New Rules on JV Securities Companies: A Limited Opening of China's Securities Industry

The qualification requirements in respect of the foreign shareholder of a securities joint venture firm are set out in Article 7 of the Rules. The requirements on the foreign shareholder include, but are not limited to, the following:

(i) its securities regulatory body has signed a memorandum of understanding with the CSRC with respect to cooperation in the area of securities regulation¹ and has maintained an effective regulatory cooperative relationship;

(ii) it is a securities firm licensed to conduct a securities business in its country of incorporation and has been operating in the financial sector for over 10 years;

(iii) it has not been subject to any material sanction imposed by a securities regulatory body or judicial department during the past three years;

(iv) the various risk control targets for the past three years have met the legal requirements and the requirements of the securities regulatory body of the country of its incorporation;

(v) it has a sound internal control system;

(vi) it has a good reputation and good business achievements in the international securities market; and

(vii) other prudent conditions required by the CSRC.

Most of the above requirements are straightforward and can be measured objectively. Some of them, however, are not as obvious and may, to a large extent, depend on subjective determinations by the CSRC. For example, it is not clear what conditions may be considered to be "prudent", and which the CSRC may impose as a condition for the approval of the establishment of the securities joint venture company.² Obviously, the CSRC is the entity that will make the determination in the examination and approval process. Therefore, the CSRC will have wide discretion to allow or disallow certain foreign securities firms from entering the Chinese market.

Requirements for the Chinese Shareholder(s)

If there is only one Chinese shareholder in a securities joint venture company, Article 8 of the Securities JV Rules requires that the Chinese shareholder must be a domestically funded securities company.³ If there is more than one Chinese shareholder in a joint venture securities company, the other Chinese shareholder does not have to be a domestically funded securities company, but it needs to possess the qualifications in respect of a shareholder of a securities company as required by the CSRC. These requirements are set out in the Administration of Securities Houses Procedures (the Securities House Procedures), issued by the CSRC on December 28 2001 and effective on March 1 this year. Pursuant to this legislation, the qualifications of a shareholder who directly or indirectly holds 5% or more shares of a securities company must be approved by the CSRC. A shareholder may not be qualified to hold 5% or more shares of a securities company if: (i) it has been subject to any sanction due to operating in any material violation of laws or regulations during the three years prior to the application; (ii) its aggregate losses have reached 50% of its registered capital; (iii) it is insolvent or unable to pay debts when they fall due; (iv) the total amount of its debts have reached 50% of its net assets; or (v) there are other circumstances as prescribed by the CSRC.

The registered capital and equity ratio

Article 6 of the Securities JV Rules provides that the registered capital of a joint venture securities company shall comply with the provisions of the PRC, Securities Law (中华人民共和国証券法) on the registered capital of a comprehensive-type securities company. Article 121 of the Securities Law requires that the minimum registered capital amount for a comprehensive-type securities company should be Rmb500 million. As such, the registered capital of a securities joint venture company should be no less than this amount.

Pursuant to Article 10 of the Securities JV Rules, the interest to be held by the foreign shareholder in a securities joint venture company may not exceed one third of the total equity of the joint venture, no matter whether such interest is held directly or indirectly. If the joint venture has only one Chinese shareholder, the Chinese shareholder must be a domestically funded securities company. The Chinese shareholder that is a domestically funded securities company is required to hold no less than one third of the total equity of the joint venture. The limitation on the foreign shareholder's equity ratio is consistent with China's WTO commitments and the newly issued Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录) (issued March 11 2002 and effective April 1 2002). However, the equity ratio limitation makes a securities joint venture much less attractive to foreign investors.

Permitted business scope

Under the Securities House Procedures, a comprehensive-type securities company may, among other things, engage in: (i) underwriting of securities; (ii) dealing in securities as a broker and for its own account; (iii) securities investment consulting (including financial consulting); (iv) investment management; and (v) custody of securities. However, pursuant to Article 5 of the Securities JV Rules, the scope of business of a Chinese-foreign securities joint venture firm is limited to: (i) underwriting of shares (including A shares and B shares) and bonds (including government bonds and corporate bonds); (ii) dealing in foreign investment shares (B shares) as a broker; (iii) dealing in bonds (including government bonds and corporate bonds) as a broker and for its own account; and (iv) other businesses approved by the CSRC.

