fee for providing advisory services. Those failing to discharge their responsibilities face warnings or suspension of their primary underwriting business or even of their licences.

Tax consequences. Gains derived from rights offerings are subject to a 10% withholding tax. The costs incurred for such offerings are deductible from corporate income tax. However, the deduction is subject to approval by the local authorities.

Supplementary share issues to existing owners have become popular with listed companies as a way to raise capital, but the practice has come under close scrutiny. Based on regulations issued in 2001, listed companies can now apply for a rights issue if their average net earnings are equivalent to 6% of net assets.

In addition, the issuing company cannot have misreported or omitted major events in its financial statements or violated securities regulations in the previous three years. Dividends after a rights issue must be similar to those that could be earned on individual bank deposits, and the issue must be offered to all registered shareholders. The value may not exceed 30% of existing shares, and the plan must win approval at the shareholders� meeting. Rights issues for corporate and state shares cannot be traded.

Firms have been banned from using the proceeds from a rights issue to invest in financial institutions, including brokerage firms, since March 2001. Moreover, after an issue, companies must report the proceeds in a timely manner and report returns on investments in annual financial statements.

Tax consequences. Gains derived from rights offerings are subject to a 10% withholding tax. The costs incurred for such offerings are deductible from corporate income tax. However, the deduction is subject to approval by the local authorities.

Most private-equity placement activity takes place offshore, particularly in Hong Kong. Private equity and venture capital have been growing activities in China, as foreign investors seek to make placements in promising unlisted companies.

The China Securities Regulatory Commission (CSRC) circular on Further Improving Methods of Share Issuing, released in 1999, set the rules for onshore private placements. It states that companies with registered capital exceeding Rmb400m can allocate 25�75% of the total issued shares to legal persons in a private placement. No individual legal person can acquire more than 5% of the total issued shares of a listed company, and its minimum purchase should generally be at least 500,000 shares. Such legal persons are defined as �legal persons other than securities institutions, registered in China, and having the right to purchase ordinary shares denominated in renminbi�. The regulations

Rights offerings

Private placements

86 China


further subdivide legal persons into strategic investors (defined as companies with a close relationship to the issuer and the intention of holding the shares long term) and ordinary legal persons.

There are additional requirements for private placements to strategic investors:

• Before making a private placement to ordinary legal persons and a related public offering to ordinary investors, the strategic investors must enter into a placement agreement with the listed company stating that the strategic investors will hold the shares for at least six months.

• The public offering prospectus must include the major facts about the strategic investors, the proposed number of shares issued and the intended holding period.

• If there is any change in the number of shares held by the strategic investors, they need to inform the stock exchange in writing, which will publish the report one day after receipt.

Tax consequences. Gains derived from private placements are subject to a 10% withholding tax.

Offshore sources of equity finance have played a growing role in raising capital for Chinese companies in recent years. Hong Kong, subject to Chinese sovereignty but not its legal jurisdiction, has been the prime source of such funds.

The China Securities Regulatory Commission (CSRC) must examine and approve companies that intend to issue Hong Kong�listed H-shares. Furthermore, they need to bring their articles of association and their activities into accordance with the provisions of the Company Law, in addition to the necessary clauses for the articles of association of companies to be listed in Hong Kong.

The Hong Kong Stock Exchange founded the Growth Enterprise Market (GEM), a small-cap market designed for technology stocks, in 1999. CSRC permission is also required for Chinese companies to list on the GEM, even if they do so via an overseas subsidiary.

Chinese companies have also turned to the US markets to raise equity capital. Some major American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs) outstanding include those of Aluminium Corp of China, China Eastern Airlines, China Life, China Mobile, China Petroleum & Chemical, China Southern Airlines, China Telecom, China Unicom, Guangshen Railways, Huaneng Power International, Jilin Chemical Industrial, Netease.com, PetroChina, Sinopec Petrochemical and Yanzhou Coal Mining.

In addition, several China-based companies incorporated offshore (mostly in Bermuda) have listed their shares in ADR form on the New York Stock Exchange. The best known are Brilliance China, Ek-Chor Motorcycle and China Tyre.

