Cash Flows and External Security: The CSRC Addresses Some Old Issues

Cash flows between listed companies and the provision of external security by listed companies to related parties are issues that have been addressed in piecemeal fashion in securities industry legislation for a number of years. On August 28 2003 the China Securities Regulatory Commission (the CSRC) published the Several Issues Concerning the Regulation of Cash Flows between Listed Companies and Their Affiliates and Security Provided to Outside Parties by Listed Companies (the Circular) in a fresh attempt to address these two issues in a coherent manner.¹

In relation to cash flows between listed companies and their shareholders and/or affiliates, the Listed Company Governance Guidelines issued on January 7 2002 require listed companies to generally adopt effective measures to prevent company funds, assets or other resources being appropriated by shareholders and/or affiliates. The Circular focuses on the controlling shareholders specifically (the relative controlling shareholders should also be covered, though this is not clearly stated in the Circular), and provides that controlling shareholders and/or affiliates may not require the listed companies to pay their salaries, welfare, insurance premiums and like costs. In addition, other cash flow methods that may disguisedly allocate listed companies' money to their controlling shareholders and/or affiliates are also prohibited. These include providing loans to them, entrusting them to make investments or assuming their debts.

Providing external security is a risky business for listed companies. The CSRC has published the Questions on the Provision of Security by Listed Companies Circular (the Security Circular) that specifically addresses this issue. By comparison with the Security Circular, the new Circular imposes more strict requirements that are designed to effectively control the external security provided by listed companies. First, a listed company may no longer provide security for any subsidiary in which it holds less than a 50% share or any debtor whose liability-to-assets ratio exceeds 70%. In the past the restriction on provision of security was limited to a listed company's shareholders and/or other affiliates. Second, the accumulated amount of the external security shall not exceed 50% of net assets as stated in the consolidated accounting statement of the latest fiscal year, regardless of to whom the external security is provided. Third, the Circular now makes mandatory clauses in a listed company's articles of association that address approval procedures for providing external security and the credit standards of the debtors to be secured. Fourth, if the external security is to be approved by the board of directors, the Circular requires that there must be a two-thirds majority of directors in favour of it. Fifth, the independent directors of a listed company must be involved in this matter