If you would like us to send you new issues by e-mail each month, please click here to subscribe. There is no charge for this service. If not, please click here to unsubscribe (Please provide the correct Email address which you received our message or forward the message which you received to us for further process).
Lehman, Lee & Xu - China Capital Markets in the news

The China Law News keeps you on top of business, economic and political events in the China.
Blawg | Newsletter Archive | |

In the News

China tightens lending rules for trusts, corporate bill market

China is readying twin initiatives to curb opaque financing practices that threaten the stability of the country's $864 billion investment trust industry and booming corporate paper market, sources with direct knowledge of the plans told Reuters.

The moves, coming separately from the People's Bank of China (PBOC) and the China Banking Regulatory Commission (CBRC), form part a campaign to clean up China's financial system as it opens up domestic capital markets to diversify funding options for cash-strapped firms in the world's No 2 economy. Two sources close to the CBRC said China's big four managers of bad loans - so-called asset management companies (AMCs) - will be banned from lending directly to investment trust companies under the pretext of acquiring bad debt.

Meanwhile, continuing a clampdown on the corporate bill that began in 2011, the PBOC will, from next year, stop bankers acceptances and similar products from being used to camouflage off-balance-sheet lending to firms, sources with direct knowledge of the situation said. Trade in commercial bills began to cause concerns in Beijing when the economy showed signs of overheating on a flood of cheap credit in 2010 and issuance of such notes exploded.

Neither the CBRC nor the PBOC provided comment on their plans when contacted by Reuters. The initiatives could provide reassurance that Beijing is serious about rooting out hidden risks that investors fear lurk in a financial system dominated by state-controlled banks and government-backed business.

For years, China has shuffled bad debt that was run up by big state firms between state banks, other state companies and the government in labyrinthine deals that hid the cost of bad banking, and shielded un-viable state enterprises from bankruptcies. These losses lurk in the system unaccounted for, tarring banks' and China's fiscal health, and frustrating potential investors who say Beijing quashed the bad debt market by refusing to sell dud loans openly to protect state firms from creditors.

The new rules take aim at two key areas - real estate and lending to China's biggest, mainly state-backed, firms. "Right now, asset management companies are focusing their main acquisitions among property trusts," one of the sources with knowledge of the CBRC plan said.

"The new rules are obviously targeting areas in the property trust sector vulnerable to problems," added the source, who is not authorised to talk to the media. Property trusts absorb nearly 13 percent of China's total trust investment and have been pressured in the past year as falling home sales strain developers' ability to repay loans. Some developers have sold land or half-finished projects held as collateral with trusts to repay debts, with the four AMCs emerging as buyers, Chinese media have reported. That raises the risk of collateral being pledged twice, or that developer simply uses land to raise fresh loans to fund another unviable project.

Chinese trusts are essentially private capital funds that get money from rich individuals and wealth management arms of Chinese banks on the hunt for lucrative investments. They had 5.5 trillion yuan ($864 billion) of assets as of the end of June, and had 5.3 trillion yuan of cash to invest, data from the China Trustee Association showed.

PROPERTY TRUST BOOM Property trusts have boomed in the past two years after Beijing banned real estate developers from borrowing from banks, or raising money in public capital markets in an attempt to dampen record rises in house prices. Meanwhile the target of the new PBOC rules is the trade in vaguely endorsed, repeatedly discounted corporate bills, which change hands in an intermediate market of "bridge institutions" that regulators fear impair transparency in the financial system.

These bills are notes from a firm instructing a bank to pay a specific sum to a third party payee on a particular date. But if the payee needs the money earlier, it can cash the bill early for a discount - either at the same bank or a different one.

The discounted bill is recorded on the bank's balance sheet, but Chinese banks that wish to decrease the amount of loans that appear on their balance sheets may use repurchase agreements with domestic brokerages, trust firms, wealth management products or rural credit co-operatives to temporarily erase the asset from their balance sheets in order to avoid breaching loan-to-deposit ratios or other lending restrictions. According to PBOC data, undiscounted corporate bankers acceptance notes increased by 608.9 billion yuan ($95.65 billion)in the first half of 2012, on track to match or exceed the 1.02 trillion yuan increase China posted in 2011.