China finalised negotiations with the Tokyo and London stock-exchange regulators in 1997 to allow direct listing of Chinese shares in these markets, and

GDRs/ADRs

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London�s share of the Chinese initial public offering market has increased considerably recently. The CSRC also signed memoranda for co-operation with securities watchdogs in Brazil, Malaysia and Ukraine. Singapore allows secondary listing of Chinese shares. Companies based in China have also listed shares of offshore-incorporated subsidiaries on stock exchanges in Canada and Australia.

Tax consequences. Gains derived from such issues are subject to a 10% withholding tax.

None.

When lending to foreign-invested enterprises (FIEs), domestic banks are careful about evaluating a project�s viability and demanding appropriate guarantees. They generally insist on taking a mortgage on the assets, or they demand foreign-parent or foreign-bank guarantees. Loans by foreign banks for joint-venture projects are frequently secured by the earnings or fixed assets of the project, in addition to a guarantee from a financial entity. Loans from specialised banks have been difficult to obtain in the past few years. Nevertheless, some foreign investors have been successful in borrowing from the domestic banking system for fixed assets.

Renminbi loans are generally easier to obtain from the local banking system than are hard-currency loans (which are mostly raised through foreign banks). Renminbi loans can be secured with assets in China. Specialised banks demand appropriate collateral and sometimes a foreign-parent-company guarantee. Some foreign banks issue stand-by letters of credit to a Chinese bank to facilitate the renminbi loan against the counter-guarantee of the foreign investor or the foreign investor�s home bank.

The State Administration of Foreign Exchange relaxed its rules in 1999 and allowed FIEs to pledge foreign-exchange (forex) equity contributions and current-account receivables to obtain renminbi financing. FIEs are also allowed to use their expected export-tax rebates as collateral for loans from commercial banks.

Hard-currency loans. Interest on hard-currency loans from foreign bank branches in China is theoretically fixed �with reference to� the central bank�s guideline rates. But the banks� usual practice is to tie lending rates to international benchmarks, such as the London, Singapore or Hong Kong interbank offered rates (LIBOR, SIBOR or HIBOR). Hard-currency loans raised on the international market are always tied to international rates. The range of interest rates for a company in good standing is fairly broad, depending on the borrower and the guarantor.

The amount of external financing that can be raised for a project is sometimes spelled out in the joint-venture agreement. The contract governing Shanghai Volkswagen Automotive (50% owned by the German parent), for example, limits loans and other external financing to 40% of total investment; the remaining 60% must be in the form of capital and other equity.

Alternative markets

Bank loans

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Loan syndication by the foreign banks that have set up operations within China is becoming more common. With the number of foreign banks still growing, they can now organise loan syndication without going back to the home office, although foreign banks usually book a portion of their loans with their Shanghai or Chinese branches.

Foreign lenders mostly arrange syndicated lending for domestic projects offshore, especially in Hong Kong. The prime borrowers in this market, which also benefit from the best rates, are Chinese financial institutions authorised by the government to borrow abroad. They arrange these credits and then lend them to local companies. The bulk of these loans go to support specific projects in the government�s investment plan, but Chinese enterprises with foreign partners are sometimes eligible.

Tax consequences. A withholding tax of 10% applies to all interest income, including medium- or long-term loans. Since March 1998 the withholding tax also applies to fees received on guarantees on loans or contracts to any organisation, enterprise or individual. The purpose of this rule is to prevent banks from declaring interest income as fee income.

Interest income from certain loans made to the government or the five large state banks is exempt from tax. Moreover, tax exemption may also apply where the lender is in a country that has a tax treaty with China. However, local authorities occasionally charge arbitrary taxes (though the central government is trying to eliminate such practices).


Loans(US$ bn)


0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Long-termShort-termTotal

1211100908072006

Most leasing customers appear to be in textiles, light industry and transport. In recent years, leases have taken diversified forms�including sell- and lease-backs, leverage leases, entrusted leases, subleases and management leases�to cope with different demands. There has been increasing demand for domestically produced equipment and for sales and purchases counted in local currency, because of the improved quality of domestic equipment and sales promotion of products made by multinational companies in China. With the increase in China�s investment overseas, export leasing is on the agenda.

Financial leasing

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In order to avoid the type of bad-debt accumulation that characterised earlier leasing deals, the State Development Planning Commission and the State Administration of Foreign Exchange stipulated in an April 1996 circular that all financial leasing for trade transactions, except for aircraft leases, requires authorisation under the state�s medium- to long-term borrowing plan.

