China's Post-WTO Compliance and the Pending Auto Financing Regulatory Measures

China has made commitments on auto financing pursuant to the WTO Working Party Report. Upon China's WTO accession, foreign non-banking financial institutions should have been allowed to provide "motor vehicle financing services".³ Within five years after accession, foreign investors will be allowed to provide auto-related services, including domestic sales, auto import and export and distribution, operation of commercial transport companies, auto retail and dealer finance, auto manufacture financing, and leasing services.

Criteria for authorization to deal in China's financial services sector are "solely prudential"; i.e., there are no economic needs tests or quantitative limits on licences. Branches of foreign institutions are permitted.⁴

Annex 1A of the Working Party Report requires notification to the WTO Council for Trade in Services of: (a) regularly updated lists of related new laws and policies; (b) China's licensing procedures and conditions, if any, between domestic and foreign service suppliers, measures implementing the free choice of partners and the list of transport agreements covered by most-favoured nation exceptions; (c) regularly updated lists of the authorities, at all levels of government (including organizations with delegated authority), for the adoption, implementation and reception of appeals for laws and policies; (d) independence of the regulatory authorities from the service suppliers; (e) information on foreign and domestic suppliers in sectors of specific commitments indicating the state of play of licensing applications on sector and sub-sector levels (accepted, pending or rejected).

CHINA'S AUTO FINANCING MARKET

In order to transform Chinese commercial banks from state to privately oriented entities, the central bank decided that China would not establish a separate entity for auto financing, but would allow Chinese financial institutions to develop their auto financing services. Before the announcement of the draft auto financing rules, major Chinese state-owned commercial banks made substantial inroads into the auto financing market.

On July 7 2001, the Industrial and Commercial Bank of China (ICBC) granted a comprehensive credit line of Rmb9 billion (US$1.09 billion) to Shanghai Auto for production, management and sales.⁵ Early in 2002, ICBC took the lead in establishing the Shanghai Auto Financing Service Network Association. The members of this association include auto financing companies, commercial banks, insurance companies, people's courts, auction firms, leasing companies and used-auto supermarkets. The goal is to integrate the sale of auto financing products, and to be able to comprehensively handle financing risks. The varied membership is intended to represent the whole auto production chain. This was the first time that one of China's top state-owned commercial banks made cooperative arrangements with the domestic auto industry in auto financing services.⁶ Additionally, Shanghai Auto's subsidiary dealers and branches have access to bank draft discounting services to apply for discounts from designated ICBC branches, allowing them to receive cash in advance. The bank will offer draft-discounting services totalling Rmb3 billion to dealers chosen by Shanghai Auto.

In late August, the Agricultural Bank of China signed a cooperation agreement with China First Auto Group, with the aim being to provide auto loans totalling more than Rmb20 billion. The China Construction Bank has also announced its own auto loan plan of more than Rmb10 billion (US$1.2 billion). The domestic auto financing market will no longer be dominated by the key state-owned commercial banks. Early in December 2001, Dongfei Auto Group established a joint venture in auto sales and financing services with Taiwan's LONGYU Group.

Currently, informed source indicates that auto loans provided by the four major Chinese banks have exceeded Rmb35.886 billion (US$4.3 billion). ⁷

However, China still lacks a creditor registration system and personal credit history system. The complicated application requirements might serve as obstacles for the development of an auto financing market. The WTO Working Party Report does not cover these issues. Auto financing market access should be implemented in a manner that enhances the smooth flow of imported products into the China market. Auto finance implementation will have a great impact on the nascent state of much of China's auto industry. Local protectionism and questions about the transparency of business deals should be expected.

HIGHLIGHTS OF THE DRAFT REGULATORY MEASURES

Capital Requirements and Establishment Requirements

The Draft Regulatory Measures require that an auto financing institution established in China have total assets of Rmb8 billion (US$966 million), paid-in capital of Rmb500 million (US$60.4 million), and that the entity making the application show continuous profitability for the three years prior to the date of the application. As we understand it, these capital requirements are significantly higher than those required by any other country for similar financing institutions.

