China’s financial regulators have suggested in recent weeks that liberalisations that would permit greater foreign participation in China’s financial markets were pending. Mr. Yi Gang, the chairman of the People’s Bank of China, announced the guiding principles and spirit of these liberalisations at the Boao Forum on April 11, 2018.
Three principles are guiding the opening of the sector: (1) that such foreign invested institutions will receive national treatment and investments will be subject to a negative list; (2) the opening of financial services will go hand in hand with progressing on the convertibility of RMB; and (3) as the opening occurs emphasis will be placed on combating financial risks and improving the abilities of the financial regulators.
In accordance with the spirit of “Better early than late, better fast than slow”, Yi Gang also announced the following liberalisations, amongst others, will be implemented in the next few months. The foreign equity holding limitations in securities companies, fund management companies, futures companies and personal life insurance companies would be raised to 51% from 49%, and within three years the equity holding limitation would be abolished. Restrictions on foreign equity holding in banks and financial asset management companies will now be abolished in the coming months, and foreign banks will be permitted to open branches and subsidiaries in China. Foreign investors meeting the relevant criteria will be allowed to engage in the insurance agency business in China.
Mr. Yi Gang also announced that before the end of the year, policies to encourage foreign investment in the trust, financial leasing, auto finance, cash agency and consumer finance sectors would be put in place, together with further liberalisations in the insurance sector.
All of these liberalisations will be dependent on specific regulations for implementation. These liberalisations will mark a significant opening of the financial sector that will create new opportunities for international financial service providers.
New measures for foreign invested securities companies
The Administration Measures for Foreign Invested Securities Companies (Measures), which came into effect on 28 April 2018, are among the first of the new regulations implementing these liberalisations and reflect how these liberalisations may be handled for other financial services sectors. The Measures introduce a number of important changes for foreign investment in the securities sector. Under the prior regulations, foreign investors, with a few limited exceptions, qualified pursuant to the Mainland and Hong Kong Closer Economic Partnership Arrangement, have been limited to holding minority stakes in investment banks. The Measures pave the way for greater foreign equity holding and a greater range of business activities.
The Measures are applicable to newly formed foreign invested securities companies, foreign acquisitions of, or investments in, existing domestic securities companies and domestic securities companies whose actual controller becomes a foreign investor. The Measures set out the documents and procedures required for the establishment, acquisition or transformation for such entities.
The Measures provide that foreign equity holding will be limited based on national arrangements for the opening of the securities industry to foreign investment, which will in this case raise the permitted level of foreign equity holding to 51% from the current 49%. It is expected that the limitation will be lifted after three years allowing wholly foreign owned enterprises (WFOEs) to qualify as securities companies. The draft version of the Measures released in March also contained specific provisions relevant to foreign equity holding in listed securities firms which included raising the maximum holding by a single foreign investor to 30% from 20%. This provision however was not included in the final Measures but may be introduced in separate regulations.
The Measures update the criteria that a foreign investor needs to satisfy in order to invest in a securities firm. While the criteria are stricter than those under the prior regulations, the new criteria are consistent with the China Securities Regulatory Commission’s (CSRC) current requirements for foreign investment in other financial services sectors. A foreign investor is required to (1) be from a jurisdiction with a sound regulatory system and whose securities regulator has entered into a memorandum of understanding with the CSRC on cooperation; (2) be a financial institution meeting the local financial requirements for their home jurisdiction securities regulator for the last three years; (3) have been in operation for at least five years, free of any material administrative or judicial penalty for the last three years, and not be under investigation for a material violation; (4) have in place effective and complete internal control systems; (5) have a good international reputation and performance record and have income and profits at a leading international level in the last three years, and long term credit rating shall have been maintained at a high level in the last three years; and (6) meet such other criteria as determined by the CSRC. These criteria will also be applied to domestic actual controllers of domestic securities companies if those actual controllers become foreign, and to foreign investors that acquire more than 5% of the equity of a listed domestic securities company.
Greater flexibility is now permitted for the business scope of such entities. The initial business scope of a foreign invested securities firm must correspond to the core business of its controlling investor or largest shareholder. The business scope, however, is no longer limited to investment banking. The permissible business scope under the PRC Securities Law will be open to foreign investors. Pursuant to the Securities Law, the business scope of a securities firm may include (1) securities brokerage business; (2) securities investment advisory business; (3) financial advisory business related to securities trading and securities investment activities; (4) securities underwriting and sponsoring business; (5) securities business for its own account; (6) securities asset management; and (7) other securities business. A foreign invested securities firm should be able to add to its initial business scope, which shall be based on the core business of its controlling shareholder after its first year of operations.
The Measures also give foreign investors more options in selecting a PRC joint venture partner as PRC partners in joint venture securities firms are no longer limited to financial institutions. Expanding the range of permissible partners will be particularly welcome.
The Measures reflect China’s commitment to opening up the financial sector to foreign investment and providing some guidance on how China will implement the results of its trade discussions. For financial service providers these will be very exciting developments.
Third party electronic payment processing
In connection with the further opening of the financial services sector, the People’s Bank of China (PBOC) has opened electronic payment services to foreign institutions through its release of PBOC Announcement No. 7 (Announcement) on 18 March 2018. Pursuant to the Announcement, foreign institutions, subject to licensing, would be allowed to provide electronic payment services to parties inside of the PRC with respect to both domestic and cross-border transactions. These services have largely been closed to foreign investors with very limited exceptions for pre-paid card services.
The Announcement permits a foreign organization to use a foreign invested enterprise (FIE) in China to apply to obtain a payment service operator’s license under the “Measures for the Administration of Payment services by Non-financial institutions” (Administration Measures). A foreign investor making such applications will be subject to the investor qualification requirements set out in the Administration Measures. The required level of capitalization of the FIE will be determined by the Administration Measures depending on the nature of the business. The Announcement does not restrict eligible FIEs to joint ventures, so in theory a WFOE could obtain a payment service operator’s license.
The applicant for the license will need to have established within the PRC a safe, systemized, independent and complete capacity to process payments. A disaster recovery system will also be required. The corporate governance, operations, risk management, fund handling, deposit and emergency procedures of the payment services operator will be subject to the requirements and supervision of the PBOC.
The Announcement specifically makes references to data protection requirements that are of growing concerns for foreign investors with FIEs in China. The Announcement requires that personal and financial information generated or collected in the PRC must be stored in the PRC and can only be transferred out of China with the consent of the relevant party and in compliance with the rules and regulations of the relevant authorities. The PRC Cybersecurity Law will be directly applicable to such transfers and overseas entities that receive such information will be subject to confidentiality obligations. The PRC’s quick developing cybersecurity requirements will create challenges for foreign investors seeking to enter this sector and a large degree of uncertainty remains with respect to what will be required for cybersecurity compliance.
While the Announcement is a very welcome development, the extent to which the service sector opens up to foreign participation in practice remains to be seen. A wide variety of regulations and restrictions imposed by other agencies and regulators will be relevant to the operations of such entities. Foreign exchange control regulations and internet and telecommunications related licensing requirements may restrict the development of such enterprises or indirectly impose limitations on the foreign ownership of such enterprises. The willingness of the Administration of Industry and Commerce to issue a business license that permits these activities may also be an issue. The issuance of the Announcement does not settle many operational issues, but it is an exciting development that offers foreign investors new opportunities in this important industry sector.