Chapter 14 of the Contract Law regulates financial leases. Regulations specify that the lessor is required only to warrant the lessee�s right to possession and use of the leased item. The lessor bears no liability if the leased item does not conform to the contract, unless the lessee has relied on the lessor in determining the item or the lessor has interfered in the selection of the item.

Tax consequences. Income from financial leasing is treated in the same way as interest income. Interest payments are deductible if incurred in connection with business activity. The deduction is subject to the approval of the local authorities.

China�s corporate bond market is among the largest in Asia and has picked up significantly since 2008. Corporate bond issues in China totalled Rmb132.0bn in 2010, up from Rmb71.5bn a year earlier, according to the China Securities Regulatory Commission (CSRC). In the first four months of 2011, Chinese enterprises issued Rmb61.8bn in corporate bonds, up from Rmb12.7bn in the same period in 2010.

New rules, published by the CSRC in August 2007, permit listed companies to issue corporate bonds on a trial basis. Prior to that rule change, only a small number of major state-owned enterprises, such as Baosteel and PetroChina, were permitted to issue bonds.

Under the new rules, to qualify to issue bonds, a company must have a sound credit rating, and the average distributable profits over the past three years must be at least as big as the interest the company must pay on the bond issue. The value of any company�s outstanding bonds should also not exceed 40% of its net assets.

In May 2009 the Agricultural Bank of China issued Rmb50bn in bonds, the largest corporate bond sale to date in the country. This included an Rmb20bn 10-year tranche with a coupon of 3.3%, an Rmb25bn 15-year tranche with a coupon of 4% and an Rmb5bn tranche with a floating coupon of 60 basis points over the benchmark one-year deposit rate. Major oil firm PetroChina received approval from shareholders in May 2009 to issue Rmb100bn in bonds. In February 2010 PetroChina reported that it had issued the bonds gradually in several bond sales during 2009.

In another sign of China�s willingness to develop a vibrant and multilayered bond market, the government allowed the issue in April 2008 of a debenture bond (a bond lacking a bank guarantee). Instead of being backed by a bank, the issuer, China National Materials Group, had support for its five-year Rmb500m bond only in the form of a rating from China Chengxin International Credit Rating. The bond had a fixed annual coupon of 6.4%. The government allowed the debenture mainly because the requirement of a bank guarantee was seen as too strict, hampering the development of the corporate bond market.

Corporate bond issues

90 China


The bond market has so far been closed to foreign participation, but there are signs that it is gradually opening up. In December 2009 the CSRC said it wanted to expand the size of the bond market, suggesting there might be a role to play for foreign companies, and in May 2010 a local subsidiary of Bank of Tokyo-Mitsubishi (Japan) issued Rmb1bn in two-year renminbi-denominated notes, the first Chinese subsidiary of a foreign firm to launch such an issue. The coupon was 48 basis points above the three-month Shanghai interbank offered rate. The issue had 12 underwriters, including Bank of China and Industrial and Commercial Bank of China.

The Asian Development Bank (ADB) and the International Finance Corp (IFC) issued a �panda bond��a renminbi-denominated bond issued by overseas organisations�on October 18th 2005. The total issue was Rmb2.13bn, with the ADB issuing Rmb1bn and the IFC the rest. The ten-year bonds carry a coupon of 3.34%. Bank of China International was the lead manager. The IFC launched a second panda bond on November 10th 2006, this time valued at Rmb870m with a seven-year maturity and a coupon of 3.2%. Additionally, renminbi-denominated bonds issued abroad have become a new trend.

Five types of bonds are now issued in China: state Treasury bonds, financial bonds, enterprise bonds, investment bonds and foreign-currency bonds. Annual quotas, established by the People�s Bank of China (PBC�the central bank) in consultation with the National Development and Reform Commission (NDRC) and approved by the State Council, govern each category of bonds. Corporate bond issues are used mainly to solve fund shortages at enterprises with promising futures and to fund key construction projects.

The Company Law of 1994 restricts bond issuance to firms that meet certain criteria, including net asset value of at least Rmb30m. It sets out the ratio of distributable profits to interest payments. It also limits the use of funds raised, which must be invested in industries that comply with the policies of the state and may not be used to cover losses or nonproductive expenditures. Moreover, the interest rate may not exceed the limit set by the State Council. The issuer must also comply with any other conditions that the State Council might impose.

