Insolvency Laws and Securitisation

Insolvency laws are crucial for securitisation, because a primary legal objective for most securitisation transactions is the insulation of the underlying assets from the originator’s bankruptcy risks. Whether “true sale” is a precondition for the bankruptcy remoteness of financial assets depends on the type and structure of the transaction. For a “credit asset securitisation” or a “trust-type asset-backed note” transaction (the structure of which is elaborated in 8.2 Common Structures) on the Interbank Bond Market, the underlying assets are entrusted by an originator into a special purpose trust (SPT), and the underlying assets’ bankruptcy remoteness is provided under Article 15 of the Trust Law of the People’s Republic of China (the Trust Law), meaning that true sale is not an issue for such transactions. However, in the case of a “business asset securitisation” carried out on securities exchanges, and where the underlying assets are transferred from an originator to a special purpose vehicle (SPV) (called an “asset-backed special scheme”), the question of whether the transfer of the underlying assets constitutes a true sale or a financing guarantee is a decisive factor in determining the underlying assets’ remoteness from the originator’s bankruptcy risks.

Insolvency Laws for True Sale v Secured Loan

Pursuant to Article 30 of the Enterprise Bankruptcy Law of the People’s Republic of China (the Bankruptcy Law), if the underlying assets have already been legally transferred to others when a bankruptcy petition pertaining to a transferor (as the debtor) is accepted by a court, then the underlying assets will not be held as part of the bankruptcy estate of the transferor, unless the transfer falls within the scope of revocable transfers (including unrequited transfer and transaction at manifestly unreasonable price) within one year prior to the acceptance of the bankruptcy petition, as provided under Article 31 of the Bankruptcy Law.

If a debtor only creates security rights over certain assets then, according to the applicable laws, when the debtor enters into a bankruptcy proceeding, these assets shall be part of the debtor’s bankruptcy estate, but the secured party has a priority claim on the assets. Under Article 19 of the Bankruptcy Law, after a court accepts a bankruptcy petition, preservation measures pertaining to the debtor’s estate shall be lifted and enforcement procedures over the estate shall be suspended, which means the secured party must delay the exercise of security rights over the estate. In bankruptcy liquidation and bankruptcy settlement proceedings, while a secured party may make a claim to the administrator at any time to exercise the priority of compensation with respect to the disposition and liquidation of the security property, the administrator may decide to dispose of the security property with the rest of the bankruptcy estate as a whole if the disposition of such security property alone would reduce the value of the rest of the bankruptcy estate, and the disposition and distribution plan of the bankruptcy estate shall be approved by the meeting of creditors, which makes the exact timing of the realisation of the security rights ultimately uncontrollable. In the bankruptcy reorganisation proceeding, if there is any evidence proving that the security property is necessary for the reorganisation, and the administrator or the debtor can provide a corresponding guarantee or compensation, the People’s Court may rule not to approve the resumption of the exercise of the security right. Thus, in a secured loan transaction, a creditor’s right over the collateral will be affected by the debtor’s bankruptcy procedure in various aspects; in a true sale situation, by contrast, a transferor’s bankruptcy will not have any impact on the transferee’s exercise of rights over the underlying assets.

Currently, China’s Company Law, Securities Law, Bankruptcy Law and other laws and regulations fail to provide room for the development of SPVs in the form of special purpose companies and special purpose limited partnerships. The Trust Law was enacted in 2001, wherein the principle of trust property independence provided the legal basis for the pilot securitisation of credit assets that began in 2005. Therefore, in credit asset securitisations and trust-type asset-backed notes (ABNs) where a trust company serves as an issuer/issuing vehicle manager, SPTs are adopted. As for business asset securitisations on the securities exchanges, the initial issuers were limited to securities companies or subsidiaries of securities companies, and due to the separate operation of the trust industry and securities industry under the Chinese legal framework, SPTs are not adopted; instead, asset-backed special schemes are used.

Neither SPTs nor asset-backed special schemes (collectively referred to as SPVs) constitute legal entities, but rather form contractual relationships, where the trustee or scheme manager conducts transactions or administrative activities on behalf of the trust or the special scheme according to the contracts, and no operations or debts unrelated to the securitisation are allowed. The trustee or scheme manager may further engage the servicer, fund custodian and other institutions to provide services for the SPV.

An asset-backed special scheme is set up by the scheme manager, who purchases the underlying assets from the originator on behalf of the investors. According to Article 5 of the Administrative Provisions on Asset Securitisation by Securities Companies and Subsidiaries of Fund Management Companies (Announcement of the China Securities Regulatory Commission (CSRC) [2014] No 49) (the Administrative Provisions on Asset Securitisation) issued by the China Securities Regulatory Commission, the assets of special schemes are independent from the inherent property of the originator, manager, custodian and other business participants, and if the above-mentioned entities are subject to liquidation due to dissolution, revocation or declaration of bankruptcy, the assets of the special scheme do not belong to the liquidation property. Naturally, whether the assets of the special scheme can achieve bankruptcy remoteness from the originator also depends on whether the transfer of the assets from the originator to the special scheme can be recognised by the court as a true sale.

For an SPT, according to Article 15 of the Trust Law, the trust property is differentiated from other property which the settlor has not entrusted; after the establishment of the trust, when the settlor is dissolved, revoked or declares bankruptcy, if the settlor is not the only beneficiary, the trust survives and the trust property shall not be regarded as its estate or liquidation property. Meanwhile, according to Article 16 of the Trust Law, the trust property differentiates from the property owned by the trustee (inherent property), and if the trustee is dissolved, revoked or declares bankruptcy, the trust property does not belong to its liquidation property. Based on the aforementioned provisions, in credit asset securitisations and ABNs that adopt the trust structure, the underlying assets are generally not consolidated with the bankruptcy estate of the originator or the trustee.

True Sale v Secured Loan

In China, the typical form of property security is the statutory mortgage or pledge, with a clear security agreement between the guarantor and the creditor, which is different from a sales contract. In practice, there is an atypical kind of security called “security by transfer”, whereby the debtor or a third party enters into a contract with the creditor to superficially transfer a property under the creditor’s name; if the debtor pays off the matured debt, the creditor shall return such property to the debtor or the third party; if the debtor fails to pay off the matured debt, the creditor could auction or sell the collateral, or be paid off with the collateral based on its estimated price. Due to the similarity in form, such transactions are easily confused with true sales. If the court determines that the purpose of the property transfer is security rather than a true transfer, it will decide following the Security Law.

China is a country with a statutory law system, where a judge’s discretion is relatively limited. Based on limited judicial cases, when deciding the nature of a deal, a People’s Court tends to respect party autonomy, thus taking an approach whereby the text of the contract is closely analysed to determine whether its true meaning complies with the characteristics of a sales contract as defined under the Civil Code (ie, transfer of ownership versus consideration). The courts seldom use the equity principle to overturn explicit expressions of the will of the parties to a contract.

Therefore, to achieve the target of a true sale and bankruptcy remoteness, at least the following factors need to be ensured in a transaction:

• there is a true and explicit expression regarding the transfer of the ownership of the underlying assets in the relevant transaction documents; and
• the transferee shall pay a reasonable consideration to acquire the underlying assets – the fairness of the consideration is primarily to ensure the transaction will not be revoked by the aggrieved party or its creditors/bankruptcy administrator as manifestly unfair or prejudicial to the interests of the creditors.

A basic premise is implied in this type of transaction: that the underlying assets can legally generate steady cash flows which can match the payment of the securitisation products.

In some securitisation transactions, the originator may commit to make up for a shortfall in cash flows of the underlying assets compared to the predicted value, or to repurchase the underlying assets under certain circumstances (such as the deterioration of the transferor’s business condition or a material breach of contract). No judicial case has yet indicated that these arrangements will affect the recognition of a true sale. However, with the increase in legal disputes related to securitisation, it remains to be seen how judicial practice will evolve in respect of the standards for true sale.

“Internal Effect” and “External Effect”

Under PRC laws, the transfer of a creditor’s claim can have both an “internal effect” and an “external effect”. The internal effect of the transfer refers to its effect in relation to the transferor and the transferee. In this regard, as long as the contract providing for the transfer of assets (transfer agreement) has come into effect and the preconditions of the transfer provided in the transfer agreement have been met, then the transfer of the assets will be effective against the transferor.

