Trust companies take the next step

Business scope

A trust company is not permitted to trade with its existing business. A collective trust with two or more settlers may trade the SIFs for hedging and arbitrage purposes. Where the trust product is a single trust with one single settler, the trust company may trade SIFs for speculative purposes in addition to the above two types of business.

Entry thresholds and other provisions

In order to obtain the qualification to trade SIFs from the CBRC, a trust company must meet various stringent thresholds.

The applicant must be rated Grade 3C or above for the preceding year. To carry out the speculative trading, the applicant needs to be rated Grade 2C or above. Furthermore, the applicant must have traded SIFs for hedging or arbitrage purposes for at least one year.

The applicant must have effective internal control and risk management systems for SIFs trading, competent qualified transaction personnel, a competent IT system, an adequate business website, security and other facilities, and a strict business separation system that effectively isolates the hedging and non-hedging businesses.

A trust company shall work with an escrow bank as well as a futures trading firm to trade SIFs. The futures trading firm should be a CFFEX member with full settlement or transaction settlement capacities, a B rating from a recent annual supervision, a technical qualification of Grade 2 or above, and with a proper risk reserve balance that conforms with its business scale. The escrow bank should have an independent asset escrow business department with specialists familiar with the SIFs business, have a safe and effective settlement, closing and evaluation system for SIFs business, etc.

The trust company may use an investment adviser as long as the trust documents provide so in managing the SIFs trading business. An investment adviser must meet various requirements as well, including having a minimum paid-in capital of Rmb10 million, having a competent and qualified SIFs investment and research team with a sound reputation, and having a complete business management, risk control and regular back stage management system and business model. In addition, it must have a fixed business site, and hardware and software commensurate with the business volume.

The Guidelines require that trust companies formulate detailed hedging and arbitrage plans, and the risk management department of the trust companies shall carry out feasibility study on the plans, and monitor the trust business management department on a real-time basis to ensure the feasibility and efficiency of the hedging and arbitrage transactions.

Trust companies are required to exercise prudence in customer selection and fully disclose to them the risks involved. Trust companies must disclose relevant information according to the laws and trust documents in a timely, accurate and complete manner.

Restrictions on holding positions

The Guidelines also control the holding positions of the trust companies. At the end of any trading day, for a collective trust engaging in the hedging business, the value of the selling SIFs held by the trust company shall not exceed 20% of the total market value of all equity securities held by the collective trust. At the end of any trading day, the value of the buying SIFs shall not exceed 10% of the net value of the trust assets.

At the end of any trading day, the risk exposure of any single trust shall not exceed 80% of the trust assets.

In case of situations such as the fluctuation of the futures market and change of trust scale which result in the non-compliance of the investment percentage requirement, the trust companies must report to the CBRC within two working days after the occurrence of the event, shall adjust within 10 working days, and report to the CBRC again after completion of the adjustment. When the SIFs trust business terminates, the trust company shall apply to cancel the SIFs transaction code within three working days after the completion of the settlement, and report to the CBRC within five working days.

Reactions from market players

These strict restrictions have received mixed reactions from the market players. Due to the initial stage of the SIFs trading in China and the lack of experience in this area, the CBRC was more cautious in drafting the Guidelines and imposed high entry standards on the trust companies. This also embodies the Chinese government's plan to promote the financial derivatives market gradually in stages.

Major trust companies such as Shanghai Trust, Huarun Trust, and Hwabao Trust have shown their interest in pursuing the SIFs trading qualification in spite of the stringent qualification criteria. Other trust companies however indicated that due to their lack of qualified personnel and experiences, as well as the preparation work required, they may not seek to attain the qualification as of now.

Practical consideration

Trust companies were prohibited from holding any securities account from 2009. The China Securities Regulatory Commission however has not issued any circular regarding opening securities accounts for trust companies. Without such securities account, trust companies will not be able to trade any SIFs. Therefore, same as for QFII investors, when the implementation rules for the Guidelines will be issued is yet to be seen.

Foreign investors preparing to get in on the action

China has not made any commitment on trust companies upon WTO accession, and trusts were not an active investment area at the time. However, since the promulgation of the two milestone regulations on trusts, the Measures for the Administration of Trust companies (信托公司管理办法) and the Measures for the Administration of Plans of Collective Trust Funds of Trust Companies (集合资金信托计划管理办法), both effective from March 1 2007, trusts have attracted more interest from both domestic and international investors given the expanded scope of trust businesses and the added flexibility of the new trust regime. Trust companies in China can acquire equity interest in sectors such as insurance, securities broking, asset management and private equity. Trust companies can also offer corporate banking services such as asset management and indirect fund-raising for domestic enterprises. Trust companies' being able to trade SIF is one of the new advantages offered to trust companies in China.

Following the release of the above two regulations, the CBRC issued the Administrative Allowances Implementation Measures for Non-Bank Financial Institutions (非银行金融机构行政许可事项实施办法) (Implementation Measures). These clearly set out the maximum ownership percentage of 20% for a foreign investor to invest in a trust company in China. In addition, such foreign investor shall invest in no more than two trust companies in China. The Implementation Measures has provided a clear roadmap for foreign investors to directly participate in a trust company in China.

As of 2011, there have been more than a few joint ventures in the trust sector being successfully established, in the negotiation stages, or on a waitlist for approval by the CBRC. Foreign participation in the trust sector brings experience and expertise with a proven record to the China market, while the Chinese market provides a new and challenging market for expansion to foreign players. With such momentum, China's trust sector is set to grow in strength and gain a more important role in the nation's economy.

Julia Kong, Jade & Fountain PRC Lawyers, Shanghai