Companies are barred from new issues if they failed to raise the full amount required on a prior attempt or if they defaulted on payment of principal or interest on previously issued bonds. The law empowers the State Council to set limits on the total size of company bond issues, with the CSRC to approve issues within this overall limit.

Convertible notes. A company may also issue convertible notes if it satisfies conditions for both a bond issue and a public share issue. Provisional Measures for the Administration of Convertible Company Bonds, in effect from March 1997, apply to the renminbi-denominated convertible bonds of both listed domestic companies and �key� nonlisted state-owned enterprises. The measures require a paperless issuance method, with a term for the convertible bonds of three to five years. A qualified securities brokerage firm must underwrite such bonds, and they must be listed on the securities exchange on which the issuer is listed or intends to list.

China 91


Securities-ratings agencies. The PBC has approved two national-level securities-ratings agencies: China Chengxin Credit Management Co and Dagong Global Credit Rating. Another 30-odd ratings institutions operate at the national level without approval, and an additional 50-odd operate at the local level. Many of these are consulting or accounting firms that provide rating services.

Tax consequences. Although normal tax regulations should apply to interest earned on corporate bonds, the tax authorities often grant a tax exemption to make a bond more attractive. They are known to do this where there is a large state-owned enterprise involved.

The market for privately placed debt has yet to emerge because the public bond market remains small, and joint-stock Chinese companies prefer to issue shares and secure low-interest bank loans. Foreign-invested enterprises are not yet allowed to make private placements of notes.

Securitisation in any form is a new concept in China. Before China can have a fully functioning asset-backed securities (ABS) market, there are a number of regulatory or technical complications to overcome:

• If the transaction involves a sale of state assets, central-government appraisal of the value of the assets might be needed. This introduces an element of unpredictability that is impossible to quantify in advance.

• Under Chinese law, the sale of a receivable can take place only with the consent of the person owing the debt (unlike in other jurisdictions, such as Hong Kong). This would probably create practical obstacles, since a bankrupt Chinese company has no incentive to give consent when its debt is to be transferred from a (generally compliant) state bank to what amounts to a glorified debt-collection agency.

• The nature of ABS transactions requires that ownership of the receivables be transferred into a conceptually sophisticated corporate entity or trust. At present, such vehicles are unknown in Chinese law. The passage of the Trust Law of 2001 was meant to change this situation, but it did not.

Tax consequences. Tax treatment of such issues is not yet specified in the country�s tax legislation.

In China, as in much of the rest of Asia, infrastructure development has lagged behind economic growth. The Chinese government has been putting in place numerous public-sector investment programmes to remedy this. Because of the breadth of China�s infrastructure needs, the government is keen to involve private-sector capital. Such involvement could come in the form of commercial loans; nonrecourse financing, such as build-operate-transfer (BOT) schemes; shareholdings; or international bond issues. Much of the needed infrastructure financing in recent years has come from offshore, especially in the form of syndicated loans and, increasingly, project-finance deals combining limited-recourse loans, mezzanine financing and equity. Financial institutions in Hong Kong and Singapore have played a major role in raising overseas funds.

Private placement of notes

Structured finance

Infrastructure financing

92 China


The legal basis for infrastructure financing is the Administration of Project Financing Conducted Outside China Tentative Procedures issued in 1997. The legislation was intended to prevent domestic institutions from tapping non-project-related revenue and to require that the State Administration of Foreign Exchange (SAFE) approve all project-finance deals at the state level. The latter rule also applies to projects of less than US$30m, which had previously been free of any approval requirements. Projects in excess of US$100m require approval by the State Council.

The measures define a project-finance deal as follows: creditors have no recourse against assets or revenue other than those of the project itself; no institutions in China can affect any mortgage, pledge or debt payment with assets, rights, interests or revenues other than those of the construction project; and no institution in China provides financial guarantees in any form.

The measures, which stipulate that Chinese and foreign parties must �reasonably� share project risks, are directed more towards foreign financial institutions than foreign investors. They have as their main objective the elimination of the past practice by foreign banks of relying on Bank of China guarantees. They stipulate that foreign creditors of projects, with respect to debt payment, are equal in rank to domestic creditors.

