The Rise of Asset Backed Securities Market in
The Rise of Asset Backed Securities Market in China CAO Honghui Ph. D. Director, Financial Market Division, Institute of Finance & Banking(IFB), Chinese Academy of Social Sciences (CASS) Shanghai, China, November 7 -9, 2005
Table of Content § I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems § II. Various Experiments & Development of Asset-backed Securities in China § III. Key Impediments of Developing Asset-backed Securities in China § IV. Conclusions 2022/1/15 2
I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems § A. Sustaining and Stabilizing China’s Economic Growth by Supporting Infrastructure Construction, Housing Financing and other Consumption § A Big drive behind housing development, which is necessary for sustainable rapid economic growth. Rapid growth in many districts is conducive to real estate. § Enhancing stability of China’s financial system by disposing several trillions of NPL. § Improving efficiency of financial management and control in the financial institutions esp. banking sector. 2022/1/15 3
I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems § B. Facilitating Improvement of Diversifying Financial Risks in China’s Capital Market § Diversifying financial risks § Improving financial structure and enhancing financial innovation § Promoting bond market development, pushing forward interest rates marketization 2022/1/15 4
I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems § C. Promoting China’s Commercial Bank Reform, Improving Capital Structure of Financial Institutions § Improving capital structure and liquidity of financial institutions, enhancing banking efficiency § Improving bank assets/liabilities management § Diversifying banking risks and strengthening bank risk management § Expanding bank sources of income and enhancing overall competitiveness 2022/1/15 5
I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems D. Market Supply and Demand Analysis of Asset-backed Securities in China ♦ Market Supply of Asset-backed Securities Market § Mortgaged housing loans § Credit loans § Non-performing loans § Infrastructures § Rented Equipments 2022/1/15 6
I. The Role of Asset-backed Securities Market in China’s Economy and Financial Systems ♦ Market Demand of Asset-backed Securities Bonds and securities obtain not more than 20% in the financial assets of residents in the mainland (Table) n Insurance allowance n Mutual fund n Pension fund n Commercial bank n Securities firm n Corporation n Other investors 2022/1/15 7
Table Ratios of Residents’ Financial Assets Year Currenc y Savings Bonds Securities Insurance allowance (%) Total 1992 19. 3 60. 6 15. 1 3. 9 1. 2 100 1993 22. 4 66. 6 5. 9 3. 9 1. 2 100 1994 13. 7 79. 4 5. 6 0. 5 0. 7 100 1995 5. 0 87. 1 6. 6 0. 3 1. 0 100 1996 7. 1 77. 5 11. 5 2. 8 1. 2 100 1997 10. 9 67. 1 11. 9 7. 7 2. 5 100 2022/1/15 8
II. Various Experiments & Development of Asset-backed Securities in China § A. Overview on the Offshore Exploration ♦ Case One: Zhuhai Highway ♦ The first standard securitization exploration in the mainland, Zhuhai Highway Bond issuance in international bond market in 1996, which was supported by the cash flow of the Registration Fee from the local vehicles and the fee from the passing-by vehicles of other places. ♦ The 0. 2 billion US dollars securitization was operated through a SPV in Cayman isle both including priority bond and sub-bond. But its cost was much higher than the domestic interest rates since 1996. §
II. Various Experiments & Development of Asset-backed Securities in China § Case Two: North America Co. , COTC ♦ The floating interest bill issued in 1997 by China Ocean Traffic Company and sustained by the shipping income in North America, which raised 0. 3 billion us dollars capital. Case Three: CICG The most successful offshore securitization case, China International Containers Group (CICG), which issued several circular asset-backed commercial paper (ABCP) not more than 80 millions US dollars in 2003. ♦ 2022/1/15 10
II. Various Experiments & Development of Asset-backed Securities in China § B. Overview on Various Experiments of Sub-securitization in the Mainland China § Case One: NPL Disposal of Huarong AMC ♦ The asset pond of Huarong AMC composed of 13. 25 billions Yuan, related to 256 enterprises in 22 provinces. In 2003, it sold its right of income of all entrusts to the investors. And the assets were entrusted to CITICS Trust Company as property entrust. Meanwhile, the assets were also entrusted to Huarong AMC to manage. ♦ Comments: ♦ Total cost 125 millions Yuan, higher than usual; ♦ Lack of liquidity, transaction structure based on the contract instead of securities in the capital market; 2022/1/15 11
II. Various Experiments & Development of Asset-backed Securities in China 2022/1/15 12
