Insurance AMCs and Risk Control Guidelines: New Rules Aim to Meet Industry Demand

The Insurance AMC Provisions set out detailed requirements in relation to the establishment of Insurance AMCs, minimum capital requirements, authorized scope of business, protection of insurance funds under management by Insurance AMCs, risk control systems and other provisions.

Establishment Requirements for an Insurance AMC

An Insurance AMC may be established either as a limited liability company or a company limited by shares. One of its shareholders must be an insurance company or an insurance holding company that satisfies the following requirements:

(i) it has engaged in the insurance business for at least eight years;

(ii) no administrative penalty has been imposed on it in the past three years as a result of misuse of funds;

(iii) its net assets must not be less than Rmb1 billion; its total assets must not be less than Rmb5 billion, and in the case of an insurance holding company or an insurance company undertaking life insurance business, its total assets must not be less than Rmb10 billion;

(iv) it must meet the solvency margin requirements of the CIRC;

(v) it must have a sound corporate governance structure and internal control system;

(vi) it must have established a department responsible for matching assets and liabilities and a risk control department, and it must have a good investment data management system;

(vii) the assets centrally managed by its fund management department must represent not less than 50% of its total assets or, in the case of an insurance company carrying on life insurance business, not less than 80% of its total assets; and

(viii) other requirements stipulated by the CIRC.

The eight-year track record requirement and the high thresholds for minimum net assets and total assets (particularly for life insurance companies) would make it difficult for foreign-invested insurance companies that have been established in recent years to qualify under the Insurance AMC Provisions as the lead promoter of an Insurance AMC. As a result, they will need to team up with major domestic insurance companies if they wish to establish Insurance AMCs at this stage.

Minimum Capital Requirement and Maximum Limit on Foreign Ownership

Insurance AMCs are required to satisfy a minimum capital requirement of Rmb30 million and its registered capital must be paid up in cash. In addition, the amount of the registered capital of an Insurance AMC must not be less than 0.1% of the insurance funds under its management unless its registered capital reaches Rmb500 million or more.

The Insurance AMC Provisions provide that domestic insurance companies must hold at least 75% of the equity interest in an Insurance AMC. Domestic insurance companies are defined as insurance companies and insurance holding companies that have been approved by the CIRC and are duly registered in China with legal person status. This definition suggests that foreign-invested insurance companies that have been established in China with CIRC approval would be regarded as domestic insurance companies for the purposes of the Insurance AMC Provisions. However, it is unclear whether the remaining 25% equity interest may be held entirely by foreign investors or partly by foreign investors and partly by domestic investors from other non-insurance industries.

Establishment Process

The establishment process of an Insurance AMC involves two stages, namely the preparatory stage and the business commencement stage. This establishment process is similar to that applicable to the establishment of foreign-invested insurance companies pursuant to the Administration of Foreign-invested Insurance Companies Regulations and their implementing rules. The detailed requirements of the establishment process are summarized below.

Preparatory Stage

An applicant shall submit a written application to the CIRC to commence preparations for the establishment of an Insurance AMC together with supporting documents including, among others, a feasibility study, a proposal on the preparatory work, information on the shareholders, letter(s) of intent on capital contributions of the investors or share subscription agreement(s).

Within three months after receiving a complete set of application documents, the CIRC and the relevant authorities under the State Council will conduct a preliminary review of the application and make a decision as to whether or not to approve the application. If the application is approved, the applicant must complete all preparations within six months of its receipt of CIRC approval. Subject to CIRC approval, the preparatory period may be extended for three months.

It is important to note that no business activities may be carried out during the preparatory period for the establishment of an Insurance AMC.

Business Commencement Stage

After completion of the preparatory work, an applicant should submit to the CIRC an application for the commencement of business of the proposed Insurance AMC together with supporting documents.

Within 20 days of its receipt of a complete set of the application documents, the CIRC will make a decision to approve or reject the application. If the application is approved, the CIRC will issue a Permit for Operation of Insurance Asset Management Business to the proposed Insurance AMC.

Business Scope of an Insurance AMC

In addition to the management of its own renminbi and foreign currency funds, the scope of business of an Insurance AMC is restricted to managing the renminbi and foreign currency insurance funds entrusted by its shareholders or by insurance companies controlled by its shareholders and other types of business approved by the CIRC or by other authorities under the State Council. This restriction of the scope of business to the management of insurance funds distinguishes Insurance AMCs from fund management companies regulated by the PRC Securities Investment Fund Law. The latter may accept both insurance and non-insurance funds for investment in securities investment funds under their management.

