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How does a foreign investor set up a financial institution in the PRC?

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How does a foreign investor set up a financial institution in the PRC?

Note:
We only advise on Hong Kong law. This note is based on our understanding of the position under the laws of the People’s Republic of China as at 20 September 2014.

1. Executive Summary

This note has been prepared for overseas companies (the “Company”) to provide an overview of certain financial entities (including commercial banks, securities companies, securities investment funds management companies, futures companies, finance companies of enterprise groups and currency brokerage companies) in the People’s Republic of China (“PRC” or “China”) which the Company may consider setting up or acquiring for the purpose of carrying out, inter alia, trading of local and foreign securities (for clients or its own account), investment, lending, financing and other general banking activities.

As set out in detail below, foreign investment in the Chinese financial sector is subject to a number of restrictions. In September 2013, the Chinese government established the China (Shanghai) Pilot Free Trade Zone in which it intends to experiment with a number of economic reforms, including in particular the liberalisation and innovation of its financial sector. The blueprint for the new zone envisaged increased scope for private and foreign investment in the banking sector within the zone. Some nine months on, however, the proposals remain at the policy level only and further implementing regulations will be necessary to bring them to fruition. Nevertheless, there is a clear policy commitment to implementing a wide range of financial reforms on a trial basis in the zone, and the first of these, in the form of the reform of the administration of foreign exchange procedures for entities established in the zone have already been implemented. It is likely that the major reforms in terms of allowing free convertibility of the Renminbi (“RMB”) and relaxation of deposit interest rates will be implemented first in the Shanghai Free Trade Zone. Thus, while the restrictions on foreign investment in financial institutions in the zone are not yet any less stringent than those that apply outside the zone, with the exception of the removal of a requirement to have had a China representative office for two years prior to applying to establish another type of financial institution, setting up in the new free trade zone is likely to offer the most opportunities in the long term.

Commercial banks

According to the Annual Report issued by the China Banking Regulatory Commission (the “CBRC”), as at the end of 2012, banks from 49 countries and regions had set up 42 locally incorporated entities (including both wholly foreign-owned banks and Sino-foreign joint venture banks), 95 branches of foreign banks and 197 representative offices in China. Despite the rising importance of foreign-funded banks in China, restrictions remain on foreign entry to China’s banking sector.

Chinese regulatory restrictions limit the stake which foreign institutions can take in domestic banks to no more than 20%. This rules out acquisitions and means foreign banks must build their Chinese businesses from scratch. In doing so they face considerable competition from their domestic rivals which benefit from extensive branch networks; by way of example, Bank of Communications, a domestic institution of which HSBC owns 19%, has 2,690 branches, 1 while HSBC, currently has the most China branches of any foreign bank with 160.

The options for a foreign bank looking to establish or acquire a commercial bank in China are to set up one of the following:

  • a locally incorporated bank in the form of a wholly foreign-owned bank (“WFOE Bank”);
  • a Sino-foreign joint venture bank with a PRC investor (“JV Bank”)); or
  • setting up branch(es) and/or sub-branch(es) of the Company (“Foreign Bank Branch”) in China.

Generally, regardless of the form the Company prefers, a representative office (“Representative Office”) has to be set up initially; for a WFOE Bank or a Foreign Bank Branch, the Representative Office must have been in existence for at least 2 years whereas no time limit is prescribed for a JV Bank.

Securities companies

Foreign investment is allowed in a securities company which trades in A-shares (shares denominated in RMB traded on the Shanghai and Shenzhen stock exchanges), B-shares (shares denominated in foreign currencies traded on those exchanges), H shares (shares of companies incorporated in mainland China which are traded on the Hong Kong Stock Exchange), government bonds and corporate bonds. However, a foreign investor’s maximum holding in a Chinese securities company is limited to 49%, while foreign equity investment in a listed securities company is capped at 20%.

Futures companies

The Catalogue of Industries for Guiding Foreign Investment (外商投资产业指导目录) (Decree No.12 of the National Development and Reform Commission and the Ministry of Commence) (the “Catalogue”), published in 2011, requires a Chinese party to be the controlling shareholder of a futures company. In addition, the Provisions on Issues Relevant to Changes in the Registered Capital or Equity of Futures Companies (关于期货公司变更注册资本或股权有关问题的规定(证监会公告[2012]11号)) (“Futures Companies Provisions”) promulgated in May 2012 restrict a foreign investor’s ownership (direct or indirect) of a domestic futures company to 5% (subject to certain exceptions). Draft new rules which propose allowing foreign investment in futures companies up to 49% (as for securities companies) were published by the China Securities Regulatory Commission (“CSRC”) on 29 August 2014. These are subject to a public consultation which will end on 28 September 2014.

Securities investment fund management companies

There were 47 Sino-foreign joint venture fund management companies in the PRC as at March 2014. The proportion of foreign investment in a fund management company is currently limited to a maximum of 49% and therefore the Company may need to look for a suitable domestic securities investment fund management company to be its partner. Further, the securities regulatory authority of the home country of the foreign shareholder must have entered into a memorandum of understanding on securities regulatory cooperation with the CSRC or any other institution recognised by the CSRC, and must maintain effective regulatory cooperation. We note that the CSRC signed a memorandum of understanding with the Russian Federal Financial Markets Service in 2008.

Currency brokerage companies

Depending on the Company’s proposed scope of business, it may also set up or acquire a currency brokerage company which is engaged specifically in financing and foreign exchange dealings for commission. Currently, the CBRC is responsible for regulating currency brokerage companies while the People’s Bank of China and the State Administration of Foreign Exchange work together to supervise foreign exchange dealings in the inter-bank market etc. to ensure monetary stability.

Other financial entities

Other financial entities which may be established or acquired in the PRC include finance companies of enterprise groups (which principally provide financial management services for members of the enterprise group), trust companies and financial leasing companies.

The Shanghai Free Trade Zone

Established in September 2013, the Shanghai Pilot Free Trade Zone is intended to be the region in which the PRC government experiments with a number of key reforms before rolling them out in the rest of the country. Key reforms proposed include the gradual opening of various sectors of the economy to greater foreign investment. Most keenly anticipated of the proposed reforms are the proposals to ultimately allow full convertibility of the RMB and allow the market to set deposit interest rates. The introduction of these reforms will however be gradual and implemented only when the government deems the timing to be right. Nevertheless, a presence in the new free trade zone will offer institutions the advantage of being among the first to benefit from China’s continued opening up.


1 “Foreign banks in China – Lenders of little resort”, The Economist, June 28th 2014

Skills

Posted on

2014-11-06