The measures require project developers to submit a written proposal and a feasibility study to the National Development and Reform Commission (NDRC) for preliminary approvals. Once the feasibility study is approved, a project company must be established in China. Under the measures, the project company is responsible for all financing-related activities and must complete project financing within one year of approval of the feasibility-study report. Foreign-source limited or nonrecourse financing used to fund a project is to be included in the state�s guiding plan for the use of international commercial loans. The conditions of the project-finance deal must be competitive and are subject to examination and approval by SAFE.

Foreign-exchange (forex) funds raised by a project company must be remitted into China in a timely manner and used for the import of technology, equipment and materials, and for other purposes approved by the NDRC. The balance must be retained or settled in accordance with relevant exchange-control regulations. Project companies are required to register their foreign debt with SAFE and report by end-March of each year the details of their use of funds, revenue situation and debt payments during the preceding year.

Foreign analysts say an irksome feature of the 1997 project-finance rules is the stipulation that SAFE approve a project after the NDRC has given its approval. The requirement seems redundant, since the local SAFE branch and central SAFE office must give approvals before the NDRC can sign off on a project.

In general, foreign lenders and investors are not keen on Chinese infrastructure risk, for a number of reasons. First, China has capped the rate of return on infrastructure projects at 15%, whereas private investors engaged in such projects in developing countries are often looking for a minimum annual return of 20�25%. Second, although the government has suggested several project-financing models (such as BOT), none of these has really satisfied investors.

China 93


There is no formal law on BOT projects as of July 2011, although legislation has been repeatedly promised. The government in late 1998 put forward a new financing model, named transfer-operate-transfer (TOT). Under a TOT scheme, a foreign investor would take over a facility, manage it for a fixed period of time and then hand it back to the government. Under these schemes, investors are not involved in the construction of the plant and are thus protected from all risks related to construction and completion.

Power generation. In May 1997 the Ministry of Power Industry issued Several Provisions on Foreign Investment in Power Projects. The government signed a contract in September 1997 with an Anglo-French consortium for the precedent-setting US$600m Laibin B power station in Guangxi.

The complexity of power pricing in China means that valuation continues to be a major issue in BOT power-plant projects. Foreign investors must be careful to ensure that their contracts include favourable tariff-adjustment clauses that let them reset prices if the regulatory regime or market conditions change. Nevertheless, infrastructure investments in the power sector remain a hazardous undertaking. For example, since early 2007, the price of coal has gone up significantly, but the government refuses to let power generators pass on the costs to consumers in the form of higher electricity prices for fear of triggering inflation. In 1998 foreign-invested power plants were stripped of their rights to negotiate guaranteed minimum generating and tariff agreements. This removed investors� only tangible guarantee of making a return on their investments.

Water provision and treatment facilities have seen plenty of foreign participation. Suez Environment of France in December 2009 signed a �34m contract with Chengda Engineering Company of China to build a water treatment plant at a PetroChina refinery near the southwest Chinese city of Chengdu.

Tax consequences. Interest income from infrastructure-related lending is normally taxed in the same way as other forms of interest. However, the tax consequences on infrastructure projects are set on a case-by-case basis. In projects of national importance, the central government or the local authority may grant a tax exemption.

China has enjoyed exceptionally strong expansion in the US dollar value of its merchandise exports; however, the global financial crisis has arguably given the export sector its most serious challenge yet. In 2010, the value of merchandise exports was down 31.1% from a year earlier to US$1.58trn. In the first five months of 2011, exports increased 25.5% from the same period in 2010 to US$712.4bn.

Foreign-invested enterprises (FIEs) are playing a growing role in China�s export sector. Between 1992 and 2010, FIEs� merchandise exports surged from US$17.4bn to US$738.0bn, or from 20% to 46.7% of total exports, according to customs statistics.

The Export-Import Bank of China (China Eximbank), formed in 1994, is one of three policy-lending banks. Its mandate is to support China�s balance of

Trade financing and insurance

94 China


payments by providing export buyers� and sellers� credits and also export-credit insurance and guarantees. The bank has taken on a central role in providing export buyers� credit to other developing countries, thus serving as a conduit for the country�s bilateral aid programmes. The bank said it had extended Rmb436.4bn in loans in 2010, up 18.6% from a year earlier, with the total stock of outstanding loans reaching Rmb717.8bn at end-2010. It said in its yearbook that the nonperforming-loan ratio had fallen from the 2009 level of 1.11%, but did not give a specific figure.

