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CSRC to Revise Rules on Foreign Investments in Securities Companies


On March 9, 2018, approximately four months after China promised to ease or lift foreign investment restrictions in the PRC financial market during the visit by President Trump, the Administrative Measures on Foreign-invested Securities Companies (Consultation Draft) (the “Consultation Draft”) was published by the China Securities Regulatory Commission (the “CSRC”) for public comments.  The Consultation Draft, once promulgated, will replace the Rules on Establishment of Foreign Equity-participated Securities Companies (the “Current Rules”) that are the major current rules dealing with the establishment of foreign invested securities companies.


In parallel with the Current Rules, Supplement Agreement 10 to Closer Economic Partnership Arrangement (CEPA 10) between the mainland, Hong Kong and Macau governments provides for certain special treatments to qualified Hong Kong and Macau investors and allows such investors to set up a limited number of foreign invested securities companies in certain designated areas and hold 51% or 49% equity interest therein.  Over the past couple of years, a number of foreign invested securities companies have been established by taking advantage of these special treatments.  Pursuant to the CSRC, this pilot program under CEPA 10 has accumulated experiences with respect to the opening up of the securities industry, which can now be replicated and made generally available to all foreign investors.


We have prepared the following table which aims at assisting you to understand what changes the Consultation Draft proposes to bring about and how the Consultation Draft compares with the Current Rules and CEPA 10 requirements.


Current Rules

CEPA 10

Consultation Draft

Comments

Foreign shareholding limit (for un-listed securities companies)

Not to exceed 49% in the aggregate.

Not to exceed 51% in the aggregate for the foreign invested securities companies established in Shanghai, Guangdong and Shenzhen (only one such type of securities company is permitted to be established in each of the three areas); and not to exceed 49% in the aggregate for the foreign invested securities companies established in the financial reformation pilot districts (only one such type of securities company is permitted to be established in each pilot district).

Not to exceed the promises (currently 51%, which limit is to be removed in its entirety in 3 years’ time) and not to fall below 25% in the aggregate, except that the 25% shareholding floor will not apply where a domestic-funded securities company is converted into a foreign-invested securities company

The Draft Rules proposes to lift the foreign shareholding cap and to introduce a foreign shareholding floor.  Once the Consultation Draft is passed, qualified investors from regions other than HK and Macau will also be able to set up foreign controlled securities companies

Foreign shareholding limit (for listed securities companies)

Not to exceed 25% in the aggregate and not to exceed 20% for a single foreign investor.

N/A

Not to exceed the promise (currently 51%) in aggregate and not to exceed 30% for a single foreign investor.

Business scope

Limited to

Ÿ   underwriting and promotion of shares (including Renminbi-denominated ordinary shares and foreign-denominated shares) and bonds (including treasury bonds and corporate bonds);

Ÿ   brokering of foreign-denominated shares;

Ÿ   brokering and self-operation of bonds (including treasury bonds and corporate bonds); and

Ÿ   any other businesses approved by the CSRC.

No special limit and can be fully licensed.  However under current CSRC rules that apply to all securities companies, initial scope of businesses shall not exceed four types of businesses, which can then be gradually increased. 

The initial business scope shall match the securities operation experience of the controlling shareholder or the largest shareholder.

Ÿ   Special limit on business scope is to be lifted;

Ÿ   New requirement that the initial business scope should match that of the controlling/largest shareholder to be introduced, which can as a matter of fact limit the scope of business of  a foreign invested securities company, at least initially. CSRC explained that the purpose is to “avoid disordered application of securities business licenses”.

Ÿ   Note that the Consultation Draft also requires all foreign investors to be financial institutions with at least 5 years securities business experiences. 

Foreign shareholder qualification

Among other things, (1) at least one of the foreign shareholders shall be a financial institution; and (2) the foreign shareholders shall have good reputation and operation record

In addition to the requirements generally applicable to a foreign invested securities company, (1) the HK/ Macau shareholder shall be registered in and with the headquarter in HK/ Macau; and (2) if the controlling shareholder or actual controller of the HK/ Macau shareholder is a financial holding company or financial institution, it shall meet one of the following three requirements: (i) registered in and with the headquarter in HK/ Macau, (ii) publicly listed in HK/ Macau, with 50% or more profits in recent 3 years from HK/ Macau, or 50% or more of the senior managers being HK/ Macau permanent residents, or (iii) publicly listed in HK/ Macau, with 50% or more of the revenues or pre-tax profits are from the HK/ Macau shareholder of the foreign invested securities company.