The representative office of a foreign auto financing company can become a subsidiary company after submitting an application and after a six-month preparation period. In addition to the registered and paid-in capital requirements and the profitability stipulations above, other particulars apply to the representative office of a foreign auto financing company. In particular, for non-financial institutions, the net assets at the end of the year must be not less than 30% of the total assets, and the aggregate amount of investment must not exceed 50% of the net assets. For financial institutions, the capital adequacy ratio must be not less than 10%, and the aggregate amount of investment must not exceed 50% of the net assets.

Business Scope and Impact on the Chinese Auto Industry

The Draft Regulatory Measures stipulate the business scope that auto financing institutions may engage in all or part of, as follows:

(i) issuing corporate bonds and commercial notes;

(ii) borrowing money from a financial institution by surety;

(iii) accepting fixed deposits for a term of more than three months from shareholder units and enterprise purchasers through loans;

(iv) providing loans to auto dealers for auto purchases and investment in business facilities;

(v) providing auto purchase loans and auto rental services;

(vi) providing surety for auto loans;

(vii) providing agent services relating to the above-mentioned auto financing activities; and

(viii) "other businesses approved" by the People's Bank of China.

Since the Draft Regulatory Measures allow auto financing institutions to finance their businesses by the means of issuance of corporate bonds and shareholders' fixed deposits for a term of more than three months, capital flows initiated by the auto financing rules will promote reconstructions, mergers and acquisitions in the auto industry in China, an official of the Bank of China told the China Economic Observer.⁸ The development of auto financing services closely relates with that of auto sale services. As a result, it is estimated that Volkswagen will be the most likely pioneer to open the first auto financing company, because FAW-Volkswagen and Shanghai Volkswagen hold 60% of the sedan market in China, compared with the 10% market share that General Motors and Citröen jointly hold.

Documentation Required for Application

An applicant seeking to establish an auto financing institution shall submit the following materials in both Chinese and English to the People's Bank of China:

(i) a letter of application for the establishment of the auto financing institution, specifying the name of the auto financing institution to be set up, the location of the institution, the registered capital, the shareholders and the respective ownership structure, and business scope;

(ii) a feasibility study for the establishment of the auto financing institution, of which the content shall include:

(a) a research report on market demand and development for the establishment of the auto financing institution;

(b) information on the promoter of the auto financing institution (the name, legal representative, photocopy of the business licence, conditions of the business operation, credit certificate and guarantee of capital contribution); and

(c) a balance sheet, profit-and-loss statement and cash-flow statement for the three successive years prior to the application for the applicant that are authenticated by the People's Bank of China;

(iii) the articles of association of the proposed auto financing institution;

(iv) a list of the persons in charge of the establishment preparation of the auto financing institution and their respective curriculum vitae; and

(v) any other documents required by the People's Bank of China.

During the period of establishment preparation, if the applicant is a foreign financial institution under the supervision of a financial regulatory authority of its host country, it shall provide a written opinion issued by its regulatory authority indicating its conformity with the laws of that country. Also during establishment preparation, financial and non-financial institution applicants who are not under the supervision of a regulatory authority in compliance with their national laws shall submit credit assessment reports for the three successive years prior to the application. The result of the credit assessment shall be "good" or higher.

Examination and Approval of Senior Management Personnel

The Draft Regulatory Measures require that the senior managers of an auto financing institution shall be examined and approved by the PBOC. Three years of experience in auto sale and financing services is required for the general manager, vice general manager and the executive directors of the auto financing institutions.

Interestingly, for the first time in the drafting of a piece of financial legislation, the PBOC gives the definition for "senior management personnel". In the Draft Regulatory Measures, the term includes the chair and vice chair of the board of directors, the supervisor general, the general manager and vice general manager, the executive directors, the independent directors, the financial controller, and other personnel who may have significant influence upon the management of the institution.

The PBOC will inquire of the legal representative or other senior managers of an auto financing institution as to problems discovered in their daily supervision, and order the institution to correct or rectify any problems identified. If the institution refuses, the central bank may revoke the qualification of the legal representative or relevant senior managers.

Approval

According to the Draft Regulatory Measures, the PBOC will make a decision on submitted applications within six months. An applicant who has been rejected must wait a full year before re-filing the same application.

