Financial Regulation of Banking Derivatives, Securitisations and Trusts in China

Derivatives are an interesting and exciting financial instrument that the Financial Times described in March 1995 as being like a razor,1 the law on financial derivatives is by turns a progressive and complex topic. This book analyzes the relationship between the financial derivatives regulation, Basel II, and trusts and securitizations, and offers an additional complication by looking into regulations in China. Although it analyzes the regulations that were issued by the China Banking Regulatory Commission, the interpretation of these regulations is from an English Law perspective. Since 2003, the laws in China have evolved rapidly in this area. The Provisional Administrative Rules Governing Derivatives Activities of Financial Institutions 2004 received further amendments in December 2006, thus strengthening the risk management of derivatives activities. This illustrates that the derivatives regulations are still evolving, and demonstrates that the existing legal principles on the financial derivatives in China have been moving rapidly in line with international practice. More importantly, the legal treatment of derivatives overlaps with a wide range of other established legal subjects, such as contract, trust and securitization regulations. Therefore, the book attempts to explain the main features of the subjects and conflicts in China albeit from a comparative and an English Law perspective. Rather than being an introduction to the legal history of China, this book sets out the socialist market and characteristics, commencing from the 1980s at the beginning of Chapter 1. It is suitable for undergraduate and postgraduate courses and for those who are interested in Chinese Law and economics. Readers will find a general comment regarding the promulgated Regulations and Rules in China and a subsequent analysis of the Regulations. The review of the development of Chinese Regulations facilitates understanding of the market liquidity of credit assets. Chapter 1 introduces issues arising in the state-owned banks in China and the steps that have been taken to maintain adequate credit risk management for the purpose of enhancing competitiveness. It also addresses the ability of banks to develop the cost-effective solutions needed for the disposal of assets for the creation of liquidity. Since the economic reforms of the early 1980s, China has yet to experience the impact of banking activity on the infrastructure of its market economics. The framework recommended by Basel II and the derivatives instruments have become a means to enhance credit risk management among banks. Arguably, Basel II establishes an institutionalized process that transforms risk into a numerical concept that is capable of becoming a property in its own right. Banks employ the derivatives technique to separate the risk from assets. The combination of institutional risk management and the structuring of credit derivative techniques have created a new property right. This book attempts to trace the evolution of risk and asset separation. The book seeks to address the differences between legal obligations and rights, the relationship between rights and property, action for tangible and intangible property, civil law and common-law systems, the transfer of and obligation and the effect of credit derivatives on banking balance sheets. This book reconciles the differences between civil and common law aspects of credit derivatives and recommends a convergence that retains Chinese characteristics. Arguably, the regulations give way to an economic reality that shapes the legal definition of credit risk management and credit derivatives. The consequences suggest a re-shuffle of private property and risk that would not have been possible had there been no credit derivatives. The global investor will share the risk of economic development in China by holding the credit risks of state-owned entities, individuals and banks in China, albeit indirectly. Equally interesting is that the China Banking Regulatory Commission (CBRC) has promulgated administrative rules and chosen the trust model as the means for securitizations, which will see the importation of English Trust Law. Other than the original Chinese Trust Law promulgated in 2001, the latest Rules Governing Trust Companies were passed in 2007 while this book was being prepared. At the time of writing, the CBRC has issued a public notice (July 2007) regarding amendments made to the Provisional Administrative Rules Governing Derivatives Activities of Financial Institutions 2004. The Chinese version was published in early December 2006. In response to the amendments, the interpretation of derivatives activities was based on the 2006 amendments. Any errors are entirely the author’s responsibility.