Insurance AMCs are subject to the same investment restrictions as are applicable to insurance companies under existing Chinese regulations. Accordingly, the Insurance AMC Provisions provide that Insurance AMCs may only invest insurance funds in bank deposits, government bonds, financial bonds and other forms of investments approved by the State Council (presumably this would include investments in securities investment funds in which insurance companies are allowed to invest (subject to limits) under current Chinese regulations).

The Insurance AMC Provisions contemplate that Insurance AMCs may engage in other types of business subject to approval by the CIRC and/or other authorities under the State Council. One important recent development in this area is that under the Management of Enterprise Annuity Funds Tentative Procedures promulgated by the Ministry of Labour and Social Security (MOLSS), the China Banking Regulatory Commission, the China Securities Regulatory Commission and the CIRC on February 23 2004 and effective on May 1 2004 (the Enterprise Annuity Funds Procedures), Insurance AMCs may, subject to obtaining approval from the CIRC and the MOLSS, manage enterprise annuity funds, a type of supplementary pension funds for employees in China. In order to qualify under the Enterprise Annuity Funds Procedures, Insurance AMCs must satisfy a number of requirements, including a minimum capital requirement of Rmb100 million and minimum net assets of Rmb100 million. The Enterprise Annuity Funds Procedures pave the way for Insurance AMCs to enter China's lucrative pension market, which has a promising future and has generated a great deal of interest among foreign investors.

The Insurance AMC Provisions require approval by China's foreign exchange control authority for the management of foreign exchange funds and the carrying on of other types of foreign exchange business by an Insurance AMC.

Protection of Insurance Funds

The Insurance AMC Provisions contain a number of provisions that are designed to protect insurance funds against improper use or mismanagement.

Appointment of an Independent Custodian

An Insurance AMC is required to appoint an independent custodian to keep custody of the insurance funds under its management. This is to ensure that the insurance funds will be held by an independent third party in order to reduce the risk of misappropriation of funds by Insurance AMCs. The custodian should be a commercial bank or other specialist financial institution approved by the CIRC.

Segregation of Different Types of Funds

The Insurance AMC Provisions require Insurance AMCs to manage self-owned funds and the insurance funds under its management by different investment managers and in separate accounts. In addition, different types of insurance funds entrusted by the same insurer should also be separately managed.

Other Measures to Protect Insurance Funds

The Insurance AMC Provisions set out the following requirements in relation to the protection of insurance funds:

(i) any assets generated from the management of insurance funds shall be included as part of the insurance funds;

(ii) any profits or other interests obtained by an Insurance AMC as a result of managing entrusted insurance funds (other than agreed remuneration stipulated in the relevant asset management contract) should be included as part of the insurance funds;

(iii) Insurance AMCs must not set off the rights arising from the insurance funds under its management against any liabilities associated with its self-owned assets. Further, Insurance AMCs must not set off the rights and liabilities associated with insurance funds entrusted by different parties against each other;

(iv) in the event that an Insurance AMC undergoes dissolution or is declared bankrupt, the entrusted insurance funds under its management should not be included as part of the liquidation assets;

(v) in the event that an Insurance AMC is in dispute with a third party, no freezing order or attachment order may be imposed on the insurance funds under its management.

In addition, the Insurance AMC Provisions prohibit an Insurance AMC from engaging in the following activities:

(i) providing any security;

(ii) undertaking that the insurance funds under its management will not suffer any loss or guaranteeing a minimum return on the insurance funds under its management;

(iii) entrusting another party to manage the insurance funds under its management;

(iv) seeking gains for the benefit of a third party (other than the party who has entrusted the insurance funds) by misusing the insurance funds under its management;

(v) engaging in transactions involving investment of insurance funds with its shareholders and insurance companies that have entrusted insurance funds to it or manipulating insurance funds from different sources to carry out transactions between such funds;

(vi) seeking illegal gains in collaboration with the entrusting party in the guise of asset management fees or by other means; and

(vii) other activities prohibited by Chinese laws and regulations or by regulatory authorities.

Other Provisions Relating to Insurance AMCs:

Senior Management Qualifications

Senior managers of Insurance AMCs are required to satisfy a number of qualification requirements that are similar to those applicable to senior managers of insurance companies in China. These include having a university degree and a certain number of years of related work experience. The qualifications of senior managers are subject to verification by the CIRC before they are appointed to their respective positions in an Insurance AMC. The senior managers of an Insurance AMC are prohibited from concurrently holding positions in other companies or profit-making business organizations.

