China's Financial Sector Opens Its Door Wider to Foreign Investors

More Financial Sectors Open to Foreign Investors

China is opening more financial sectors to foreign investors.  For example, in the insurance sector, foreign investors can now establish and invest in the pension fund management business, although currently this sector is still operated under a pilot basis, i.e. regardless of the nationality of investors, the establishment of pension fund management companies will be approved on a case-by-case basis if the authority considers the preparation for such establishment has become mature.  In capital markets, foreign rating agencies are now able to provide credit ratings on all types of bonds in the Chinese inter-bank bond market and exchange-traded bond market, and qualified foreign-invested entities may become class A lead underwriters in the Chinese inter-bank bond market.  On Jan. 28, 2019, S&P Ratings (China) Co., Ltd., the wholly-owned subsidiary of S&P Global Inc., obtained approval to be the first foreign-invested ratings agency in China and less than six months later, it issued its first credit rating to a Chinese financial institution.

Such foreign access relaxation may encourage foreign investors to reconsider their strategy in doing business in the Chinese market and provide existing players with an opportunity to renegotiate with their Chinese partners for a controlling stake

Removal of Foreign Ownership Restrictions

Currently, foreign investors are permitted to obtain 100% ownership in most types of financial institutions and the remainder is expected to be removed by end of 2020.

• In the banking sector, the caps on foreign ownership in Chinese-funded commercial banks and financial asset management companies (20% and 25% respectively) have been removed, and foreign investors are free to set up wholly-owned banks and financial asset management subsidiaries, and own controlling stakes in joint venture banks and financial asset management companies.

• In the insurance sector, foreign investors are now permitted to set up wholly-owned insurance companies and hold controlling stakes (no more than 51%) in life insurers, and the caps on foreign ownership in life insurers will be further removed by end of 2020. In addition, the requirement that Chinese insurance companies must own at least 75% of an insurance asset management company has been abolished, and foreign investors can own more than a 25% stake in an insurance asset management company.

• For the capital market business, foreign investors have been permitted to increase their ownership in securities companies, futures companies and fund management companies to no more than 51% since July 2018. As announced by China Securities Regulatory Commission (CSRC), such caps will be removed as from Jan. 1, 2020 for futures companies, from April 1, 2020 for fund management companies, and from Dec. 1, 2020 for securities companies.

Such foreign access relaxation may encourage foreign investors to reconsider their strategy in doing business in the Chinese market and provide existing players with an opportunity to renegotiate with their Chinese partners for a controlling stake.  Indeed, a number of foreign investors have already caught the wave, for example, it was reported that UBS received approval to increase its ownership in its securities joint venture to 51%, J.P. Morgan and Nomura Holdings have obtained approval for majority control in their newly established securities joint ventures, and Allianz has obtained CBIRC's approval to operate China's first wholly foreign-owned insurance holding company.  There are more approvals in the pipeline: for example, Japanese-based Daiwa has submitted an application to establish another foreign majority-controlled securities joint venture, and Credit Suisse AG is pending approval to increase its ownership in an existing securities joint venture to 51%.

Lowered Entry Barrier and Expanded Business Scope

The liberation initiative is also instantiated by the lowered entry barrier for foreign investors and expanded business scope of foreign-invested financial institutions.  These measures are expected to provide more room for mid- or smaller-sized foreign financial institutions to enter the Chinese market, create more flexibility in the avenue of investment, and foster a more level-playing field between foreign and domestic financial institutions.

The measures are in line with China's overall opening-up initiative in the financial sector (including the fintech area) to foreign investors in the past few years.  For example, following China's relaxed restrictions on foreign investors engaging in the bank card clearing business in 2015, American Express' 50:50 joint venture obtained PBOC's approval in November 2018 to become China's first foreign-invested bank card clearing and settlement institution.  Also, PayPal is now able to provide online payment service in China following PBOC's approval of its acquisition of a majority stake in a Chinese digital payment license holder in 2019.

More Aspects to be Considered Along with Opportunities

Corporate Governance Transition

The newly enacted FIL is expected to reshape the governance structure of foreign-invested enterprises by unifying the corporate governance requirements for domestic enterprises and foreign enterprises.  New market entrants, especially those through greenfield joint ventures or equity investment, need to comply with the governance rules prescribed in the PRC Company Law (中华人民共和国公司法) as opposed to the old joint venture rules.  For foreign shareholders of existing joint ventures, not only can they consider a higher or controlling stake in light of the removal of foreign ownership caps, they may also utilize FIL to renegotiate a different joint venture governance structure to their benefit.  However, it cannot be ruled out that the joint venture parties might fail to reach agreement on such change of governance required by FIL and eventually result in operational difficulties or stalemate.

The NSR may also be triggered if the foreign investment is considered to have negative influence on China's national security…

Merger Filing and National Security Review

While foreign access restrictions have become more relaxed, the regulatory requirements in the financial sector have become more comprehensive.  Also, it is noteworthy that there are certain non-industry-specific pre-establishment regulatory requirements for foreign investors to start or expand its financial business in China.  Pursuant to FIL, foreign investment in China could be subject to merger control and national security review (NSR).  Under China's merger control regime, foreign investment through M&A or joint venture will be subject to merger filing requirements, if such investment results in an acquisition of control or decisive influence over another undertaking (i.e. the control test), and the combined sales turnover of all parties, as well as the respective PRC sales turnover of each of at least two parties exceeds the prescribed thresholds (i.e. the turnover test).  The NSR may also be triggered if the foreign investment is considered to have negative influence on China's national security, and this procedure may be triggered either by foreign investors' proactive application or by other stakeholders, including regulatory authorities if they identify any national security concern during their review of application for establishment.  In fact, the NSR clause has been especially mentioned in recently enacted or amended financial sector related regulations, including the Measures for the Administration of Foreign-invested Securities Companies (外商投资证券公司管理办法) (see Article 23), the Measures for the Fiscal Regulation of the Asset Appraisal Industry (资产评估行业财政监督管理办法) (see Article 70) and the Measures for the Administration of Bank Card Settlement Institutions (银行卡清算机构管理办法) (see Articles 13 and 26 (corresponding Articles 4 and 12 of the 2019 exposure draft of proposed amendments)), suggesting that it could be a pre-requisite procedure for market access to securities, asset appraisal and bank card clearing industry.  In light of the above, it is highly recommended that foreign investors engage professional advisors to assess potential concerns and responsive measure (if necessary) at an early stage of the investment initiative.

Cybersecurity and Data Protection

As a trending regulatory concern, data compliance requirement has been recognized by the PRC Cybersecurity Law (CSL) (中华人民共和国网络安全法) adopted in 2016 and is applicable to all network operators in China.  Since any entity that owns or manages a network or provides network services will be deemed as a network operator, it is likely that a financial institution may also be deemed as a network operator.  Under the CSL, network operators are required to perform security protection obligations under a multilevel protection system, where the level of security protection is decided based on the potential influence of network failure as prescribed in relevant rules or standards.  Given that financial institutions operate finance data, it is likely that they may be deemed as operators of critical information infrastructure that are subject to more rigid cybersecurity obligations.  Furthermore, financial institutions' collection of personal information and cross-border data transmission are also subject to regulatory requirements.  Therefore, it is also very important for foreign financial institutions to bear in mind China's data compliance requirements.