Generally, the external effect of the transfer of a creditor’s claim first refers to the effect of the transfer in relation to the debtor. According to Article 546 of the Civil Code of the People’s Republic of China (the Civil Code), which came into effect on 1 January 2021, any transfer of a creditor’s claim is invalid against the debtor unless the debtor has been informed. This means that if a debtor has not received notice of the transfer of the creditor’s claim, the transferee cannot, on its own, assert the right against the debtor.

The external effect of the transfer of a creditor’s claim also includes the effect on the creditors of the transferor and any third parties. Although it’s not a requirement, the transfer of account receivables can be registered in the Movable Property Financing Unified Registration and Public Notice System (the Registration and Public Notice System) of the Credit Reference Center of the People’s Bank of China (PBOC). According to Article 768 of the Civil Code and Article 66 of the Interpretation of the Supreme People’s Court on the Application of the Security System of the Civil Code of the People’s Republic of China (the Interpretation of the Security System), when one account receivable is the underlying asset of a factoring, pledge, and transfer simultaneously, the People’s Court will determine the order of priority based on factors such as whether the registration of transfer has been completed, the time order of the registration, and the arrival time of the notice of the transfer to the debtor.

In addition, regarding the mortgage and pledge securing the creditor’s claim, although these security rights are transferred to the transferee along with the creditor’s claim, the transferee’s right may not be able to confront a bona fide third party if no change of mortgage/pledge registration has been made to put the transferee’s right on public notice.

General Requirements

As mentioned above, certain perfection measures are required in order to make a transfer of financial assets definitively enforceable against the debtors, the transferor’s creditors and bona fide third parties. These include registering the transfer of account receivables, notifying the debtors of the transfer, a change of mortgage/pledge registration, and the transfer of possession of the pledged movables, etc. For a more detailed analysis on right perfection measures, see 5.3 Principal Perfection Provisions.

Opinion of Counsel

In a securitisation transaction, a legal counsel is normally not required to issue an opinion on whether a transfer of the underlying assets constitutes a true sale. However, when legal counsel does issue an opinion on whether the underlying assets could achieve bankruptcy remoteness, it would consider the nature of such transaction and its effect on bankruptcy remoteness.

Since China has formulated specialised regulations for various types of securitisations, the transaction structures are relatively “fixed” under the relevant regulations. For now, bankruptcy remoteness can only be achieved through the two means mentioned under 1.3 Transfer of Financial Assets.

Except for transferring the financial products stipulated in the Notice on Full Launch of the Pilot Scheme on Levying Value-Added Tax in Place of Business Tax (Ministry of Finance [2016] No 36), a transfer of financial assets is not currently subject to VAT. The transfer of underlying assets is not subject to stamp duty as well because a trust agreement or a purchase and sale agreement in asset securitisation transactions are not regarded as taxable documents listed in the Stamp Duty Law of the People’s Republic of China (2022) (the “Stamp Duty Law”).

A potential tax on the transfer of underlying assets is income tax. If the transfer price is greater than the tax basis of the transferred assets (ie, the historical cost or the actual amount of costs incurred by the acquisition of the assets), then enterprise income tax may be due on the taxable income. In practice, since the financial assets are usually transferred at parity or at a discount on their historical cost, usually no income tax is due on the transfer.

In asset securitisations, the transfer of underlying assets to the SPVs does not generally give rise to a tax burden for the SPVs. On the other hand, income derived from the underlying assets by the SPVs might be subject to enterprise income tax and value-added tax.

Income Tax

In regard to credit asset securitisations, according to Ministry of Finance [2006] No 5, if the trustee has allocated the income of the trust to institutional investors during the fiscal year, then the institutional investors shall pay the enterprise income tax on this income and, in order to avoid double taxation, no income tax needs to be paid by the trust. However, the unallocated trust income during the fiscal year shall be subject to enterprise income tax at the trust level. If the income allocated to the investors has already been taxed, then the investors do not need to pay the income tax thereon, to avoid double taxation.

According to the Enterprise Income Tax Law of the People’s Republic of China, “enterprises” and “other income-earning organisations” shall pay the enterprise income tax. For other types of asset securitisation business, whether the SPV is an SPT or an asset-backed special scheme, neither constitutes an “organisation” under the law, and therefore neither is subject to enterprise income tax.

Value-Added Tax

If the underlying assets are interest-bearing assets such as loans or financial leases, then the SPV will acquire rights to such interest or income after the underlying assets are transferred to it. According to the Notice of the Ministry of Finance and the State Administration of Taxation on Specifying the Value-added Tax Policies for Finance, Real Estate Development, Educational Support Services (Ministry of Finance [2016] No 140) and the Notice on the Relevant Issues concerning Value-added Tax Levied on Asset Management Products (Ministry of Finance [2017] No 56), etc, the manager of the asset management products shall pay VAT at a rate of 3% on its taxable activities occurred in the operation of the asset management products. This rule also applies to securitisations. Nevertheless, if an asset securitisation transaction cannot be achieved off-balance sheet, the competent tax authority may still require the originator to continue to pay VAT at a rate of 6% on the proceeds from the transferred underlying assets, which may result in the problem of double taxation. Although originators and trustees in many transactions have communicated with the competent tax authorities, this issue has not been effectively resolved because the State Taxation Administration has not yet provided any clear instruction on it.

Stamp Duty

The Notice on Relevant Issues concerning Taxation Policies on the Securitisation of Credit Assets (Ministry of Finance [2006] No 5) provides certain exemptions from stamp duties for credit asset securitisations. An originator or trustee is temporarily exempted from stamp duty arising from taxable agreements between the originator, the trustee and the fund custodian, the securities depository or other service providers in a securitisation transaction. The trustee’s sale and the investors’ purchase and sale of credit asset securities, as well as accounting books established for the trust, are temporarily exempted from stamp duty. So far, there are no special tax exemptions for business asset securitisations.

The relevant parties in an overseas assets transfer shall follow the general tax regulations on the transfer of financial assets. Generally, if the transfer of assets constitutes a true sale, the foreign SPV has not acquired income as transferee during the transfer and the foreign investors have not acquired any income from China, then the transfer will not give rise to any withholding tax issue. However, if the transaction between an originator in China and an overseas SPV (or its investors) is deemed from a tax perspective to be a loan to the originator, then the payment of withholding tax will be an issue.

Additionally, a Chinese originator who sets up a conduit company for securitisation for tax avoidance purposes may be subject to an anti-tax avoidance investigation. The Enterprise Income Tax Law of the People’s Republic of China and the Measures for the Administration of General Anti-Tax Avoidance (Trial Implementation) (Order of State Administration of Taxation No 32) have established the general anti-tax avoidance system, according to which a conduit company may be subject to an anti-tax avoidance investigation by the tax authorities for suspected abusive use of the corporation form and tax havens in order to avoid taxes.

If the underlying assets in a securitisation transaction (for example, REITs which are partially carried out pursuant to the securitisation regulations) include real estate or equity interests, the transaction might also be subject to taxes related to real estate ownership and transactions, such as property tax, land value-added tax and title deed tax, or enterprise income tax. To alleviate the tax burden on the originator or their affiliates, direct transfers of real estate are generally avoided in favour of transfers of equity rights in the company that holds the real estate to be transferred.

If necessary, transaction parties may ask accredited tax advisers for professional opinions concerning specific tax issues. Lawyers advising on a transaction do not usually provide opinions on specific tax issues.

The accountant’s determination regarding the consolidation of an SPV and a true sale is, to some extent, based on the economic essence of the transaction reflected in the terms of the transaction agreements. According to the Accounting Standards for Business Enterprises No 33, published by the Ministry of Finance, the scope of financial statements consolidation shall be determined on the basis of control. When determining control, the accountant may consider three factors: power, variable returns, and the relationship between power and returns.