Establishment preparation of an auto financing institution can take a maximum of six months. The original approval shall be automatically void if no business operations commerce before the end of this period, or the qualifications for starting a business have not been met. In exceptional circumstances, the period for establishment preparation may be extended, but the extension shall not exceed an additional six months, upon the approval of the PBOC. No business activities shall be undertaken in the name of the auto financing institution during the period of establishment preparation.

Two Licences for Business Operations

The central bank will issue a "financial institution legal person licence" to the approved auto financing institution. With this licence, the auto financing institution shall commence its business operations only after it has registered with the Administration for Industry and Commerce for the "enterprise legal person business licence". The PBOC will revoke the licence of the approved auto financing institution if the institution does not start business within three months or terminates its business for six successive months from the date it obtains the business licence.

Prudential Controls by the Central Bank

The PBOC will carry out a system of field and non-field inspections in the administration of its auto financing institution regulating authority. The central bank will inquire of the legal representative or other senior managers of an auto financing institution as to problems discovered in their daily supervision, and order the institution to rectify any problems. If the institution refuses, the PBOC may revoke the qualification of the legal representative or relevant senior managers.

Suspension of Business

The PBOC may suspend the business of an auto financing institution if one of the following conditions occurs:

(i) losses of the present year exceed 30% of the registered capital or losses exceeded 10% of the registered capital in three consecutive prior years;

(ii) difficulty in balance of payments;

(iii) violation of relevant laws, regulations or rules;

(iv) other conditions that the PBOC deems to necessitate suspension.

After suspension, the auto financing institution may apply to the central bank to resume normal business if the following conditions are satisfied:

(i) the balance of payment resumes;

(ii) the loss is eliminated; or

(ii) the illegal acts are corrected.

The maximum suspension period shall not exceed one year.

Separate Rules Pending for Investment in Auto Financing Institutions

The Draft Regulatory Measures state that detailed rules for investing in auto financing institutions will be provided in separate regulations.

BUSINESS COMMUNITY CITES 'SERIOUS CONCERNS'

In remarks made to the US Trade Policy Staff Committee (TPSC) at a public hearing on September 18 2002 on China's WTO compliance, the American Chamber of Commerce-China representative noted the lack of codified auto financing regulations in China. AmCham stated that US companies were concerned about the draft regulations because they were more stringent than those implemented by other countries. AmCham urged the USTR to work with China to resolve this issue.⁹

When the draft regulation was released in October, AmCham-China voiced an immediate criticism, stating that the "provisions establishing unreasonable capital requirements, high asset requirements, and restrictions on participation in activities considered fundamental in auto financing operations in other markets around the world raise serious concerns".¹⁰ This criticism is consistent with fears that Chinese regulators are attempting to protect the existing and primarily domestic auto financing sector. Currently, the author is not aware of any immediate reaction from US-based auto companies or from the US government.

Auto FINANCING MARKET ACCESS AND CHINA'S WTO COMPLIANCE

To the Chinese government, the opening of the financial services market is a major step in its financial reform efforts. The Chinese authorities hope to make such reform in a coherent manner, rather than allowing foreign financial institutions to rush into China. The authorities realize that the commitment to opening of the auto-financing sector will also significantly influence key institutional investors in China's "premature stock market".¹¹

According to a recent report issued by the State Council's State Development Centre, the government plans accelerated opening of trade in services, including financing, retail and distribution, telecommunications, transportation and technology services, among others. China realizes that the international competitiveness of its enterprises is far behind foreign competitors. Undoubtedly, many Chinese enterprises will establish strategic alliances with multinational corporations in order to improve their own competitiveness. And the demand of consumers for foreign investment in the service industry will increase significantly. China estimates that the annual growth rate of foreign investment in the services sector will be between 10% and 15% in the coming years. Further, it is believed that the market share of newly established foreign-invested enterprises in service industry will rise to about 40%.¹²

Almost at the same time as the government issued the Draft Regulatory Measures on Auto Financing Institutions, the China Securities Regulatory Commission (CSRC) promulgated regulations allowing private and foreign investors to acquire controlling stakes in domestically listed companies.¹³ Prior to the issuance of these regulations, China only allowed Greenfield foreign direct investment. New M&A rules have been planned for some time but the specifics of the rules were unclear until the CSRC published its regulations.