As a government institution, China Eximbank�s lending policies are often motivated by politics. In January 2011 the Financial Times said the China Eximbank and China Development Bank together had signed loans to government and companies in developing countries in 2009 and 2010 totalling US$110bn, more than the US$100.3bn that agencies of the World Bank had extended to the developing world in the period from mid-2008 to mid-2010. This is in line with China�s wish to strengthen ties in regions such as Africa, South Asia and Latin America.

Like other policy banks, China Eximbank has limited capital. Its loan disbursement is minuscule compared with the main state commercial banks. Large projects have involved extensive co-financing by commercial banks, despite their concessionary nature. China Eximbank�s focus on financing trade in machinery and equipment�one of the weakest sectors of China�s industrial base�will probably saddle it with serious collection problems in the future.

In addition to Chinese domestic banks, foreign bank branches in many large cities offer trade-finance facilities.

Export-insurance programmes. China Export and Credit Insurance Corp (Sinosure), the first specialised export-credit insurance company in the country, was established in December 2001. The company, which is controlled by the state and is expected to support the government�s trade policies, was created by merging the export-credit operations of the People�s Insurance Co of China (previously, the preferred insurer among local exporters) and those of China Eximbank. Sinosure had assets of Rmb19.8bn as of end-2009 (the latest date for which data is available), and it had established 16 domestic subsidiaries as well as a representative office in London by the end of 2010.

Sinosure has said it gives priority to companies specialising in the export of high-tech products, machinery and electronics. Coverage has so far been very low in China, but slowly growing. In 2010 Sinosure�s coverage accounted for 22.8% of general exports (that is, after deducting reprocessing trade�where China imports key components and assembles them before re-exporting to third countries). This was up from 18.6% in 2009.

Official export-credit programmes. China Eximbank has begun to take an active role in providing export credits to both buyers and sellers. State-owned firms and the large foreign-trade corporations have been the main beneficiaries.

The bank has begun to widen the scope of its operations. Although China Eximbank officials have said the bank would begin extending policy-oriented

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loans previously earmarked for the state sector to nonstate firms, the bank�s major clients have remained large- and medium-sized state-owned enterprises.

High technology and high-value-added items are priorities for China Eximbank support. Specific eligible sectors include machinery, electronics, chemicals, petrochemicals, textiles and some other light industry, aerospace, aviation, shipbuilding, metallurgy, transport and factory equipment.

Private export-financing techniques. Foreign bank branches can advise on documentary credits and negotiate and discount bills drawn on them for Chinese beneficiaries. In the past, some banks also financed export receivables via packing credits.

Import credit. Banks are able to open documentary credits on behalf of joint-venture companies to import goods. Banks also handle inward documentary collections drawn on any organisation in China.

When a foreign company needs to import, it can do so directly or through one of the country�s foreign-trade corporations. A letter of credit (L/C) opened by one of the Chinese banks in favour of the foreign supplier would be the usual mechanism. Some L/C arrangements have been introduced to help finance machinery and equipment used in investment projects in China, including joint-venture arrangements. An L/C combined with a term loan can enable a venture to finance an entire production line and to pay for its financing as the project proceeds and income is generated. For foreign investors, this type of borrowing facility can minimise the amount of capital contributed to the venture and thus the risk.

Funds under such a long-term L/C are drawn down when the machinery arrives, either in separate shipments or in its entirety. The borrower then has several years (typically five) to pay off the loan after production from the machinery is generating income. The L/C itself is closed as soon as the machinery arrives; then the term loan (covered by appropriate agreements) kicks in. Typical terms for such facilities would be five years, with fees of around 1%.

However, L/Cs are not as reliable in China as in other countries. Many Chinese banks have refused to honour L/Cs when contractual disputes have arisen between the local importer and the supplier.

Countertrade. The government strongly encourages countertrade operations to finance projects inside the country and to help stop foreign-exchange outflows resulting from the purchase of machinery and equipment from abroad.