CLOSING LOOPHOLES The latest proposed regulations would address highly technical aspects of the corporate bill trade, related to how such instruments are endorsed and resold, but the result would close another loophole for banks attempting to use commercial bills to hide lending, a trader at an Asian bank said.

At the same time, it also appears the rules will make it even more difficult for mutual funds and brokerages to participate in the corporate bill market, sources said. "The central bank is preparing to hold a training session in Guangxi by the end of the month, and if the revision of the document requesting suggestions goes smoothly, the rules should be implemented next year," a source close to the situation told Reuters.

The last time Beijing cleaned up its banks and rescued them from bankruptcy, it took three broad waves starting in 1998 and ending in 2005, required huge capital injections and bad loan transfers to specially created asset management companies. The four loan managers are China Cinda Asset Management Corp, Orient Asset Management, Great Wall Asset Management and Huarong Asset Management. They were set up in 1999 to remove about 1.4 trillion yuan of bad debt from China's top four banks.

The Bank for International Settlements estimates 20-24 percent of 2004 GDP was pumped into the banking system, in one of the biggest bank rescues in history. China's Premier Wen Jiabao says he wants to break the lending monopoly that state-controlled banks enjoy, bringing private capital into carefully policed markets away from unregulated, underground lending that the PBOC estimates was worth 2.4 trillion yuan as at the end of March 2010.

Web link: http://www.brecorder.com/market-data/stocks-a-bonds/0/1228924/

US-China Accounting Standoff A Threat to Hedge Funds, Capital Markets

The list of problems in the financial world seems extremely long at the moment. The most obvious issue is the European debt crisis, but we can safely add a slowing global economy, the pending U.S. fiscal cliff and a host of other items to this ever-expanding directory of struggles.

Naturally, it never rains but it pours, so we should also consider another issue from the world of accounting. Currently set on simmer, this nuisance, if left unchecked, could quickly rise to a boil.

Some readers may recall that Chinese stocks listed in the United States have taken a substantial thrashing over the last year or so due to issues surrounding the accuracy of their financial statements. Not helping the cause of these Chinese firms was the fact that many of them gained listing in the United States through reverse mergers with existing publicly-traded firms, thus enabling them to sidestep the typical rigors of the traditional IPO process.

The Securities and Exchange Commission launched a probe into the allegations, but the Chinese have been very reluctant to open up the ledger for the SEC. In truth, the Chinese Securities Regulatory Commission (CSRC) has not only been slow moving, but has actively blocked many of the efforts of the SEC, claiming that such information would be classified as state secrets and, as such, could not be divulged.

The plot thickened a couple of months ago when the SEC handed Deloitte China a subpoena concerning the financials of a firm called Longtop Financial. Deloitte China refused to divulge the audit records, allegedly because the CSRC threatened jail time and business failure for the firm and its executives. The SEC then utilized Sarbanes-Oxley legislation to move forward with punishing Deloitte China, punishments which could include excluding the firm from performing audits on U.S.-listed firms.

Here is where it gets interesting. Firms that wish to handle audit work of U.S.-listed organizations must be registered with Public Company Accounting Oversight Board (PCAOB), another Sarbanes-Oxley creation, and the PCAOB must perform inspections of those firms. The SEC movements against Deloitte China, and by all accounts the rest of the Big 4 audit firms with a Chinese branch, will likely make this an area with little wiggle room and an uncertain outcome.

Since China will not let the PCAOB to perform their inspections, the PCAOB may have to deregister the firms and the SEC would have to prevent them from practicing before them. This would leave these Chinese firms without an auditor, which is a requirement for a publicly-traded organization in the United States. The exchanges would have little choice from there.

These firms would have to be delisted from the stock exchanges on which they are currently traded, since they would have no auditor and be unable to file financial statements with the SEC.

