Review

Who does this affect?

Foreign investors looking to invest in securities companies in China.

What do you need to do?

Understand the changes made by the new rules and measures and structure their investments accordingly. We can help.

Author
Shan Lai  (赖珊华)
Senior Associate

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John Shi  (史衛)
Partner
T +86 10 5927 2168

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Hong Kong
Stuart Valentine  (萬思陶)

Beijing
David Olsson  (沈文)
John Shi  (史衛)

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Following the third Sino-US Strategic Economic Dialogue (SED III) held on 13 December 2007, China has released two long-awaited rules and measures governing the re-opening of its domestic capital markets to foreign investors.

On 28 December 2007, China Securities Regulatory Commission (the CSRC) issued the Decision on Amendments to the Rules Concerning the Establishment of Securities Companies with Foreign Investment (the Amended SJV Rules) which amended the Rules Concerning the Establishment of Securities Companies with Foreign Investment promulgated on 13 June 2002 (the Old SJV Rules).

The CSRC further released the Trial Measures for the Establishment of Subsidiaries by Securities Companies (the Subsidiary Measures) to address the legislative vacuum in this area. The Amended SJV Rules and the Subsidiary Measures became effective on 1 January 2008.

The issuance of these two rules and measures indicates that China will resume the approval process for the establishment of joint venture securities companies (SJVs).

Foreign investors are allowed to invest in “full license” securities companies

The most significant change brought by the Amended SJV Rules is to allow foreign investments in listed domestic securities companies. Under the Old SJV Rules, a foreign invested security company could only be in the form of a limited liability company, meaning that it could not be a listed company (which must take the form of a company limited by shares).

The Amended SJV Rules now stipulate that foreign investors may invest in listed securities companies either through the stock exchange or by way of establishing a strategic cooperation relationship with a listed domestic securities company without causing its original business scope to be reduced.

Business scope of SJVs remains the same but application for expansion could be made

The business scope of a SJV remains largely the same and, in particular, the brokerage of domestic currency A-shares and securities asset management have not been opened up. The business scope of a SJV is limited to underwriting and sponsoring of shares and bonds, brokerage of foreign shares and brokerage and proprietary dealing of bonds.

However, an application to expand its business scope can be made under the Subsidiary Measures if the following requirements are satisfied:

• The SJV has been in continuous operation for 5 years, maintained good reputation and not engaged in any material non-compliance or illegal activities within the last 3 years.
• Each risk control indication meets the required standard within the last 12 months.
• The SJV is capable of good business management and making a profit, and its market share in major business areas is not lower than the industry average in the last year.
• The SJV has completed its governance structure and perfected its risk management system and internal control systems.

According to the CSRC, the expanded business scope must also fall within the parameters of China’s WTO commitments.

Foreign investors and SJVs face less stringent requirements

The criteria for foreign investors in a SJV have been expanded from securities business operators to include financial institutions and general institutional investors. The minimum continuous operation requirement for the foreign investors has been shortened from 10 years to 5 years and the minimum number of licensed securities personnel employed by a SJV has been lowered from 50 to 30.

Provided the domestic shareholder(s) hold a majority of shares in a listed domestic securities company, the company is no longer required to have at least one domestic shareholder having to hold at least 1/3 of the total shares. Foreign investment (including direct holding and indirect control) in a listed domestic securities company is capped at 20% for a single foreign investor and 25% for aggregate shareholdings.

33% cap on foreign ownership remains

Although foreign investors had been hoping the CSRC would increase the investment ceiling to 49%, the 33% cap on foreign ownership of mainland securities joint ventures remains unchanged..

3 years lock-up period for foreign investors on share transfer

Under the Amended SJV Rules, foreign investors may not transfer their shares in a SJV within 3 years from the investment date. This was not required under the Old SJV Rules. This change reflects the Chinese regulator’s intent to encourage long-term investment.

Notable requirements for subsidiaries under Subsidiary Measures

The Subsidiary Measures apply to all subsidiaries of securities companies, including those subsidiaries jointly established with the foreign investors. It is notable that under the Subsidiary Measures:

• A securities company and its controlled subsidiaries, or subsidiaries controlled by the same securities company are prohibited from engaging in similar businesses which involve conflicting interests or compete with one another. In other words, a parent company is prohibited from engaging in any competing business with its subsidiaries.
• In respect of a subsidiary controlled by a domestic securities company (other than a wholly-owned subsidiary), voting rights at shareholders’ meetings and board meetings as well as board composition must be in proportion to the respective shareholdings of the shareholders. Any agreements or other arrangements between the subsidiaries and its shareholders which conflict with this requirement are expressly prohibited.
• Mutual shareholdings are prohibited. A subsidiary is not allowed to directly or indirectly hold any equity right or share in its controlling shareholder, or in another subsidiary which is controlled by the same parent securities company, or to otherwise invest in the above entities.
• A risk segregation system is required to be established between the securities company and its subsidiary, and between subsidiaries controlled by the same parent securities company, to prevent risk transfer and conflict of interest.

Disclaimer

The views set out in this publication are based on our experience as international counsel representing clients in their business activities in China. As is the case for all international law firms licensed in China, we are authorised to provide information concerning the effect of the Chinese legal environment. However we are not admitted to practice Chinese law and so are unable to issue opinions on matters of Chinese law.