Private countertrade deals are also undertaken. In one type of transaction, the seller of the equipment accepts products manufactured with that equipment and finds buyers for them abroad. Another type entails the supplier accepting unrelated products marketable internationally or needed by the foreign supplier.

Foreign companies willing to enter into such arrangements have not always been satisfied. Deals involving a swap of equipment for output have sometimes been marred by quality and delivery problems. The Chinese government itself

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creates obstacles by insisting that exchanged products be in plentiful supply in China and not compete with traditional Chinese exports. But nontraditional exports are difficult to place in world markets, especially for an equipment supplier who is unfamiliar with the market for that product. Even foreign machinery manufacturers with in-house trading arms have run into trouble with these deals.

For foreign companies interested in using China for sourcing products or commodities, but not wishing to commit capital to a full-fledged joint venture, countertrade arrangements can be a good bet. �Red clause� L/C arrangements are used by such firms to finance the underlying transaction, by allowing the Chinese supplier to piggyback on the good credit standing of the foreign buyer. Usually, the �red clause� L/C provides short- or medium-term financing of two to three years for machinery imported by the Chinese partner in the arrangement.

The loan generally comes from a foreign bank but is guaranteed by one of the big state-owned commercial banks. Typically, the Chinese producer in such a case lacks the capital to make high-quality products without upgrading its equipment and processes. The ideal use for �red clause� financing is for high-quality equipment that is owned by the foreign customer and sold to the Chinese side in the arrangement.

Forfaiting. Some banks and forfaiting houses make forfaiting facilities available for capital-equipment sales into China. The business is centred mainly in Europe, but Hong Kong is also used as a base for many forfaiting operations.

An expanding number of foreign banks offer forfaiting services, mostly to companies or existing clients from their countries of origin. The margins charged on these transactions have been narrowing for a while, because of growing competition. Credit risk is perceived to have improved since 2002, with margins falling to less than 2% for terms of up to five years.

Key contacts

• Bank of China (BOC), 1 Fuxingmennei Dajie, Xicheng District, Beijing 100818; Tel: (86.10) 6659�6688; Fax: (86.10) 6659�3777; Internet: http://www.boc.cn/en/index.html.

• China Banking Association, 11-12/F, 20 Finance Street, Xicheng District, Beijing 100033; Tel: (86.10) 6655�3358; Fax: (86.10) 6655-3356; Internet: http://www.china-cba.net (Chinese only).

• China Banking Regulatory Commission (CBRC), No 15-A Finance Street, Xicheng District, Beijing 100140; Tel: (86.10) 6627�9113; Internet: http://www.cbrc.gov.cn/english/home/jsp/index.jsp.

• China Chengxin Credit Management Co, 26 Finance Street, Xicheng District, Beijing 100032; Tel: (86.10) 5760-2288; Fax: (86.10) 5760�2299; Internet: http://www.ccx.com.cn (Chinese only).

• China Construction Bank (CCB), 25 Finance Street, Xicheng District, Beijing 100033; Tel: (86.10) 6759�7114; Internet: http://www.ccb.com/en/home/index.html.

• China Development Bank (CDB), 29 Fuchengmenwai Dajie, Xicheng District, Beijing 100037; Tel: (86.10) 6830�7304; Fax: (86.10) 6831�1517; Internet: http://www.cdb.com.cn/cdb_e/index.html.

• China Export and Credit Insurance Corp (Sinosure), Fortune Times Building, 11 Fenghuiyuan, Xicheng District, Beijing 100032; Tel: (86.10) 6658�2288; Fax: (86.10) 6651�6758); Internet: http://www.sinosure.com.cn/sinosure/ english/English.html.

• China Financial Futures Exchange, 6/F, 1600 Century Avenue, Shanghai 200122; Tel: (86.21) 5016�0666; Fax: (86.21) 5016�0606); Internet: http://www.cffex.com.cn/en_new/.

China 97


• China Insurance Regulatory Commission (CIRC), 15 Finance Street, Xicheng District, Beijing 100140; Tel: (86.10) 6628-6688; Internet: http://www.circ.gov.cn (Chinese only).

• China Securities Regulatory Commission (CSRC), Focus Place, 19 Finance Street, Xicheng District, Beijing 100033; Fax: (86.10) 6621�0205; Internet: http://www.csrc.gov.cn/pub/csrc_en/.