For the assessment of the first factor, power, the originator’s power over the SPV as reflected in the transfer agreement and the servicing agreement is determinative. According to the Accounting Standards for Business Enterprises No 33, factors to be taken into consideration when determining whether the originator can de-recognise certain financial assets include whether or not the originator has transferred almost all the risks and rewards relating to the ownership of the financial assets to the transferee, including whether the originator has transferred the rights to collect the cash flow and, if not, whether it has undertaken to pass on the cash flow of the financial assets. In most securitisation transactions, before sending the notice of transfer to the debtors, the originator still bears the obligation to pass on the cash flows of the financial assets. Therefore, the accountant needs to conduct the “pass-through test” by examining whether the originator has complied with the “no-advance”, “no-misappropriation” and “no-delay” principles, which involves an inspection of the advance payment and reimbursement by the servicer, investment of idle funds, frequency of cash flow allocation, and other transaction arrangements.

For the purpose of de-recognising financial assets, at the request of the accountant, the legal counsel may have to modify some specific provisions in the transaction documents, subject to the consent of the participating parties. According to the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions (Order of CBRC [2005] No 3), a legal opinion from a practising lawyer is also needed for proving that the originator does not have any actual or indirect control over the credit assets that have been transferred, and that the transferred credit assets have achieved bankruptcy remoteness from the originator.

Since the securitisation market in China is segmented, and each market segment and business type is subject to different sets of regulations and rules, introductions to these regulations and rules will be given separately.

Information disclosure regarding credit asset securitisations mainly follows the rules published by the PBOC, including the Rules for the Information Disclosure of Asset-Backed Securities (Announcement of PBOC [2005] No 14) and the Announcement of Matters Regarding Information Disclosure of Credit Asset Securitisations’ Underlying Asset Pool (Announcement of PBOC [2007] No 16), and the disclosure guidelines for various kinds of underlying assets published by the National Association of Financial Market Institutional Investors (NAFMII), which include micro and small-enterprise loans, retail auto loans, personal mortgage loans, redevelopment of shanty towns loans, personal consumer loans, and non-performing loans.

Information disclosure regarding ABNs issued in the Interbank Bond Market shall mainly follow Administrative Measures for Debt Financing Instruments of Non-financial Enterprises in the Interbank Bond Market (Order of PBOC [2008] No 1) published by the PBOC, and the rules published by NAFMII in relation to information disclosure, such as the Guidelines on Asset-Backed Notes by Non-Financial Enterprises (Announcement of NAFMII [2017] No 27), the Registration Documents and Forms for the Public Offerings of Debt Financing Instruments by Non-Financial Enterprises (2020) (Announcement of NAFMII [2020] No 5), the Rules for Information Disclosure on Debt Financing Instruments of Non-Financial Enterprises in the Interbank Bond Market (2021) and the Duration Information Disclosure Forms for Debt Financing Instruments by Non-Financial Enterprises (2021) (Announcement of NAFMII [2021] No 10).

Information disclosure regarding business asset securitisations shall primarily follow the Administrative Provisions on Asset Securitisation by the CSRC and the Disclosure Guidelines for the Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies (Announcement of CSRC [2014] No 49). Based on these provisions, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) have respectively published disclosure guidelines for different types of underlying assets, including the Disclosure Guidelines on Financial Lease Claim Asset-Backed Securities, the Disclosure Guidelines on Public-Private Partnership Project Asset-Backed Securities, the Disclosure Guidelines on Account Receivable Asset-Backed Securities and the Disclosure Guidelines on Infrastructure Asset-Backed Securities. In addition, in respect of periodic reports and interim reports, the SSE and SZSE respectively issued the Guidelines on the Content and Format of Periodic Report of Asset-Backed Securities and the Disclosure Guidelines on Interim Report of Asset-Backed Securities, which stipulate in detail the relevant periodic reporting and interim information disclosure requirements in a business asset securitisation.

There is no general disclosure law that applies to all securitisation products, but the rules that apply to each different product share some common aspects.

Laws and Regulations on Credit Risk Retention

Following the global financial crisis in 2008, the Notice of the People’s Bank of China, China Banking Regulatory Commission and Ministry of Finance on Further Expanding the Pilot Programme on Credit Asset Securitisation (Yin fa [2012] No 127) first began to require the originator to retain the lowest class of securities for no less than 5% of the aggregate volume of the securities issued, which requirement was criticised by the market for being too strict. Subsequently, the PBOC and CBRC made adjustments to the risk retention rules with the Announcement of PBOC and CBRC [2013] No 21, which is still in effect today. The adjusted rules require the originator to retain no less than 5% of the total issuance amount of the securitisation product, and in the meantime no less than 5% of the lowest class of securities. The originator may choose either horizontal retention or vertical retention, as long as it meets the minimum requirements.

As far as business asset securitisation under the supervision of the China Securities Regulatory Commission (CSRC) is concerned, no compulsory requirement on risk retention is stipulated in the general rules. However, since the end of 2017, the SSE and SZSE have issued guidelines on the confirmation of eligibility for the listing of asset-backed securities (ABS) backed by financial lease debt claims, account receivables of enterprises, etc, which clearly stipulate the requirement on risk retention. However, the applicable rules for different types of underlying assets are slightly different.

There are currently no compulsory requirements on risk retention regarding ABNs, but if the fund-raising party chooses to retain the risk then such arrangements will generally be disclosed in the offering documents.

Regulation and Enforcement

The risk retention rules for credit asset securitisation are formulated by the PBOC and the China Banking and Insurance Regulatory Commission (CBIRC). The risk retention rules for business asset securitisations are formulated by the SSE and SZSE, authorised by the CSRC. The issuing/listing supervisory authorities will generally review the risk retention arrangements. If the risk retention arrangements in the transaction documents do not comply with the compulsory requirements described above, the project will not be able to obtain the pre-issuance approval/registration or confirmation of listing.

Penalties for Non-compliance

Currently, there are no explicit rules relating to penalties for violations of the risk retention requirements, but the relevant regulatory authorities can take regulatory measures such as issuing an order to correct, a warning letter, and an order for public explanation, etc.

Requirements Regarding Periodic Reporting

In a credit asset securitisation, the trustee shall provide reports when the payments on the securities are made, and on an annual basis, for the life cycle of the securities. These reports must disclose the status of the asset pool in relation to the securities, and provide information on the principal and interest payments of each class of the securities, statistics on the asset pool, the reinvestment of the assets (if a revolving structure is involved), the disposal of loans in default, etc. The rating agencies shall also disclose the annual monitoring report to the investors, which must include information on the changes in the underlying asset pool and credit risk analysis.

Regarding ABNs, the issuer shall disclose the asset operation report before each payment on the notes, and throughout the life cycle of the notes. The annual asset operation report and semi-annual asset operation report must be disclosed prior to 30 April and 31 August of each year for notes issued publicly; for notes privately placed, the annual asset operation report must be disclosed prior to 30 April each year. The asset operation report must include the basic information of the notes, the contract performance status, the operation and overall condition of the asset pool, the payment of the returns and taxes on each class of notes, use of the issuance proceeds, risk retention, the reinvestment arrangement, etc. The rating agencies must disclose the annual monitoring report and intermittent monitoring report in a timely manner, and it must include the target products, the condition of the originator and underlying assets, and the analysis of cash flow and macro policy.

In a business asset securitisation, the scheme manager is required to disclose the income distribution report before each payment date of the securities to the qualified investor, throughout the life cycle of the ABS; it must also disclose the asset management report annually, including information on the operation status of the originator, the inflow and outflow of the funds in the special scheme, the payment of principal and interest on each class of securities, etc. The rating agency’s monitoring report must also be disclosed annually, including information on the change in the underlying assets, the efficiency of the revolving structure (if involved), the payment of the securities, the operation of cash flow, the result of the stress test, the credit analysis and ratings of the originator and other parties, etc.

The SSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities and the SZSE Guidelines on the Periodic Report Content and Format of Asset-Backed Securities stipulate the compilation of and disclosure requirements for the annual asset management report and annual fund custodian report, making information disclosure more targeted and effective for the purpose of helping investors to make better investment decisions and enhancing risk disclosure.

Regulators and Penalties for Non-compliance

The disclosure of trustee reports in credit asset securitisations and ABNs is subject to self-regulatory management by NAFMII and supervision by the PBOC. The disclosure of asset management reports and income distribution reports in business asset securitisations is subject to self-regulatory management by the securities exchanges, the Securities Association of China (SAC) and the Asset Management Association of China (AMAC), and to supervision by the CSRC and its local counterparts.

