Article

by Daniel Laprès

Currently, the People's Republic of China (PRC) controls some 25 per cent of the world's total stock of international reserves. The Chinese currency is not only officially convertible on the current account, but also, to a large extent, on the capital account. Also, Chinese financial institutions are positioning themselves among the leaders in the global financial sector, with two of their number already ranking among the world's top ten largest corporations in terms of market capitalization. Accordingly, the quality of their governance has become a universal concern.

While the isolation of its capital markets buffered the impact of the 1997 Asian financial crisis on financial conditions within the PRC, the country's current openness to financial flows entails the risk of contagious spread of incidents from Chinese financial markets to the rest of the world, as has already been observed during the mini-crash of the Chinese stock markets in 2007. While some 70 per cent of economic activity is now under private control, almost all financial intermediaries and service providers are state-controlled, as are the vast majority of companies listed on the stock exchanges.

The Chinese regulatory model

Financial sector reform began in the PRC in 1979 when the commercial functions of the People's Bank of China (PBOC) were spun off among four State-owned commercial banks (SOBCs). Gradually, the PBOC's scope of authority was diminished over securities-related and insurance-related activities, and it was supplanted by sub-sector-specific regulatory authorities. In the meantime, a variety of financial institutions was spawned.

The regulatory model adopted for the financial sector has been characterized by the cloistering of banking, capital markets and insurance activities. Operators in one sub-sector do not carry on activities in the others, and institutions in one sub-sector remain independent of those in others.

But as in other countries, the financial montages intended to circumvent the walls between the sub-sectors render them ever less effective, at the risk of generating latent and unregulated systemic risks. The conflicts of jurisdiction and the risks of holes in its application that the segregated model generates have required cooperation between the regulatory authorities. Since January 2008, on a trial basis, the authorities have allowed the formation of globalized financial institutions spanning the full breadth of the financial services market and capable of competing head-to-head with the major financial institutions overseas. China Life, for example, is reported to have applied for authorization to invest in the insurance business.

Lead regulatory authorities

Currently, each sub-sector has been subjected to a specific lead regulatory authority:

- for banking activities, the PBOC and more recently the China Banking Regulatory Commission (CBRC),

- for capital markets, the China Securities Regulatory Commission (CSRC) and

- for insurance-related activities, the China Insurance Regulatory Commission (CIRC).

But in one or another context, a range of authorities have issued norms impacting upon the financial sector. Some of these include the State Council, the Ministry of Finance, the Ministry of Justice, the State-owned Assets Supervision and Administration Commission (SASAC), the National Development and Reform Commission (NDRC, formerly the State Planning Commission), the State Commission for Restructuring the Economic System and last, but not least, the Chinese courts and arbitral organizations.

Other countries also experience jurisdictional overlaps and conflicts among authorities concerned with securities regulation, but the nature of the development process in China has created unusual uncertainty. This is because progress has often proceeded through official tolerance of presumably impermissible activities until they are either regulated or prohibited by whichever of the potentially competent authorities decides to take the initiative. Often, the first authority to act has often been situated at the lowest echelon.

Banking

Since 1986, the PBOC has been the organ through which the state has managed monetary policy, accredited banks, urban and rural credit cooperatives and establishments of foreign banks. Since 1995, it has been transformed into a central bank along the lines familiar overseas. A governor nominated by the State Council and confirmed by the National People's Congress (NPC) administers the PBOC.

In April 2003, the State Council established the CBRC to assume some of the supervisory and regulatory functions then performed by the PBOC. The CBRC supervises nearly all of the 34,000 banking and non-banking financial legal entities, including trust and investment companies, group finance companies, automobile financing companies, financial leasing companies and foreign financial institutions.

The CBRC has the authority to carry out on-site inspections; however, due to its limited resources these inspections are rather infrequent and are reserved for institutions subject to high risks, those with problems of vital importance or which have acted illegally, such as by the issue of false disclosures of financial information or experiencing severe deficiencies in risk management or internal controls. The CBRC has set up a rating system and an early warning mechanism on the basis of which the frequency and the scope of on-site inspections and other supervisory actions are determined.