• China Stock Markets Web; Internet: http://www.hkex.com.hk/csm/homepage.asp?LangCode=en. • China Venture Capital and Private Equity Association, Room 2109, 21/F, Office Tower E1, 1 East Chang An Avenue,

Beijing 100738; Tel: (86.10) 8515�3584; Fax: (86.10) 8515�0835; Internet: http://www.cvca.com.hk/index.asp. • Dagong Global Credit Rating, 29/F, Unit A, Eagle Run Plaza, 26 Xiaoyun Lu, Chaoyang District, Beijing 100125; Tel:

(86.10) 5108�7768; Fax: (86.10) 8458�3355; Internet: http://www.dagongcredit.com/dagongweb/english/index.php. • Export-Import Bank of China (China Eximbank), 30 Fuxingmennei Dajie, Xicheng District, Beijing 100031; Tel: (86.10)

8357�9000; Fax: (86.10) 6606�0636; Internet: http://english.eximbank.gov.cn. • Industrial and Commercial Bank of China (ICBC), 55 Fuxingmennei Dajie, Xicheng District, Beijing 100140; Tel: (86.10)

6610�6614; Fax: (86.10) 6821�7920; Internet: http://www.icbc.com.cn/icbc/sy/default.htm. • Ministry of Commerce (MOFCOM), 2 Dongchangan Jie, Beijing 100731; Tel: (86.10) 5165�1200; Fax: (86.10) 6567�7512;

Internet: http://english.mofcom.gov.cn. • Ministry of Finance (MOF), 3 Nansanxiang, Sanlihe, Xicheng District, Beijing 100820; Tel: (86.10) 6855�1114; Fax: (86.10)

6855�1781; Internet: http://www.mof.gov.cn (Chinese only). • National Development and Reform Commission (NDRC), 38 Yuetan Nanjie, Xicheng District, Beijing 100824; Tel: (86.10)

6850�1111; Fax: (86.10) 6850�2728; Internet: http://en.ndrc.gov.cn. • People�s Bank of China (PBC�the central bank), 32 Chengfang Jie, Xicheng District, Beijing 100800; Tel: (86.10) 6619�

4114; Fax: (86.10) 6619�5370; Internet: http://www.pbc.gov.cn/english. • Securities Association of China (SAC), 2/F, Tower 2, 19 Financial Street, Xicheng District, Beijing 100032; Tel: (86.10)

6657�5800; Fax: (86.10) 6657�5827; Internet: http://www.sac.net.cn/en/homepage/index_en.jsp. • Shanghai Gold Exchange, 99 Middle Henan Lu, Shanghai 200001; Tel: (86.21) 3318�9588; Fax: (86.21) 3366�2058; Internet:

http://www.sge.sh/redirect.asp?locale=1033. • Shanghai Stock Exchange, Zhi Quan Bldg, 528 Pudong Nanlu, Shanghai 200120; Tel: (86.21) 6880�8888; Fax: (86.21)

6880�4868; Internet: http://www.sse.com.cn/sseportal/en_us/ps/home.shtml. • Shenzhen Stock Exchange, 5045 Shennan Donglu, Shenzhen 518010; Tel: (86.755) 2591�8545; Fax: (86.755) 8208�3947;

Internet: http://www.szse.cn/main/en. • Social Security Fund, 11, Fenghuiyuan, Xicheng District, Beijing 100032; Tel: (86.10) 5836�2358; Internet:

http://www.ssf.gov.cn/Eng_Introduction/. • State Administration of Foreign Exchange (SAFE), Huanrong Plaza, 18 Fucheng Lu, Haidian District, Beijing 100048; Tel:

(86.10) 6840�2265; Fax: (86.10) 6840�2147; Internet: http://www.safe.gov.cn/model_safe_en/index.jsp?id=6. • State Administration for Industry and Commerce (SAIC), 8 Sanlihe Donglu, Xicheng District, Beijing 100820; Tel:

(86.10) 6801�0463; Fax: (86.10) 6801�3447; Internet: http://www.saic.gov.cn/english/index.html. • State Administration of Taxation (SAT), 5 Yangfangdian Xilu, Haidian District, Beijing 100038; Tel: (86.10) 6341�7114; Fax:

(86.10) 6326�3366; Internet: http://www.chinatax.gov.cn/n6669073/index.html.

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