In relation to credit asset securitisations and ABNs in the Interbank Bond Market, NAFMII may impose self-regulatory sanctions on non-compliant information disclosers. These include public denouncements, orders to correct, public denouncements of the relevant responsible persons and orders for the relevant responsible persons to participate in mandatory training at NAFMII on information disclosure, etc. In serious cases, NAFMII may suspend the relevant business operation. If the non-compliant act is suspected of violating the laws and regulations, NAFMII shall hand the matter over to the relevant authorities, including the PBOC.

For misconduct in the disclosure of information regarding business asset securitisations, the CSRC and its local agencies may impose regulatory measures such as orders to correct, warning letters, orders for public explanation and orders to make periodic reports. It also has the power to impose administrative penalties such as confiscation of illegal gains, fines, suspension or revocation of the professional qualification of responsible persons, etc. AMAC may conduct regular or ad hoc on-site and off-site investigations into securities companies and fund management company subsidiaries, and may impose disciplinary sanctions such as written warnings, orders to correct, public condemnations, suspensions of record-filing and cancellation of membership, etc, depending on the seriousness of the case. In addition, according to the self-regulatory rules of the SSE and SZSE, the securities exchange may record disclosure violations in credit files, and may prudently accept and process the subsequent application or documents submitted by the relevant parties.

Rating services provided by rating agencies (RAs) are regulated by the regulatory authorities of the respective issuance/trading markets and the professional self-regulatory organisations (SROs). The substantive regulations may be divided into the following three categories:

• market entry regulations, including rules for the entrance of different markets and different products;
• requirements relating to business processes, methods and prevention of conflicts of interest; and
• requirements on the disclosure of rating reports.

The rules vary depending on the rated product and market concerned. The Chinese regulators have started to permit foreign RAs to provide rating services via their local branches or subsidiaries. In 2018, three rating agencies – Moody’s, Fitch and S&P – established Chinese subsidiaries, among which S&P Ratings (China) Co, Ltd. and Fitch (China) Bohua Credit Ratings Limited have been officially admitted to provide credit rating services in the Interbank Bond Market.

Regulators of RAs include the credit rating industry regulating authority and the credit rating business administration authorities. The former refers to the PBOC, which is responsible for the supervision of credit rating business across the country, and has the authority to formulate the market entry principles and fundamental rules; the latter refers to the National Development and Reform Commission, the Ministry of Finance and the CSRC, which regulate the credit rating business in their respective jurisdictions. RAs are also subject to the regulation of SROs in the corresponding markets. The regulators and SROs have the power to supervise and inspect the RAs providing rating services in the markets under their respective jurisdictions. If RAs are found to be violating any law, regulation or rule, then the regulators may, according to the respective rules, impose administrative sanctions such as fines, suspension of business, revocation of business approval, etc, or impose regulatory measures such as issuing a directive to correct, a warning letter, a directive to make public explanation, a directive to attend training, a directive to make regular reports, etc.

Applicable Capital and Liquidity Rules

The volume of risk-weighted assets will affect a commercial bank’s capital adequacy ratios, and the securitisations that a commercial bank engages in will affect the measurement of its risk-weighted assets. According to the Measures for Administration of Capital of Commercial Banks (Trial Implementation), if a financial institution incurs securitisation risk exposure as a result of its business of credit asset securitisation, then the institution shall set aside corresponding capital reserves according to the risk-weighted asset measurement rules.

In terms of liquidity risk regulatory indicators, engaging in securitisation or investing in ABS will affect a commercial bank’s liquidity coverage ratio or high-quality liquid asset adequacy ratio, net stable funding ratio and liquidity gap ratio. The Measures for Administration of Liquidity Risk of Commercial Banks do not include RMBS as high-quality liquid assets (HQLA).

According to the Administrative Measures for Risk Control Indicators of Securities Companies (2020 Revision) and the Provisions on the Calculation Standard for Risk Control Indicators of Securities Companies (2020), securities companies shall calculate the risk control indicators such as net capital, risk coverage ratio, capital leverage ratio, liquidity coverage ratio, net stable funding ratio, etc, in line with the principles of prudence and substance over form. Securities companies shall set aside capital reserves for ABS held according to the measurement standard provided by the CSRC; in measuring indicators such as liquidity coverage ratio and net stable funding ratio, different measurement factors shall be applied to ABS of different ratings.

One important regulatory indicator for insurance companies is the solvency ratio. According to the Administrative Provisions on the Solvency of Insurance Companies (2021 Revised), the comprehensive solvency ratio of an insurance company (ie, the ratio of the actual capital to the minimum capital) shall not be lower than 100%. The actual capital of an insurance company refers to the difference between the recognised assets and the recognised liabilities. In calculating recognised assets, different recognised values will be assigned to the credit ABS in which an insurance company has invested, depending on the outside ratings of the products.

Regulation of Capital for Securitisation

In respect of traditional securitisation transactions, the sponsor may deduct the securitised assets from the calculation of risk-weighted assets if:

• the material credit risk related to the transferred asset has been transferred to an independent third party;
• the sponsor does not retain actual or indirect control over the transferred assets;
• the sponsor does not bear payment obligations or responsibilities towards the investors of the ABS;
• the trust agreement and other legal documents related to the securitisation do not contain certain specific provisions (such as allowing the originator to change the assets in the asset pool, so as to enhance the weighted average quality of the asset pool); and
• the procedures for a clean-up call are compliant with the regulatory requirements.

As for the capital measurement of securitisations, Annex 9 of the Measures for Administration of Capital of Commercial Banks (Trial Implementation) – Rules on Risk Weighted Asset Measurement in Securitisation provides for two rating approaches: the standardised approach and the internal ratings-based approach.

Under the standard approach, if external ratings issued by qualified rating agencies evaluated by the commercial banks are used to determine the risk weight, then the risk weight of the securitisation risk exposure should be determined according to the conversion table of risk weights for ratings provided by the regulations. Taking the long-term ratings as an example, the corresponding risk weights of securitisation exposures are as follows.

• AAA to AA-: 20%.
• A+ to A-: 50%.
• BBB+ to BBB-: 100%.
• BB+ to BB-: 350%, but 1250% for sponsors.
• B+, below B+ or unrated: 1250%.

If a securitisation risk exposure is not rated, or if the rating is not admitted by the commercial bank as a reference for risk weight, then the following rules shall apply when measuring capital reserves:

• in regard to the risk exposure of the highest class of ABS, if the commercial bank is able to determine the average risk weight of the asset pool, then it may determine the risk weight according to the average risk weight of the asset pool;
• in regard to a qualified liquidity facility that complies with the regulation but has no qualified external rating, the risk weight will be the risk weight of the single exposure with the highest risk weight in the asset pool; and
• risk-weighted assets of other unrated securitisation risk exposures shall be calculated with the risk weight of 1250%.

Under the internal ratings-based approach of securitisation, there are two sub-categories: the ratings-based approach and the regulatory formula approach. For securitisation risk exposures that have external ratings or are unrated but whose ratings can be inferred, the ratings-based approach shall be used to measure the regulatory capital requirement. For securitisation risk exposures that have no external ratings and whose ratings cannot be inferred, the risk-weighted asset may be calculated under the regulatory formula approach or calibrated at 12.5 times the exposure. The risk weight for securitisation risk exposures calculated under the regulatory formula approach shall not be lower than 7%.

Derivatives such as interest rate swaps, currency swaps, foreign exchange swaps and credit risk mitigation instruments could be used in securitisation transactions, based on the needs of the particular transactions. Currently, there are no specific laws or regulations on the use of derivatives in securitisations; however, relevant parties (including the scheme manager, trustee and investors) shall comply with the general rules applicable to the trading of derivatives and to each type of specific derivatives.

In respect of credit derivatives, the available instruments in securitisation transactions are mainly credit risk mitigation agreements and credit risk mitigation warrants. The former is a kind of financial agreement between the buyer and seller of credit protection, while the latter is a kind of security of value created by the warrant issuer. The trading of such instruments is mainly subject to a series of rules published by NAFMII, the SAC, AMAC, the SSE and the SZSE. Due to various reasons (including transaction party qualifications and transaction cost, etc), they have only been utilised for a few products.