Though this may seem like a far-fetched outcome, one could see the basis for such an event occurring. From the Chinese viewpoint, allowing U.S. regulators to enter their country to perform their reviews, especially after they have been repeatedly told no, would be a public embarrassment. This says nothing about what any such reviews may find; the practices of the audit firms in China as well as the companies who have contracted these auditors would be placed under a microscope.

If there is any fraud or wrongdoing, the fallout could be immense. The opposite perspective from the American side is equally compelling. If they allow the Chinese to get away with this flagrant disregard of U.S. securities laws, it would fly directly in the face of what the United States has spent the decade since Enron trying to stamp out: corporate fraud and manipulation of the system.

Moreover,if the SEC, PCAOB, and stock exchanges allowed these firms to continue operating, and cases of fraud came forward after the regulators caved to the Chinese demands, the regulators could be financially on the hook for not performing their necessary oversight.

Quite clearly, this is a minefield of notable proportions. The far-reaching implications go well beyond the nuances of this particular case, and really the securities industry in general. Future foreign investments by each country could be impacted: the Chinese may wish to avoid American capital markets due to what they perceive as regulatory restrictions, while Americans may choose to avoid Chinese markets due to a fear of fraudulent activity and their perception of a backwards bureaucracy.

In addition, Chinese-U.S. relations of a broader, political nature could be hampered or damaged by such a standoff, a dangerous possibility at such a critical juncture for the global economy and international relations. In times such as these, distrust between the world's two largest economies can only serve to destabilize the current balance, as precarious as it is.

The sincere hope, of course, is that a compromise is worked out over the coming months. One would imagine the Chinese will allow some sort of oversight or review by the American regulators, as it is unlikely they would want their firms shut out of the world's largest marketplace for securities. A concession from the American side would also be possible, notably in what sort of information they have access to in their reviews and their future role in overseeing Chinese securities.

It is roughly estimated that China owns around 8-10 percent of total U.S. debt, so it would be doubtful that the United States would want to rock this boat too much, especially given a debt ceiling debate is on the horizon.

Though not being given much attention by the popular press, or even the less popular press for that matter, this issue has substantial implications. It may come down to a battle of wills between two economic superpowers and the outcomes could prove to be profound. The aforementioned PCAOB has set a deadline for the end of the year for the issue to be resolved. Let's hope a solution does not take that long, though with so many other pressing issues before the global financial markets, a last-minute outcome would come as no surprise.

Web link: http://www.advancedtrading.com/regulations/240006015

Edward Lehman 雷曼法学博士
Managing Director 董事长

LEHMAN, LEE & XU China Lawyers
Founder of LehmanBrown

Lehman, Lee & Xu is a top-tier Chinese law firm specializing in corporate, commercial, intellectual property, and labor and employment matters. For further information on any issue discussed in this edition of China Capital Markets In The News or for all other enquiries, please e-mail us at mail@lehmanlaw.com or visit our website at www.lehmanlaw.com and Mongolia www.lehmanlaw.mn.

Lehman, Lee & Xu Mongolia is one of the first and only international law firms with a full time presence in Mongolia.  Our Ulaanbaatar office is staffed with resident foreign legal consultants having significant experience in Mongolia and qualified Mongolian attorneys. The firm’s foreign legal consultants and local attorneys are fully acquainted and experienced with Mongolia’s laws and legal system, business climate and political affairs. For any Mongolian legal matters please refer to our Mongolian website www.lehmanlaw.mn.

© Lehman, Lee & Xu 2012.
This document has been created for educational purposes for clients, potential clients and referrers of services to Lehman, Lee & Xu, and to alert readers to the services provided by Lehman, Lee & Xu. It is not intended to serve as definitive professional or legal advice, and should not be relied upon as such. Lehman, Lee & Xu does not endorse any personal opinions which may be contained herein.
We hope that you enjoy China Labor Insights. If you would like us to send you new issues by e-mail each month, please click here to subscribe. There is no charge for this service. If not, please click here to unsubscribe.