Among other things, all of the foreign shareholders shall (1) be financial institutions and shall have operated securities businesses for more than 5 years, (2) have good international reputation and operation record, and have maintained a business scale, income and profit that are ranked at the top level and a long-term credit at a high level in the recent 3 years, and (3) have not been subject to any material penalty by local regulators, administrative or judicial bodies, in the past 3 years, and is not subject to any investigation by relevant authorities due to any suspicion of material violation of laws or regulations.

The requirements of foreign investors have been significantly strengthened compared to both the current general rules and the CEPA 10 requirements.  In particular, not only ALL foreign investors need to be financial institutions, they but also need to have no less than 5 years securities business experiences.  In addition, they should not be subject to any investigations by relevant authorities, regardless of the potential outcome of the investigations.

Domestic shareholder qualification

At least one of the domestic shareholders shall be domestic securities company, and among these domestic securities company shareholders, at least one of them shall hold no less than 49% shares.

Abolished the requirement to the left.

Abolished the requirement to the left.


Special Notes:


In addition to the comparison above, we would like to highlight the following two points to existing and potential investors in a foreign invested securities company:


The lock up: The Consultation Draft removes a requirement under the Current Rules that the foreign shareholders shall not transfer its shares in the foreign invested securities companies in three years from the date when they acquire the shares.  However, foreign investors should not jump to the conclusion that they are now not subject to any lock up.  As a matter of fact, longer lock up periods are provided for in the Review and Examination Guidance Number Ten on the Administrative Licensing of Securities Company – Capital Increase and Shareholding Change (“Guidance No. 10”), which as we understand, also applies to the establishment of foreign invested securities companies.  According to Guidance No. 10, with respect to a securities company that has controlling shareholder or actual controller, the controlling shareholder or the shareholder controlled by the actual controller shall not transfer the shares of the securities company it holds within 60 months from the date of acquiring the shares, and other shareholders shall not transfer the shares of the securities company they hold within 36 months from the date of acquiring the shares; with respect to the securities company which has no controlling shareholder or actual controller, all of the shareholders shall not transfer the shares of the company within 48 months from the date of acquiring the shares.  So unless Guidance No. 10 is also amended, the removal of the 3-year lock up from the Current Rule is probably just an effort to avoid any contradiction between different rules.


The “look-through” approach:  the Consultation Draft has proposed a “look through” approach with respect to the controlling shareholder and actual controller of foreign invested securities companies in determining whether a securities company is domestic funded or foreign invested.  According to Article 2 of the Consultation Draft, foreign invested securities companies include securities companies whose controlling shareholders or actual controllers have changed into foreign investors, and according to Article 14, under this circumstance, the relevant foreign investors should satisfy the qualification requirements and shareholding limit[1] for foreign shareholders, and those who do not satisfy the requirements and limit should take corrective actions within three months, which, as we understand, including transferring the shareholding to qualified domestic or foreign shareholders. As explained by the CSRC, in recent years some actual controllers of securities companies changed their citizenship and became foreign citizens, as a result of which foreign investors indirectly held shares in domestic-funded securities companies, and this proposed change is aimed at capturing such circumstances.  Recent years we have seen this “look-through” approach being discussed or adopted in a number of foreign investment related areas, including in the draft Foreign Investment Act proposed by MOFCOM.  However, with respect to the Consultation Draft, the most likely consequence of enforcing this requirement would be that domestic actual controllers who have immigrated to other countries will have to sell their shares, as it seems almost impossible for these actual controllers to satisfy the qualification requirements for a foreign investor.  


Summary:


The Consultation Draft has stayed true to the promise that China has made with respect to the gradual lifting of foreign ownership restriction in the securities industry.  However the Consultation Draft has significantly strengthened the qualification requirements on foreign investors in a Chinese securities company, reflecting the regulators intention that only high quality foreign investors are encouraged to invest in this industry so that with the opening up, the Chinese securities industry can benefit from the advanced international experiences.


It is yet to be seen whether the Consultation Draft, once adopted, will also apply to the securities joint ventures established under CEPA 10.  Our estimate would be yes, as the Current Rules do apply to those securities companies.  If this is the case, the HK and Macau investors that intend to make use of the CEPA 10 arrangement to set up securities joint ventures will also need to satisfy the heightened qualification requirements.




[1] Article 14 however only refers to the general shareholding requirements as set forth in Article 7 (ie, not to exceed the promise and not to fall below 25%), but not the individual shareholding cap of 30% for a foreign shareholder of a listed securities company.  This could be an oversight in the drafting.