Since the interest rates of securitisation products are generally designed to be based on the interest rate types (fixed/floating) of the underlying assets to avoid interest rate mismatch risk as much as possible, interest rate swaps are also seldom used in current securitisation transactions. In addition, currency swaps may be used in cross-border securitisation transactions. A body of rules promulgated by the PBOC, the China Foreign Exchange Trade System (CFETS) and the National Interbank Funding Centre are applicable to interest rate swaps and foreign currency swaps.

The Interim Measures for Administration of Derivative Product Transactions of Banking Financial Institutions mainly impose requirements on financial institutions regulated by the CBIRC (such as commercial banks, trust companies and financial asset management companies), regarding their eligibility and licences for derivatives trading, risk management, product marketing and subsequent service, as well as sanctions for non-compliance. Securities companies and other financial institutions are also required to obtain approval from or file with the corresponding supervisory authorities. According to the PBOC’s applicable rules participants in the interbank market engaging in derivatives trading shall also be enrolled with NAFMII as members of the interbank market, and must execute the master agreement prepared and published by NAFMII.

The PBOC has the power to supervise the derivatives business in the national interbank market, while the State Administration of Foreign Exchange (SAFE), under the authorisation of the PBOC, supervises and manages the forward exchange market. Other than that, NAFMII is authorised by the PBOC to conduct self-regulatory administration over members of the interbank market and the transactions carried out therein; the CFETS provides services related to transactions carried out by members of the interbank market, and conducts day-to-day monitoring of transactions under the authorisation of the PBOC.

Banking financial institutions engaging in derivatives trading activities without approval will be subject to administrative sanctions including confiscation, fine, suspension of business and revocation of business licence, etc, by the CBIRC. For banking financial institutions that have failed to effectively implement derivatives trading risk management and internal control systems, the CBIRC has the power to suspend or revoke their licence to engage in derivative trading and impose monetary sanctions. Meanwhile, SROs including NAFMII and the CFETS have the power to impose self-regulatory sanctions, based on the seriousness of the violation.

Regulatory Mechanisms

China has not published any law or regulation dealing exclusively with the protection of investors in ABS products. Investor protection is provided for in the basic laws, including the Securities Law of the People’s Republic of China and the Securities Investment Fund Law of the People’s Republic of China, etc, as well as various securitisation regulations. These laws and regulations cover matters such as investor qualifications and limits on the number of investors (see 4.14 Entities Investing in Securitisation), due diligence, credit risk retention (see 4.2 General Disclosure Laws or Regulations) and market trading rules, as well as information disclosure (see 4.1 Specific Disclosure Laws or Regulations), the duration of standard operational responsibilities and many other aspects.

One of the mechanisms for investors’ protection is the meeting of security holders. The various securitisation regulations all require the issuing vehicle to establish the institution of the meeting of security holders as the governing organ of the issuing vehicle, to conduct decisions on important matters of the issuing vehicle. For ABN, the Procedure of the Meeting of Holders of the Non-Financial Enterprises Debt Financing Instruments in the Interbank Bond Market, specially promulgated by the NAFMII, shall apply.

Another mechanism for investor protection is the due diligence requirements for the relevant intermediaries, with the more detailed regulations being within the realm of business asset securitisations. In November 2014 the CSRC issued the Guidelines for Securities Companies and Subsidiaries of Fund Management Companies on Due Diligence for Asset Securitisation, specifying the scheme manager as the overall responsible party for due diligence, and proposing the relevant due diligence requirements. In June 2019, AMAC promulgated three detailed guidelines to specify the requirements for due diligence on the securitisation of financial leases, public-private partnership (PPP) projects and account receivables. In the ABN area, in January 2021, NAFMII published the Guidelines for Due Diligence on the Asset-Backed Notes by Non-Financial Enterprises (Trial Implementation).

Regulatory Authorities

Two kinds of authorities are in charge of the implementation of investor protection mechanisms.

Authorities that have administrative law enforcement power, such as the CBIRC, the PBOC and the CSRC, which may impose a number of administrative penalties or regulatory measures on the trustee or scheme manager for failure to fulfil the duties of honesty and diligence, including orders to rectify, warning letters, orders to make public statement, etc. Administrative penalties include fine, suspension of business for rectification or revocation of business licence.

Self-regulatory organisations, including mainly AMAC (for business asset securitisation), NAFMII (for ABNs and credit asset securitisation) and the securities exchanges (for business asset securitisations). AMAC, for example, according to the Measures for the Administration of the Record Filing of Asset-Backed Special Schemes published by it, may respond to behaviours that violate the self-regulatory rules by imposing written warnings, orders to correct, public condemnations, suspensions of filing, revocations of membership and/or other actions based on the type and seriousness of the violation.

Commercial banks as originators will be subject to the same regulatory measures on credit asset securitisations, along with other financial institutions under the supervision of the CBIRC; however, commercial banks investing in credit asset securitisation products are subject to certain specific rules, including the following:

• a commercial bank as the originator shall not invest in securitisation products originated by itself, except for the part retained by itself according to the credit risk retention rule;
• the wealth management products offered by a commercial bank shall not directly or indirectly invest in the subordinated class of ABS issued by itself;
• the wealth management products offered by a commercial bank to non-institutional investors shall not invest in any subordinated class of ABS, or any non-performing asset securitisation products;
• a single commercial bank’s holding in the ABS from a single issuance as a proportion of the total volume of the issuance, in principle, shall not exceed 40%; and
• a commercial bank’s wealth management product shall also abide by certain concentration limits when investing in ABS.

Additionally, according to the Measures for the Administration of the Large Exposures of Commercial Banks published by the CBIRC in 2018, in principle, a commercial bank’s investment in securitisation products shall be treated in a manner consistent with the “look-through approach”, according to which the ultimate obligor of the underlying assets of the securitisation products shall be identified as the bank’s counterparty and the risk exposure of the underlying assets will be counted towards the risk exposure of the ultimate obligor. Meanwhile, the same measures provide a number of safe harbours. For example, for underlying assets whose risk exposure is less than 0.15% of the tier 1 net capital of a commercial bank, if the commercial bank can prove that there is no deliberate division of underlying assets to avoid the look-through treatment or other regulatory arbitrage activities, then the investment can be exempted from the look-through approach, in which case the securitisation product itself shall be identified as the counterparty and deemed a non-interbank single client. The risk exposure of the underlying assets shall be counted towards the risk exposure of this client.

Securitisations in China mainly include credit asset securitisations, business asset securitisations (securitisations by securities companies and the subsidiaries of fund management companies) and ABNs. The regulations relating to SPVs are different for each type of securitisation. Among them, the Administrative Measures for the Securitisation of Credit Assets (Announcement of the PBOC and CBRC [2005] No 7) stipulates that the SPV for credit asset securitisations shall be an SPT. The Guidelines on Asset-Backed Notes by Non-Financial Enterprises (Announcement of the NAFMII [2017] No 27) stipulates that the SPV for ABNs shall be an SPT, a special purpose company or another special purpose vehicle approved by NAFMII. Whether in the case of credit asset securitisation or trust-type ABNs, the establishment and operation of the trust shall be governed by the provisions of the Trust Law. In regard to business asset securitisations, the Administrative Provisions on Asset Securitisation by the CSRC stipulates that the SPV shall be an asset-backed special scheme or other special purpose vehicle approved by the CSRC. Meanwhile, since the legal relationship between the originator and the scheme manager under the asset-backed special scheme is generally considered as a principal-agent relationship, the relevant provisions of the Civil Code are also applicable. Since the Company Law and the Bankruptcy Law do not contain any rules on special purpose companies (SPCs), the SPC has not been adopted in any securitisation transaction in China.

Non-financial companies can choose to issue ABNs in the Interbank Bond Market, or to conduct business asset securitisations on the securities exchanges. Their choices of market are mainly affected by the issuance cost and the efficiency of the approval/registration procedure. At least so far, neither the trust structure nor the asset-backed special scheme has any obvious advantages or disadvantages over the other in terms of tax treatment or bankruptcy remoteness.