The CBRC has the right to impose administrative sanctions for any acts committed in violation of laws and regulations within its jurisdiction, including warnings, fines, confiscation of illegal earnings, orders to stop production and business, revocation of financial permits and authorizations and cancellation of the qualifications of directors and senior managerial personnel. In serious cases, where a crime has been committed, the CBRC denounces the conduct to the procuratorate. The CBRC may assume control of a commercial bank "whenever a crisis of confidence has or is likely to have a serious effect on the interests of its depositors".

Capital markets

The authorities have proclaimed an attachment to separating the state's ownership role from the management of SOEs, as well as to separating the power of ownership from political direction.

An unusual feature of the Chinese regulatory framework is that the authorities decide whether it is opportune for any company's securities to be offered to the public. A distinctive feature of Chinese capital markets is that approximately 65 per cent of the shares of the listed companies are owned by the state or its entities and are not traded. The float on the Chinese stock exchanges represents a small fraction of total savings, but almost all trading on the exchanges is carried on for the account of individuals.

From the outset, the authorities have innovated methods of erecting walls between domestic and foreign markets while at the same time poking holes in them, for instance by differentiating shares of Chinese companies among those issued in China (whether to circulate exclusively at least originally among Chinese residents - A shares, on the one hand, or exclusively among nonresidents, B shares on the other) and those issued abroad (so called H shares when issued in Hong Kong, S shares if issued in Singapore, etc).

When financial instruments first appeared in post-1978 China, the PBOC assumed control over their issuance to, and circulation among, the public. The CSRC was constituted in 1992. It oversees activities on the securities and futures markets as well as the issue to, and the trading among, the public of securities. Its jurisdiction extends to stock exchanges, stock and futures brokerages, securities registration and clearance institutions, securities investment funds, securities investment consulting organizations, credit-rating institutions, and those law firms, public accounting firms and asset appraisal organizations involved in the securities business. The CSRC investigates potential violations of any law or administrative regulation relating to the securities market and may apply administrative sanctions. In carrying out its duties, the CSRC is entitled to enter sites of illegal activities and to conduct investigations, as well as to freeze assets subject to judicial approval. Where the CSRC suspects the commission of criminal offences, the case is referred to the judicial authorities.

The stock exchanges determine trading and clearing conditions and settle trading disputes. The Securities Association of China (SAC) was constituted on 28 August 1991 and the China Futures Association on 29 December 2000 to provide self-regulation in their respective fields.

Insurance

In 1998, the China Insurance Regulatory Commission (CIRC) was established to regulate the insurance industry. Its jurisdiction extends to insurance companies and their branches, groups, holding companies, asset management companies, representative offices of overseas insurance institutions, insurance intermediaries (agents, brokers, appraisers, etc.) and their branches, guarantee funds, overseas insurance institutions of domestic insurance and non-insurance entities. Its subject matter jurisdiction covers transformations of insurance institutions, their bankruptcies and liquidations, approvals of their senior managerial personnel, approving insurance clauses, investigating violations of insurance laws and regulations and imposing administrative sanctions.

In March 2001, the China Insurance Trade Association was established to provide selfregulation within the insurance industry.

Conclusion

Since the inception of the reform movement in 1978 and most especially in connection with its entry into the WTO in 2001, China has established a modern regulatory framework for the financial industry.

Though the PRC ranks low on international ratings for governance, the authorities have shown the determination to combat financial criminality within and outside its territory. In particular, on 27 October 2005, it ratified the United Nations Convention against Corruption. The offence of money laundering was introduced into Chinese law with the adoption of the new Criminal Law in 1997. The law applies to the fruits of tax evasion, crimes of disrupting the public as regards financial administration, crimes of financial fraud, embezzlement and bribery.

Daniel Arthur Laprès is an Avocat à la Cour d'Appel de Paris, a barrister and solicitor, Nova Scotia, Canada, and a Professeur de droit et de finance. This article is adapted from his book, Business Law in China (2008 revision) available from the ICC bookstore (www.iccbooks.com). Mr Laprès' e-mail is daniel@lapres.net.