Changes to an Insurance AMC that are subject to Approval

The following changes to an Insurance AMC are subject to the prior approval of the CIRC:

(i) amendment to its articles of association;

(ii) change in its investors or shareholder(s) holding at least 10% of its shares;

(iii) change of its scope of business;

(iv) closure of a branch organization;

(v) change of business premises; or

(vi) replacement of senior management staff.

Other Provisions

The Insurance AMC Provisions also set out general provisions relating to risk control systems of Insurance AMCs (see the discussion below). There are also provisions relating to the dissolution and liquidation of Insurance AMCs.

The Guidelines and Risk Control Systems

Risk Control Systems under the Insurance AMC Provisions

One of the key regulatory concerns of the CIRC is to ensure that insurance companies and Insurance AMCs properly manage their insurance funds and adequately control their investment risks. Accordingly, the Insurance AMC Provisions require Insurance AMCs to establish a sound corporate governance structure and an effective internal control system. Insurance AMCs are also required to establish a board of supervisors. The specific duties of the board of supervisors are not specified in the Insurance AMC Provisions, but it is expected to have a general supervisory role over the directors and the management of Insurance AMCs. The general powers of the board of supervisors are set out in the PRC Company Law(中华人民共和国公司法).

To further strengthen the supervision of Insurance AMCs, the Insurance AMC Provisions allow a company that has entrusted insurance funds to an Insurance AMC to second their own staff to the Insurance AMC for the purpose of supervising the implementation of the asset management contract by the Insurance AMC. The CIRC will also conduct inspections, including on-site inspections on Insurance AMCs at regular intervals.

The Guidelines

In order to assist insurance companies and Insurance AMCs to establish a proper and effective risk control system, the Guidelines set out general principles for the establishment and implementation of risk control systems in relation to the management and application of insurance funds. The Guidelines expressly provide that they apply both to insurance companies and Insurance AMCs. The detailed requirements of the Guidelines are as follows.

Definition of a Risk Control System

The risk control system in the Guidelines refers to the internal organizations, systems and measures employed by insurance companies and Insurance AMCs in identifying, assessing, managing and controlling risks in the management and application of insurance funds.

General Principles for the Establishment of a Risk Control System

The establishment of a risk control system by insurance companies and Insurance AMCs should comply with the following general principles.

The principle of independent checks and balances. The various departments that are involved in the management and application of insurance funds should be independent of each other and they should have separate duties and functions and should serve as checks and balances against each other.

The principle of comprehensive risk control. Risk control measures should cover all aspects of the work of all staff and all departments that are involved in the management and application of insurance funds.

The principle of timeliness and suitability. The risk control system should be suitable to the organizational environment in which it is to be implemented and it should promptly adjust to changes in such environment.

The principle of responsibility. There should be a responsible person in charge of each step of the risk management process who should supervise the management staff and identify any non-compliant activities.

Control of the Organizational Environment

The Guidelines emphasize the control of the organizational environment, which refers to the establishment of internal organizations to implement the following aspects of risk management:

(i) establishing an organizational structure where the board of directors is responsible for establishing a suitable risk control system and the management is responsible for its implementation;

(ii) strictly implementing a separation of duties in respect of related functions in the management and application of insurance funds, including separation of investment decision-making, operations and risk control functions;

(iii) designating specialized fund management departments or Insurance AMCs to manage insurance funds;

(iv) appointing independent custodians to keep custody of insurance funds; and

(v) maintaining separate accounts and separate management systems in respect of different types of insurance funds.

Key Risk Areas

The Guidelines provide that the risk control system should focus on the following seven key areas.

Management of Assets and Liabilities. The key is to ensure asset and liability matching. The board of directors of an insurance company should formulate a strategic asset allocation plan based on the insurance company's business strategies and the characteristics of its insurance funds. The management of the insurance company should formulate investment guidelines for the application of insurance funds based on the strategic asset allocation plan and taking into consideration specific factors such as the term to maturity, the required yield, risk tolerance levels and liquidity and solvency margin requirements of the relevant insurance funds.

Management of Investment Decisions. The board of directors is responsible for making high level, strategic decisions concerning investment management, including formulating rules and regulations, decision-making procedures and authorization limits for investment decisions, determining strategic asset allocation plans and investment strategies, fund management models, risk tolerance levels and investment criteria for different types of investment products. A centralized system should be established for investment decision-making, which in turn should be subject to specific authorization limits. The management and relevant staff in the investment department of an insurance company or an Insurance AMC may only make investment decisions within the scope of authorization granted by the board of directors and within their respective authorization limits. Investment decisions should be properly recorded in writing.