SPVs are established for the purpose of securitisation; therefore, their activities are limited to the needs of carrying out securitisation business, which are generally agreed and stated in the transaction documents. At the same time, relevant laws or regulatory provisions stipulate the prohibited activities of the trustee or the manager. For example, in credit asset securitisation and ABN business, trust companies shall avoid misappropriating trust property for any non-trust purpose, promising the trust property will suffer no loss or guaranteeing a minimum return, or creating security rights over trust property. In business asset securitisation, the manager shall not embezzle or encroach on the assets of the special scheme, or provide guarantees with the assets of the special scheme.

Credit enhancement in the securitisation market can be divided into internal credit enhancement and external credit enhancement. The former derives its credit from the underlying assets and the structural design of the securitisation products, whereas the latter derives its credit from third-party institutions beyond the SPV.

Forms of internal credit enhancement include over-collateralisation, securities classification, cash collateral accounts, spread accounts (or cash reserve accounts), etc. Forms of external credit enhancement include shortfall payment commitments, third-party guarantees, external liquidity support, insurance, credit risk mitigation documents, etc. In this respect, securitisation products subject to different regulations and different structural considerations present different characteristics.

State-invested or state-controlled enterprises (referred to collectively as state-owned enterprises, or SOEs) constitute an important part of the market economy of China and therefore participate in all kinds of securitisation practices. However, SOEs in the Chinese market need to be differentiated from the government-sponsored entities (GSEs) – such as Ginnie Mae, Freddie Mac or Fannie Mae – in the US market. SOEs in the Chinese market participate in the securitisation business equally with other market participants, and are not entitled to special treatment or exemptions under the laws and regulations applicable to securitisation. The products issued by SOEs do not contain an explicit or implicit guaranty by the government.

Credit asset securitisation products and ABNs are traded in the Interbank Bond Market. Entities investing in such products must open an interbank market account, either on their own or by commissioning another institution to do so. At present, the main institutional investors in the Interbank Bond Market are as follows:

• multiple financial institutions;
• securities investment funds;
• enterprise annuities;
• national social security funds;
• insurance funds;
• asset management products issued by various financial institutions;
• private equity funds; and
• non-financial companies.

In addition, foreign investors can enter the Interbank Bond Market for investment through different means.

• Foreign investment entities in the Interbank Bond Market currently include:
1. foreign central banks or monetary authorities, sovereign wealth funds and international financial organisations;
2. qualified foreign investors, including qualified foreign institutional investors (QFII) and CNY-qualified foreign institutional investors (RQFII); and
3. legally established foreign financial institutions (such as commercial banks, insurance companies, securities companies, fund management companies), investment products issued by such financial institutions, and other medium and long-term institutional investors recognised by PBOC, such as pension funds, charity funds and endowment funds.
• The aforementioned foreign investors may conduct transactions and settlements in the Interbank Bond Market through settlement agents capable of carrying out international settlement business, may activate direct transaction service through settlement agents and may also conduct cash bond transactions via third-party platform with domestic market-making institutions by requesting a quote.
• Foreign investors compliant with the requirements of the PBOC can also invest in the Interbank Bond Market through the mechanism of arrangement that mutually connects the infrastructure institutions between Hong Kong and the mainland Chinese bond market (“Northbound Connect”).

The scope of qualified investors for the securities exchange market is basically the same as the Interbank Bond Market, except that foreign investors have a comparatively narrower access to the securities exchange market: they can only invest in such market after being recognised as a qualified foreign investor (QFII/RQFII) by the CSRC.

In addition to the restrictions on commercial banks’ investment in the securitisation products discussed in 4.9 Banks Securitising Financial Assets, the current regulatory restrictions on investments by different types of investors also include the following:

• a trustee in a credit asset securitisation may not use its own funds or trust funds to invest in the securities issued by it, except for the early redemption by the trustee in accordance with relevant regulations or contracts;
• a trust company may invest in ABS with its own funds or with trust funds whose settlor is not a natural person, but the investment balance of ABS under its owner’s equity shall not exceed 50% of its net assets;
• a single banking institution shall not purchase and hold a single securitisation product exceeding 40% of its issuance scale;
• for insurance institutions, the invested product credit rating shall not usually be lower than A (or the credit level equivalent to A assigned by domestic credit rating agencies) and the pooled credit assets are limited to loans classified as pass or special mention;
• in the case of pension funds, total investment in the securities as a percentage of the net asset shall not exceed 135%; and
• cash management-based products of commercial banks and wealth management companies shall not invest in ABS with credit rating lower than AA+, and they are also subject to certain concentration limits relating to the originator of ABS.

In credit asset securitisations, the transfer of assets while maintaining bankruptcy remoteness is achieved through the provisions of the “trust agreement”. The trust property is independent and will not be affected by the bankruptcy of the settlor and the trustee, which meets the requirement of risk insulation in securitisation. Meanwhile, the trust can achieve limited recourse – both the settlor’s and the trustee’s liabilities to the beneficiaries are limited to the trust property. The trust agreement is one of the core transaction documents in credit asset securitisation transactions, and its main provisions include the following:

• the scope, type, standard and status of the trust property;
• the delivery of the trust property;
• the conditions for the establishment of the trust;
• the redemption of ineligible assets;
• the rights perfection mechanism;
• the rights and obligations of the trust parties;
• the types and characteristics of the securities;

• the cash flow allocation order;
• the trust termination and liquidation;
• the organisational form and power of the security holders; and
• the liability for defaults and indemnities.

In business asset securitisations, the transfer of assets while maintaining bankruptcy remoteness is realised through the “asset transfer agreement”. This agreement is signed between the originator and the scheme manager of the special scheme. The originator transfers the ownership of the underlying assets to the scheme manager to ensure the true sale of the underlying assets, in order to achieve bankruptcy remoteness. The main contents of the asset transfer agreement include the following:

• the status of the underlying assets;
• the purchase and delivery methods of the underlying assets;
• the purchase price and payment;
• the redemption of the ineligible assets;
• the repurchase option of the asset pool;
• the covenants and warranties of the buyer and the seller;
• defaults and liabilities; and
• the effectiveness and termination of the agreements, etc.

“Asset warranties” refer to the representations and warranties on the underlying assets of the originator as of a specific date or time of the securitisation project (such as the cut-off date, the trust property delivery date/effective date of the special scheme or the revolving purchase date). The contents of asset warranties may differ based on the different types of underlying assets, but the contents of an asset warranties clause usually include the following:

• the underlying assets meet the eligibility criteria;
• all relevant information and information disclosure of the underlying assets is true, accurate and complete;
• the originator has sole and legally valid ownership of the underlying asset;
• the underlying assets are not encumbered by pledge or other forms of burdens, nor restrictions on transfer;
• the conditions precedent for the obligor’s obligations to perform on contracts concerning the underlying assets have been satisfied;
• the provisions of the contracts concerning the underlying assets are legally valid and binding on the relevant obligors, and after the transfer of the underlying assets, the trustee or the scheme manager may assert claims against the relevant obligors in accordance with the contracts concerning the underlying assets; and
• unless otherwise provided in the contracts concerning the underlying assets, the originator has not given out any option affecting the recoverability of the underlying assets.

If the underlying assets do not satisfy the requirements of the asset warranties at the time of entering the asset pool or transfer, then the underlying assets will be recognised as ineligible assets and must be redeemed by the transferor or originator in accordance with the terms of the transaction documents.

Currently, the prevailing right perfection measures include two kinds: (i) sending right perfection notice to the debtor and the guarantor, and (ii) conducting the transfer registration for the related mortgage or pledge. Since the notice and the transfer registration need to be conducted one by one, for the purposes of facilitating the collection of the assets and reducing the transaction costs, such measures are not normally required to be taken at the delivery of the underlying assets, and are only required upon the occurrence of right perfection events provided in the transaction documents.

Right perfection events usually include but are not limited to the situations in which:

• the servicer is terminated due to the occurrence of servicer termination events;
• the servicer loses a certain credit rating; and/or
• the originator loses a certain credit rating or solvency.