These steps are leading to a significant opening of the domestic financial market, which could help explain the delay in promulgating the auto financing regulations. In response to criticisms about the time and capital requirements in the regulations, and the delay in publishing them, we understand that China may take the position that the General Agreement on Trade in Services (GATS) allows flexibility for developing countries in the liberalization of trade in services and the fulfillment of scheduled commitments. This flexibility is addressed in the GATS preamble, which explicitly recognizes the particular right of developing country governments to issue new restrictions on services, given the asymmetries between developed and developing countries in the degree of development of the services sector.

Moreover, numerous articles of the GATS, including Article III, V, VI, XV, and XIX, provide for flexibility with regard to the degree of liberalization to be granted in services regulation. China may assert that Article XIX of the GATS mandates that progressive liberalization shall take place in developing countries to open services sectors in line with the level of development and with due respect for national policy objectives. In addition, Article XIX explicitly provides "appropriate flexibility" for individual developing country members to open fewer sectors, liberalize fewer types of transactions and, when allowing market access to foreign services suppliers, attaching to such access conditions aimed at achieving the objectives of Article IV to "increase participation in trade in services".

Given that the specific rules and procedures of Article XIX are currently subject to negotiation in the Doha round of negotiations, it is likely that China will press to take advantage of the vague guidelines of flexibility included in GATS in meeting its services commitments.

In the first year after China's WTO accession, as pointed out by China's Vice Finance Minister Liqun Jin in a seminar at World Bank headquarters on October 22, the pressure on China's economy is twofold: the direct impact of implementing WTO schedules in the first year of membership, and dealing with the destabilizing effects on the world economy of the September 11 2001 terrorist attack and the corporate scandals in the US.¹⁴ Against the backdrop of a volatile global economy, it is understandable that the PBOC took an additional year to craft the regulatory measures for auto financing, including the high capital threshold and the above-mentioned prudential requirements. We look forward to seeing the promulgation of the official regulations soon.

Endnotes

1 "Auto finance battle heats up," AHNet Economic Discussion. Anhui Economic News Center, June 11 2002. See http://www.in.ah.cn/hyfx/0261185048.htm.

2 Announcement No. 23, People's Bank of China. The announcement includes the draft measures on auto financing institutions.

3 See Report of the Working Party on the Accession of China, WT/ACC/CHN/49, December 11 2001.

4 See Annex 9: Schedule of Specific Commitments on Services List of Article II MFN Exemptions, Report of the Working Party on the Accession of China, WT/ACC/CHN/49/ADD.2, December 11 2001.

5 See "China Industrial and Commercial Bank Granted Significant Line of Credit to Shanghai Auto," International Finance Post (Guoji Jinrong Bao), July 10 2000, http://www.people.com.cn/GB/paper66/974/137052.htm.

6 Shen, Xiaoshi, "Competition between domestic and oversea financial institutions: Fighting for the 60 billion auto financing market in China," China Auto Daily, August 23 2002.

7 "Auto finance battle heats up," see supra note 1.

8 "Foreign Investment in Auto Financing," China Economic Observer, October 14 2002.

9 Report to the TPSC by the US Chamber of Commerce on China's Implementation of WTO Accession Commitments, September 2002.

10 See Noah Smith, "China Issues Draft Rules 10 Months Late To Allow Auto Financing by Foreign Firms," International Trade Reporter, Bureau of National Affairs, Washington DC, October 15 2002.

11 Ibid.

12 State Development Research Center Workgroup on FDI and Industry Restructuring, "The Pace of Market Access of Foreign Capital in Financing Services is Picking Up," China Securities Times, October 14 2002.

13 Administration of Acquisition of Listed Companies Procedures, promulgated September 28 and effective December 1 2002.

14 Liqun Jin, "China: One Year into the WTO Process," World Bank Seminar, October 22 2002. See full text of the speech at http://www.worldbank.org/wbi/B-SPAN/docs/IMF-WB_address_final.pdf .