Management of Investment Operations. A separate transaction management department should be established to effectively control risks associated with investment transactions. All investment transactions should be centrally managed and executed by an independent transaction execution department. Separate verification and monitoring procedures should be put in place in respect of trading on a stock exchange and other transactions that are conducted outside stock exchanges. Insurance companies and Insurance AMCs should also establish a centralized transaction monitoring system, a pre-warning system in respect of irregular transactions, as well as a system to provide feedback on executed transactions. Proper transaction records should be kept and fair treatment should be provided for insurance funds from different sources.

Management of Risk Control Systems. Insurance companies and Insurance AMCs are required to establish a risk control system that classifies, identifies, quantifies and assesses risks that may arise during the course of the management and application of insurance funds by adopting quantifiable indicators and statistical analytical methodologies. A specialized department should be set up to be responsible for assessing and monitoring relevant risks in this regard. The Guidelines have identified the following specific risks that are required to be effectively managed: market pricing risk, credit risk, interest rate and foreign exchange risk, liquidity risk, operation risk and compliance risk. Insurance companies and Insurance AMCs are required to report to the CIRC material emergencies arising from the funds investment and/or application operations.

Management of Information Technology Systems. Insurance companies and Insurance AMCs should establish and manage their information technology systems for the investment and application of insurance funds in accordance with the Establishment of Internal Control Systems in Insurance Companies Guiding Principles promulgated by the CIRC on August 5 1999. Emphasis should be placed on the security, confidentiality and verifiability of the information technology system. Strict controls should be placed on access rights to the information technology system. The day logs of the information technology system are required to be kept for a minimum of 15 years.

Management of Accounting and Auditing Systems. The accounting systems and procedures of insurance companies and Insurance AMCs should comply with relevant accounting and financial laws, and with other relevant PRC regulations. Any change in accounting policies should be subject to approval by the board of directors in order to ensure that the accounting policies are consistently applied. The Guidelines reiterate the requirement under the Insurance AMC Provisions that the accounting system for entrusted assets under management by an Insurance AMC should be separated from the accounting system for its self-owned assets. The Guidelines also emphasize the separation of duties in the accounting department and the use of accounting vouchers to ensure the accuracy of accounting records and the formulation of accounting verification procedures to detect accounting errors. The accounting department should keep safe the custody of chops, cheque books and accounting records in order to prevent any damage, loss or unauthorized disclosure of accounting records.

Management of Human Resources. Insurance companies and Insurance AMCs should establish a human resources management system and formulate professional ethics rules for their employees. The Guidelines stress that those professional staff that are involved in the management and application of insurance funds should have a high standard of integrity and professional competence and should sign a confidentiality undertaking. Any person who has a criminal record or has been subject to administrative penalty or is otherwise disqualified by any financial regulatory authority may not be hired to manage insurance funds. Employees may not concurrently serve in the investment and information technology departments, the finance department, the risk management department or the audit and compliance department. The Guidelines require that an audit should be conducted after the departure of senior management personnel or other managers serving key positions in the departments responsible for the investment or management of insurance funds.

Inspection and Assessment of Risk Control Measures

Insurance companies and Insurance AMCs are required to set up an independent department to be responsible for inspecting and assessing the risk control measures of their fund management and fund investment departments and to provide inspection reports. They are also required to undergo a comprehensive internal inspection of their fund management and fund investment functions at least once a year and report the results to the board of directors. The Guidelines require insurance companies to submit an asset and liability matching report to the CIRC on an annual basis.

Regulatory Focus on Risk Controls

The Insurance AMC Provisions provide that the CIRC will actively monitor the management and application of insurance funds by insurance companies and Insurance AMCs, which are required to establish a linkage with the monitoring system of the CIRC in order to transfer relevant data relating to their management and application of insurance funds to the CIRC. The Insurance AMC Provisions further provide that the CIRC will regard the adoption of proper risk control measures by insurance companies and Insurance AMCs as an important consideration in determining their respective scope of permitted investments and the grading of the relevant insurance companies and Insurance AMCs. This highlights the fact that the CIRC places significant emphasis on the adoption of a sound risk control system and adequate and effective risk control measures by all insurance companies and Insurance AMCs in China in order to ensure the healthy, sustainable and well-managed growth of the Chinese insurance industry over the long run.

Endnote

1 Under the Insurance AMC Provisions, the term "insurance funds" is defined as various types of insurance reserve funds, capital funds, working capital funds, capital reserve funds, undistributed profits and other liabilities of insurance companies and assets derived from the above funds.