While it is not clear what other businesses the CSRC will allow a Chinese-foreign securities joint venture company to conduct, it does not appear that a joint venture securities firm may deal in A shares either as a broker or for its own account or provide securities investment consulting or investment management services. When the CSRC published the Draft Rules of Approval of Chinese-foreign Joint Venture Securities Companies for public comment in December 2001, it was proposed that a Chinese-foreign securities joint venture company should be allowed to engage in trading of foreign investment shares for its own account. This was removed from the text of the final legislation. The scope of business in which a securities joint venture is permitted to engage under the Securities JV Rules is not inconsistent with China's WTO commitments, given that China has only committed to permit foreign securities institutions to establish joint ventures to engage in the business of underwriting A shares and underwriting and trading B and H shares, as well as government and corporate bonds.

The management

Article 11 of the Securities JV Rules requires that the chairman, general manager and deputy general manager of a securities joint venture company meet the qualification conditions for employment of senior managers of a securities company. One of the qualification requirements for a senior manager of a securities company, which is defined to include the chairman, vice chairman, general manager and deputy general manager, is that he must be a Chinese
national.⁴ The CSRC may exempt such a requirement when there is a special circumstance. As such, if the foreign shareholder appoints a foreign national to serve as the chairman, general manager or deputy general manager of the joint venture, special approval from the CSRC must be obtained.

The approval authority and the approval process

The approval for the establishment of a securities joint venture company involves a two-phase process. The first phase entails the filing of an application with the CSRC by a representative jointly appointed by the shareholders, the review of the application by the CSRC, a decision by the CSRC on whether or not to approve the application, and registration with the administrative bureau for industry and commerce if approval is granted by the CSRC. The second phase involves the filing of an application with the CSRC for the Permit for the Operation of Securities Business and the issuance of the Permit for the Operation of Securities Business by the CSRC if approval is granted. In the event that the CSRC does not issue the Permit for Operation of Securities Business, the securities joint venture company may not engage in a securities business.

It is interesting to note that the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) or the local department of foreign trade and economic cooperation is not involved in the approval process. It may be the position of the CSRC that it is the sole appropriate authority for the approval of securities joint venture firms. This is not, however, consistent with the PRC, Equity Joint Venture Law, which requires that the establishment of a Chinese-foreign equity joint venture be subject to approval by the relevant department of foreign trade and economic cooperation. MOFTEC's position on this issue is not clear. Given that the approval authority for the establishment of joint venture banks is the People's Bank of China pursuant to the PRC, Administration of Foreign-funded Financial Institutions Regulations (issued by the State Council on December 30 2001) and the approval authority for the establishment of insurance joint venture companies is the China Insurance Regulatory Commission pursuant to the PRC, Administration of Foreign-funded Insurance Companies Provisions (issued by the State Council on December 12 2001), MOFTEC's lack of involvement in the approval process is unlikely to pose a practical problem.

Acquisition of shares of domestically funded securities companies

Instead of establishing a securities joint venture with a Chinese securities company, a foreign investor may choose to acquire a stake in an existing Chinese securities company and to apply for the conversion of the domestic securities company into a foreign investment securities company. However, the limitations on equity ratio, the scope of business, the qualification requirements in respect of the shareholders and the requirement of at least one domestic shareholder holding no less than one third of the equity interest will continue to apply. If a foreign securities firm acquires a stake in a domestic securities firm, then the portion of the business of the domestic firm that a foreign investment securities company is not permitted to conduct must be disposed of before the conversion is permissible.

Conclusion

As required by China's commitments in relation to WTO accession and in order to meet the needs of Chinese securities companies for the management skills that major international securities firms can offer, the CSRC issued the Securities JV Rules, allowing foreign securities firms to establish securities joint venture companies with Chinese securities companies or to acquire a minority stake in Chinese securities companies. However, given that the foreign shareholder is permitted to hold no more than 33% interest in a securities joint venture, that a securities joint venture is not permitted to engage in the trading of A shares as a broker or for its own account, the trading of B shares for its own account or to provide investment consulting or management services, international securities firms may find the new legislation disappointing. Still, the enactment of the legislation on Chinese-foreign securities joint ventures does represent an opening up of the Chinese securities industry to foreign securities firms and a step along in a gradual liberalization of the industry.

Endnotes

1 As of August 10 2000, CSRC had signed memoranda of understanding governing cooperation in securities regulation with the securities regulatory bodies in Hong Kong, the United States, Singapore, Australia, the United Kingdom, Japan, Malaysia, Brazil, Ukraine, France, Luxembourg, Germany, Italy and Egypt. See Zhongguo Zhengquan Bao, August 10 2000.

2 Under China's WTO commitments, the criteria for approval of the establishment of a securities joint venture firm may not contain economic needs test or quantitative limits on licences.

3 This limitation does not apply to a foreign investment securities company converted from a domestically funded securities company.

4 Article 5, the Interim Measures on the Administration of the Employment Qualifications of Senior Managers of Securities Operating Entities, issued by the CSRC on December 14 1998.