II. Various Experiments & Development of Asset-backed Securities in China ♦ No information disclosure regulations; ♦ Not real sale, for Huarong AMC is both originator and entrusted manager; CITICS Trust plays as SPV; ♦ Potential credit risk that the investors require to repurchase their rights of income, which might result in the systematic risk of the structured financing for there has no clear statement in the existing regulations as Trust Law. ♦ More like sub-securities rather than standardized operation. ♦ Anyhow, it provides the method to dispose RMB 1. 4 trn of NPLs held by the four AMCs and other significant volume of NPLs in the banking sector and to support them to restructure the balance sheets. 2022/1/15 13
II. Various Experiments & Development of Asset-backed Securities in China n n n Case Two: Ninbo Branch, ICBC NPL Disposal ♦ Ningbo Branch, (ICBC) transferred 2. 6 billions Yuan NPLs by way of SPT set up by Zhongcheng Trust Company in 2004. Its credit was enhanced by way of delaminating the cash flow inside. Within the present legal system, SPT seems to be more available. ♦ Comments : ♦ The same limitations in the transaction structure for the incomplete risk isolation and the low ratio of cash reclaiming, which was only 7. 69%, relatively less than Huarong AMC; ♦ The transaction structure more reasonable for the risks could be shared by the market players. ♦ Various experiments in securitization in China would help both the market participants and the regulators to understand details about securitization such as the choice of asset, corporation management and the recognition on the credit. ♦ By way of SPT, they avoid the impediment, though it differs from the real securitization, and they are just sold to institutional investors without secondary market to exchange. 2022/1/15 14
II. Various Experiments & Development of Asset-backed Securities in China n n n C. New Trial Experiment of Asset-backed Securities After State Council Approved the Experiment of CBC & CDB ♦ State Council approved the trial on March 22, 2005. ♦ PBC takes the leadership of the coordinate group organized by 10 departments including SDRC, MOF, MLSS, MC, SBT, CBRC, CSRC, CIRC. etc. ♦ More and more Measures involve applying process, accounting, information disclosure and transaction to be taken since then. ♦ CDB & CBC expected to issue at the end of this month, and not later than this year. ♦ Purely real sale for the first time in the mainland China. ♦ Case One: China Unicom CDMA Network In September 2005, China Unicom issued 3. 2 billion Yuan based on its CDMA network tenancy income as originators in Shanghai Stock Exchange, with CIFC as the book-keeper and the Bank of China as warrantor. 2022/1/15 15
II. Various Experiments & Development of Asset-backed Securities in China ♦ Comments: § ♦ The corporations with large fixed cash flow through the equipments and infrastructure intention to issue securities as originators to increase financing capability. ♦ The assets to be securitized expand from credit loans esp. from NPLs to noncredit assets which establish a large demand of the market. ♦ It is developed by the market itself with the support of CSRC instead of State Council. The investors are mostly the institutional investors in the stock market. ♦ Experiment of CDB & CBC ♦ Case Two: China Development Bank (CDB) ♦ Asset pond related to 12 industries, 19 provincial regions, 36 debtors; ♦ Securities divided into three classes as priority A, priority B and hypo-class whose average terms are 0. 62 year, 1. 29 year and 1. 72 year respectively, whose credit rating are AAA, A and no rating temporarily; 2022/1/15 16
II. Various Experiments & Development of Asset-backed Securities in China Case Three: China Bank of Construction (CBC) ♦ 10 billion yuan Loans of Shanghai, Jiangsu and Fujian Branch. ♦ Both issuance of MBS and ABS. ♦ Comments ♦ Over 1. 71 trillions housing mortgaged loans may result in large potential risks, which impacts banking system reform and stability. ♦ Both CDB and CBC carry out real sale and bankruptcy isolation. 2022/1/15 17
II. Various Experiments & Development of Asset-backed Securities in China ♦ Small and medium sized financial institutions could improve its liquidity by selling their credit loans. ♦ But most commercial banks especially “the big four” hold most of the loans in the mainland. CBC always prefers to the securitization development mode inside the balance sheet, unwilling to transfer its loans especially the residential mortgage loans to investors because it wants to appreciate the income of the high quality loans. ♦ Most of its branches of CBC do not have enough momentum to sell these assets at present because CBC and other three state-owned commercial banks possess so large a net of branches that the deposits are abundant , while CDB does not take advantage abundant deposits from the net correspondingly. 2022/1/15 18
III. Key Impediments of Developing Asset-backed Securities in China §A. Regulatory Framework and Market Fragmentation ♦ The approval process for the issuance and trading of bonds is fragmented by different regulators who try to establish guidelines on ABS approval procedures, approval criteria and timeline under the direction of coordinate group according to their own understanding; ♦ The regulatory framework results in the market fragmentation, limited investor base and innovation intention of the market. 2022/1/15 19