After the occurrence of a right perfection event, the asset seller or the settlor generally send right perfection notice to the debtor or the guarantor (referred to collectively as the obligor):

• informing the obligor of the transfer of the underlying assets or the establishment of the trust; and
• instructing the corresponding obligor to repay directly to the special scheme account or the trust account from the date of receipt of the right perfection notice.

If the underlying assets are secured by a mortgage or pledge, and the corresponding mortgage or pledge is required to be registered in accordance with PRC law, the asset seller or originator must conduct the transfer registration of the mortgage or pledge promptly upon the occurrence of a right perfection event, to ensure that the mortgage or pledge held by the scheme manager or the trustee will be valid against any bona fide third party.

In addition, based on new changes brought by the Civil Code and the Interpretation of the Security System (see 1.3 Transfer of Financial Assets), more securitisation transactions will consider registering the transfer of account receivables in the Registration and Public Notice System of PBOC’s Credit Reference Center. However, the actual time of conducting such registration (immediately after the transfer or after the occurrence of an agreed trigger event, that is, the right perfection event) may be decided based on the credit status of the settlor or the asset seller.

In order to ensure a smooth transaction, the originator in the transaction usually makes covenants as to the following matters in the transaction documents:

• the originator will continue to fulfil its obligations under the contracts concerning the underlying assets in a comprehensive, complete and timely manner, and not relinquish or delay the exercise of its rights;
• after the transfer of the underlying assets or the establishment of the trust, the underlying assets will not be transferred to or disposed of for the benefit of any third party, nor will any security interests be established on the underlying assets;
• any defects in assets or the transaction that might hinder the transfer of the underlying assets shall be remedied with due diligence to facilitate the smooth and lawful execution of the transaction;
• the contract concerning the underlying assets shall not be arbitrarily modified, nor shall any obligations or liabilities of the obligor on the underlying assets be waived, so that material adverse effects on the underlying assets are avoided;
• the originator will provide protection for the underlying assets and related interests to prevent such rights and interests from being infringed upon by third parties;
• the originator will not lose solvency in the foreseeable future due to the establishment of the special scheme or the trust; and
• the originator will not engage in any act that might result in the corresponding debtor exercising a right of set-off or right of defence on the underlying assets, and so on.

The originator will be deemed to be in default of the contract and liable for indemnities and other liabilities upon breach of any covenant.

The contents and conditions of the service provided by the servicer are stipulated in the servicing agreement and vary according to the types of the underlying assets. However, the main services can be summarised into the following categories:

• collecting the receivables on the underlying assets and transferring them to the SPV;
• managing the underlying assets and monitoring their conditions;
• risk management, recovery and disposal of the underlying assets;
• recording the status of the collection of funds in an accurate and timely manner;

• safekeeping the data and records concerning the underlying assets; and
• reporting the conditions of the asset pool regularly.

If the servicer fails to perform its obligations under the servicing agreement, or if any of its representations, warranties and commitments under the servicing agreement is materially false, inaccurate or misleading, the servicer is deemed to be in default and becomes liable for the breach of contract and shall continue to perform, take remedial measures and/or compensate for loss. Meanwhile, the servicer’s obligations regarding the underlying assets are generally limited to those agreed upon in the servicing agreement, which does not provide any guarantee or assurance for the collections.

In securitisation transactions, the events involving default mainly include (i) accelerated payment events; (ii) events of default; and (iii) termination events of the trustee/scheme manager, the servicer, the fund custodian, and other key securitisation service providers. Both accelerated payment events and events of default will result in changes of cash flow distribution order and early amortisation of securities, but accelerated payment events are generally less severe than events of default.

Accelerated payment events generally include:

• insolvency of the originator;
• occurrence of a servicer termination event;
• breach of the servicer’s main obligations under the transaction documents such as the transfer of collections;
• the accumulative default rate of the underlying assets exceeding a certain threshold; and
• failure to appoint a qualified successor within a certain period of time when it is necessary to replace the trustee or the servicer pursuant to the transaction documents.

Some accelerated payment events are not caused by default of participants in the transaction, but rather circumstances that may have a detrimental impact on the project.

Events of default generally include:

• failure to fully pay interest on the highest class of securities within the agreed time;
• failure to pay the full principal amount of the securities within the agreed time after the final maturity date; and
• failure to legally and effectively deliver collections to the trustee/scheme manager or to defend against the claims of third parties.

Termination events of the trustee/scheme manager, the servicer and the fund custodian usually include:

• loss of corresponding qualifications;
• material breach of contract – eg, violation of major obligations, representations or warranties;
• insolvency; or
• failure to maintain any required rating.

Upon occurrence of any aforementioned termination event, the meeting of security holders shall replace the corresponding institution.

Typical indemnification provisions in securitisations include indemnification for breach of contract by the servicer, the fund custodian and other securitisation service providers; and indemnification for trustee/scheme manager’s failure to manage the assets of the SPV in accordance with laws and transaction documents. The fundamental principle of indemnification is that if one party fails to perform its obligations as stipulated in the contract, or if one party’s representations or warranties under the contract are materially false or inaccurate, then that party is the default party, and the default party shall be liable to the non-breaching party and shall continue to perform, take remedial measures, and compensate for loss. Specifically, in terms of the originator and the trustee/scheme manager, it is generally specified in the transaction documents that the ABS are not liabilities of the originator or the trustee/scheme manager, and the investment institutions’ right of recourse is only limited to the trust property/assets of the special scheme; however, the liability for compensation of the originator or the trustee/scheme manager in the event of default under the transaction documents is not limited by the aforementioned provisions.

In credit asset securitisations, the issuers are the trustees of the SPTs. In business asset securitisations, the issuers are the managers of the asset-backed special schemes. For ABNs, it is necessary to distinguish between two transaction structures: in the first structure, the originator entrusts the underlying assets to the trustee to set up an SPT, and the SPT (represented by the trustee), acting as the issuing vehicle, issues the ABNs (this structure is often referred to as a “trust-type ABN”); in the second structure, the originator itself acts as the issuing entity and provides the underlying assets as security for the repayment of the ABNs (this structure is usually referred to as a “pledge-type ABN”).

In regard to credit asset securitisation, the issuer or the issuing vehicle manager shall be a trust company with the SPT trustee qualification approved by the CBIRC. For business asset securitisation, the issuer can be a securities company (or a subsidiary of a securities company), a subsidiary of a fund management company, or a trust company. For ABNs, if the issuing vehicle is an SPT, the trustee acting as the issuing vehicle manager shall be a trust company with the SPT trustee qualification approved by the CBIRC; if the issuing vehicle is the originator, the originator should be a non-financial enterprise, generally a corporation.

When the issuer is also the trustee or scheme manager, who stands in a trustee-settlor relationship or agent-principal relationship with the investors, and therefore owes fiduciary duties to investors, its basic responsibilities include:

• handling the approval and record-filing regarding the securities issuance;
• information disclosure during the issuance phase and life of the product;
• holding and managing asset pools;
• distributing SPV assets;
• convening the security holders meeting, if necessary;
• supervising other agencies providing services to the SPV; and
• taking measures to protect the interests of investors.

In the relevant Chinese securitisation regulations, the sponsor is generally the originator of the securitisation. In credit asset securitisations the sponsor is a financial institution that transfers the credit assets through the establishment of an SPT. In ABNs, the sponsor is a non-financial enterprise engaging the ABN business for financing purposes. In business asset securitisations, the relevant regulations do not use the concept of “sponsor”, but the entity that transfers the underlying assets to the special scheme is referred to as an “originator”; in practice, the concepts of “sponsor” and “originator” are often interchangeable.

In terms of credit asset securitisations, only financial institutions approved by the CBIRC can act as originators. These include commercial banks, policy banks, automobile finance companies, consumer finance companies, financial leasing companies, financial asset management companies and other financial institutions. In terms of business asset securitisations, although the relevant regulations do not put restrictions on the entity type of the originator, the majority of sponsors (originators) are non-financial enterprises. In terms of ABNs, the sponsor (originator) can only be non-financial enterprises.

