CBRC Measures establish trust company risk control

Llinks Law Offices
Charles Qin and Tommy Xia
[email protected]; [email protected]

he China Banking Regulatory Commission (CBRC) recently issued the Administrative Measures for the Net Capital of Trust Companies (Measures)(信托公司净资本管理办法)(办法), which establishes a system of risk control index based on the net capital of trust companies. It links the scale of capital with net capital for the purpose of strengthening the supervision and administration of trust company risk and promotes the safe and stable development of trust companies. The Measures will exert a profound influence on the business style and risk control of trust companies.

Net capital requirement

Net capital, as a liquid asset, is a comprehensive risk control indicator generated after risk adjustment and – in accordance with trust companies' business scope and asset structure features – of all essential assets, off-balance items and other relevant businesses on the basis of net capital. The underlying objective of the net capital administration over trust companies is to ensure that trust companies shall have adequate essential assets and liquidity so as to avoid potential operational risks, credit risks, market risks and various business risks in the course of the business carried out by the trust companies.

The Measures make certain connections between net capital and risk capital. Risk capital is unpredictable capital losses that may arise in various businesses (including essential business, trust business and other businesses) carried out by trust companies. The risk capital of each business can be calculated in accordance with the scale of the relevant business and the prescribed risk parameters. The Measures stipulate two risk control indicators: net capital may not be less than 100% of the sum of all risk capital; and net capital may not be less than 40% of net assets. The purpose of this is to ensure that the net capital of trust companies can cover the risk capital of the various businesses. But it is also to satisfy the adequacy requirements of essential capital and maintain the necessary liquidity so as to strengthen the supervision and administration of trust companies' risks.

The Measures stipulate that indicators of risk control for trust companies are similar to the capital adequacy ratio for commercial banks. This requires trust companies to take into consideration the scale and quality of trust assets managed by trust companies. As a result, trust companies may not expand without restriction their trust assets anymore. Trust companies need to seek balance between limited net assets and business risks. Improving net capital and adjusting business risks has become two important methods for trust companies to meet requirements stipulated in the Measures.

The net capital requirements set out in the Measures generate pressure for trust companies, in particular those with a small scale of net capital. A method to increase a trust company's capital is retaining profits, but this is dependent on the profit creation ability of the company and the pressure of dividends distribution. Therefore, retaining profits may not have a positive effect in the short term. Besides, introducing strategic investors and listing on stock markets are still the major means to increase trust companies' capital. However, increasing capital is not an effective means to solve net capital management, and may have adverse effects such as dilution of stock equity, change of control, and alteration to shareholders' structure.

The Measures provide a signal that promoting the stable development of trust companies with good capital structure and strong management ability is under contemplation by the regulators. CBRC intends to procure trust companies to establish and perfect the capital restriction mechanism, strengthen risk management and improve their business exploration abilities. Therefore, adjusting the type and structure of the trust business and seeking management initiative are important methods to adapt to the new net capital requirements.

CBRC circulates a net capital calculation table, risk capital calculation table and risk control indicator supervision form as supporting documents to the Measures. Such documents manifest the purpose of the regulators by setting different risk ratios to different businesses. Therefore, trust companies are able to select businesses based on their own net capital, risk preference and development strategy. They can also focus on businesses with competitive advantages and commit to gaining high returns conditional upon the reasonable attribution of limited capital.

The Measures have made a significant contribution to trust regulation and provided trust companies with challenges and opportunities. Trust companies can actively meet the requirements by adjusting their business structures and improving their asset management