III. Key Impediments of Developing Asset-backed Securities in China § B. Legal Impediments and Solutions: from the Point View of Different Laws Ø Trust Law of the PRC Ø Corporation Law of the PRC Ø Commercial Banking Law of the PRC Ø Guarantee Law of the PRC Ø Contract Law of the PRC Ø Bankruptcy Law of the PRC Ø Regulation on Credit Loan Securitization of the PRC Ø Regulation on Administration of Corporate Bonds 2022/1/15 20
III. Key Impediments of Developing Asset-backed Securities in China Ø Trust Law of the PRC ♦ By using SPT, risk segregation is incomplete. It depends on the number of beneficiaries. ♦ In the short term, it should make at least more than two beneficiaries in a trust structure to segregate the risk between originator and investors. But in the long period, the risk should be completely segregated from the trust property between originator and trustee and investors. Ø Corporation Law of the PRC ♦ SPC could not be settled down for the sake of the limitations of a company, which should operate as a real enterprise in mainland. 2022/1/15 21
III. Key Impediments of Developing Ass-et-backed Securities in China Ø Commercial Banking Law of the PRC ♦ Commercial banks within the mainland cannot invest in non-banking financial institutions and enterprises, which limits the mode of SPC. Ø Bankruptcy Law of the PRC ♦ This law restricts internal credit enhancement indirectly. When the originator enters into the bankruptcy process, the sold mortgaged assets surpassing the assets should be listed to liquidate as bankrupted asset. ♦ SPV actually equals to other debtors without preference recourse, which makes it impossible to enhance internal credit by surpassed mortgage. 2022/1/15 22
III. Key Impediments of Developing Asset-backed Securities in China C. Taxation: the Key Impediments of Present Experiment ♦ Up to present, there is no guidance on taxation of various elements of ABS transaction. Related guidance has been drafted but needs to signed by MOF & National Bureau of Taxation (NBT). ♦ It is vital to provide for tax neutrality. But NBT refuses to provide specific tax benefits to securitization transactions. ♦ Uncertainties respecting taxation would reduce the confidence in structuring securitization transactions because current taxation rules may make most transactions uneconomic. 2022/1/15 23
III. Key Impediments of Developing Asset-backed Securities in China ♦ Taxation for Originators of Securitization ♦ The business taxation, income taxation still uncertain, while stamp duty is potentially prohibitive because of different understanding of NBT; ♦ Income could only be confirmed in real sale, not be confirmed in guaranteed financing; ♦ If the asset is transferred to foreign investors, there would be 20% income taxation, except avoiding double taxation and arranging structured financing. ♦ Taxation for SPV of Securitization ♦ The key argument is whether SPV also plays the role of ratepaying entity. ♦ There is no clear statement in Trust Law whether various entrust instruments play the same ratepaying entity. 2022/1/15 24
III. Key Impediments of Developing Asset-backed Securities in China ♦ Taxation for Investors of Securitization 1 ♦ Whether investors’ income pay income tax and prepay tax; ♦ Whether investors’ traction pay stamp deputy; D. Misunderstanding of National Bureau of Taxation n n ♦ Misunderstanding the essence of SPV and the principle of taxation neutrality ♦ Refuses to provide benefits for the securitization transaction. 2022/1/15 25
III. Key Impediments of Developing Asset-backed Securities in China E. Other Impediments ♦ Credit Information and Internal Credit Management ♦ Credit Rating Agencies ♦ Credit Guarantee Markets ♦ Market Infrastructure Impediments ♦ Development of Interests Liberalization 2022/1/15 26
IV. Conclusion n n ♦ The approved experiment of Securitization does not mean the impediments have been eliminated. ♦ The target of the coordinated work group is to establish legal system for development of securitization instead of individual cases. But more important is to focus on the enactment of ABS Act. ♦ As for the qualification cognizance and the weight of risks, CSRC has not made definite yet. It needs to coordinate with PBC more efficiently. 2022/1/15 27
IV. Conclusion ♦ Quite necessary to set up government supported agency to issue securities, which is like Ginnie Mae, Fannie Mae, Freddie Mac in the US. or like The Hong Kong Mortgage Corporation Limited in Hon. Kong. ♦ To develop regulations on registration, accounting system, the information disclosure, and taxation of ABS. 2022/1/15 28
Thank you for your attention Email: davidcao 2002@163. com Tel: 86 -1085195343 Fax: 86 -10 -65138307 IFB, CASS, Beijing, China 2022/1/15 29
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