The responsibilities of a sponsor mainly include providing underlying assets that meet the eligibility criteria, redeeming or replacing the ineligible underlying assets, co-ordinating and supporting the issuing vehicle manager and related intermediaries in performing their duties, and providing relevant disclosure information to the issuing vehicle manager and related intermediaries in a timely manner, ensuring that the information provided is true, accurate and complete. If the cash flow of the underlying assets depends on the continued operation of the sponsor – a scenario which mainly concerns the securitisation of future account receivables – then the sponsor should also maintain normal production and operation throughout the life cycle of the securitisation, and provide reasonable support to and necessary protection for the generation and transfer of cash flow of the underlying assets.

An underwriter or placement agent is the organisation responsible for the sale of the ABS. Its general duties include the promotion and sale of the ABS, organisation of the underwriting syndicate, presiding or participating in the bookbuilding or bidding procedure of issuance of the securities, collection of issuance proceeds of the securities, etc. The lead underwriter normally acts as the transaction arranger or financial adviser, taking the lead in the design of the transaction structure, the co-ordination of the progress of the project participants, filing with the regulatory authorities and other matters.

In a pledge-type ABN transaction where the originator itself acts as the issuer and the underlying assets are pledged to the noteholders, for the purpose of completing pledge registration and protecting the rights of the investors, the lead underwriter will generally be designated as the bond agent, whose duties generally include the following:

• supervising the issuer’s use of issuance proceeds;
• completing mortgage or pledge registration and holding the rights thereof on behalf of the investors;
• monitoring the underlying assets;
• supervising the contract performance by the issuer;
• convening the meeting of the noteholders, when necessary, to resolve important matters and take actions to protect the interests of the creditors; and
• disclosing the information regarding the issuer’s performance of contracts and the status of the underlying assets to the noteholders.

The underwriters are generally domestic financial institutions that meet certain requirements on registered capital, sales capacity, etc, and are mainly banks and securities companies, as well as foreign-owned banks registered in China. Regarding ABN projects, in addition to banks and securities firms, trust companies can also act as underwriters of the notes.

For securitisations in China, servicers are generally also the originators of the underlying assets, or their affiliates. Certain kinds of securitisation (such as commercial mortgage-backed securities – CMBS) backed by real properties or incomes thereof may also use third-party professional property management institutions as servicers. The general responsibilities of the servicers include collecting the cash flow of the underlying assets and transferring it to the SPV, managing the asset pool, safeguarding the underlying assets, including legal documents and related records thereof, providing regular service reports to the SPV manager, and other duties as stipulated in the servicing agreement.

Investors in ABS generally do not actively participate in the management of the SPV, but passively collect the principal and returns on the ABS. The investors can only participate in the security holders’ meeting and vote in situations where the investors’ rights might be affected. The main obligations and responsibilities of the investors include paying the subscription price in accordance with the terms of the subscription agreement, complying with the trading limits set in the relevant laws, regulations and transaction documents, complying with the provisions on the exercise of rights, and maintaining confidentiality regarding trade secrets. The business types of investor are introduced under 4.14 Entities Investing in Securitisation.

As the character of a trustee often overlaps with an issuer, the entity type and main obligations of the trustees are described in 6.1 Issuers.

According to the Notice of the People’s Bank of China, China Banking Regulatory Commission and Ministry of Finance on Further Expanding the Pilot Programme on Credit Asset Securitisation (Yin fa [2012] No 127), the piloting of re-securitisation and synthetic securitisation is currently explicitly prohibited. In the fields of business asset securitisation and ABNs, although there is no explicit prohibition, re-securitisation and synthetic securitisation are not allowed in practice, which is in line with the goal of serving the real economy.

Regulatory authorities require that the underlying assets of a credit asset securitisation must be “credit assets”. The common underlying assets of credit asset securitisations include corporate loans, small and micro-enterprise loans, personal residential mortgage loans, personal consumer loans, auto loans, credit card assets, financial leasing debt claims of the financial institution and non-performing loans.

Common underlying assets of business asset securitisations include petty loans, financial lease debt claims of non-financial institutions, rights of returns related to infrastructure and public utilities, various kinds of account receivables, commercial mortgage loans, lending fund claims, trust beneficial rights, intellectual property, etc. According to the regulatory Q & A issued by the CSRC in April 2019, future operating receivables such as movie tickets, property management fees and park admission vouchers without a chartered or exclusive nature are no longer allowed to be the source of cash flow for the underlying assets of asset securitisation products.

The scope of underlying assets of ABNs is similar to that of business asset securitisations. However, whether future account receivables and rights to the income of certain assets that are not independent can be recognised as trust property is controversial under the law. For this kind of underlying asset, it may be more suitable to adopt the structure of pledge-type ABNs, without employing a trust structure.

Credit Asset Securitisation

The basic transaction structure of a credit asset securitisation has been clearly stipulated in the Administrative Measures for the Securitisation of Credit Assets, and is therefore relatively fixed, as follows:

• the originator, as the settlor, entrusts its legally owned credit assets (underlying assets) as trust property to the trust company as trustee, in order to establish an SPT;
• the trustee (as issuer) issues ABS representing the beneficial rights of such trust to the investors, and pays the principal, interest or income of securities from the cash flow generated by the trust property;
• the lead underwriter shall assemble an underwriter syndicate to underwrite the securities;
• the trustee engages a servicer (usually the originator) to provide daily collection, management and other services for underlying assets;
• the trustee engages a fund custodian to provide the fund custody services in respect of the collections generated by the trust property; and
• the trustee engages the China Central Depository & Clearing Co, Ltd. as securities depository and paying agent for the securities, to be responsible for the registration and depository of securities, the payment of the principal and interest on the securities.

The laws and regulations that have a material effect on the transaction structure of credit asset securitisations include the Civil Code, the Trust Law, the Administrative Measures for the Securitisation of Credit Assets, the Measures for Supervising and Administrating the Pilot Securitisation of Credit Assets of Financial Institutions (Order of CBRC [2005] No 3), and the Announcement on Further Regulating the Risk Retention of Originator in Credit Asset Securitisation (Announcement of the PBOC and CBRC [2013] No 21).

Business Asset Securitisation

The basic transaction structure for a business asset securitisation is as follows:

• the subscribers sign subscription agreements with the scheme manager and make the subscription payments to the scheme manager to set up the asset-backed special scheme and obtain the securities;
• the scheme manager (henceforth representing the special scheme) purchases the underlying assets from the originator with the special scheme fund by signing an underlying asset purchasing agreement with the originator;
• the scheme manager engages a servicer to be responsible for the recovery and collection of underlying assets and the disposition of defaulted assets and other management works of underlying assets, by signing a servicing agreement with the servicer (usually the originator);
• the scheme manager engages a fund custodian bank to safeguard the special scheme account opened in the name of the scheme manager, and engages a fund supervisory bank to supervise the collection account of the servicer; and
• the scheme manager engages China Securities Depository and Clearing Corporation Limited (CSDC) for the registration and depository of the securities and the payments of principal and interest on the securities.

The laws and regulations that have a material effect on the transaction structure of business asset securitisations include the Civil Code, the Security Law of the People’s Republic of China, the Securities Investment Fund Law of the People’s Republic of China, and the Administrative Provisions on Asset Securitisation by the CSRC.

Asset-Backed Notes

There are two transaction structures for ABNs: trust-type ABNs and pledge-type ABNs. Since the latter structure is rarely used today, only the first transaction structure is introduced below:

• the originator directly entrusts the underlying assets to a trust company (as trustee and issuing vehicle manager) to establish an SPT;
• the SPT (represented by the trustee), as the issuing vehicle, issues the ABNs in the Interbank Bond Market;
• the issuance of ABNs is conducted by an underwriting syndicate assembled by the lead underwriter;
• the trustee pays the principal and interest of the notes with the cash flow generated from the trust property;
• the trustee engages a servicer to provide management and services for the daily collections of underlying assets, and engages a funds custodian to provide fund custody services;
• Shanghai Clearing House, as the notes depository, provides the registration and depository services for the ABNs and agency services in relation to the payments on the notes.

The laws and regulations that have a material effect on the transaction structures of ABNs include the Civil Code, the Trust Law, the Measures for Administration of Debt Financing Instruments Issued by Non-Financial Enterprises in the Interbank Bond Market (Order of PBOC [2008] No 1), and Guidelines for Asset-Backed Notes by Non-Financial Enterprises.