China foreign-invested banks: Circular removes restrictions and clarifies uncertainties

On 10 March, 2017, the China Banking Regulatory Commission (CBRC) issued the Circular of the General Office of CBRC on Matters Concerning the Operation of Certain Businesses by Foreign-invested Banks (the Circular) which took immediate effect. The Circular removed certain restrictions and clarified uncertainties concerning the business operation of foreign-invested banks (FI Banks, which include foreign-invested legal entity banks and onshore branches of foreign banks) in China and presented promising business opportunities to FI Banks.

We summarise in this short note the major changes introduced by the Circular.

According to the Circular, FI Banks can now engage in the following businesses without prior CBRC approval. Instead, FI Banks are only required to report to CBRC within five days upon commencement of the relevant business mentioned below, and remain subject to the administrative approval of other regulatory authorities where applicable.

Underwriting of treasury bonds

Underwriting of treasury bonds used to be subject to approvals of both the Ministry of Finance (MOF) and CBRC. From late 2014, MOF reformed its selection standards on underwriters and announced a list of financial institutions which were regarded by MOF as qualified to underwrite treasury bonds. This list is effective for three years from 2015 to 2017. We understand that only three FI Banks are included in the  MOF’s list; they are HSBC Bank (China) Company Limited, Standard Chartered Bank (China) Limited and JP Morgan Chase Bank (China) Company Limited.

Under the Circular, CBRC approval is no longer required for an FI Bank (which in this context does not include any onshore branch of a foreign bank) to conduct the business of treasury bonds underwriting. This will obviously make the regulatory process simpler if an FI Bank intends to conduct business in this arena. The Circular does not touch upon FI Banks’ conduct of local government bonds underwriting business, which we believe will remain subject to CBRC approval.

Custodian business

For a long time, only provision of custodian services to (i) qualified domestic institutional investors for their outbound investments and (ii) mutual/private securities investment funds (collectively, Regulated Custodian Services) is expressly required to be subject to the approval of CBRC. CBRC was silent on whether or not its approval is required when banks (including FI Banks) conduct other types of custodian services.

The Circular now makes it clear that FI Banks may conduct non-Regulated Custodian Services without CBRC prior approval. CBRC can of course promulgate new rules to reshape the scope of the Regulated Custodian Services but we would not expect the scope to be enlarged given CBRC’s intention of relaxing regulatory control over such services.

Financial advisory etc. consultancy business

Under China’s legal regime, Chinese banks (including FI Banks) may only conduct traditional banking business (e.g. deposit-taking, providing loans). Therefore, the consultancy business of banks in China shall be the consultancy services associated with traditional banking business only.

In the Circular, CBRC for the first time explicitly permits FI Banks to conduct financial advisory and other consultancy business. This means that a FI Bank may conduct consultancy business beyond that which is only related to traditional banking. However, the Circular does not define what “financial advisory and other consultancy business” exactly covers. The vagueness has caused different interpretations in the market. One interpretation is that CBRC may be intended to allow FI Banks to conduct the “investment banking” business, e.g. financial advisory services for initial public offering, new share issuance and bond issuance. Another interpretation is that the “financial advisory and consultancy business” is meant to refer to ordinary consultancy business only in order to be consistent with CBRC’s permission for FI Banks to collaborate with their overseas affiliates as mentioned in the section immediately below. Further clarification from CBRC is expected.

The Circular expressly permits FI Banks to collaborate with their overseas parent groups in order to provide comprehensive financial services to domestic enterprises in their bond issuance, listing, mergers and acquisitions and financing activities at overseas markets. The Circular requires FI Banks to make clear provisions on its responsibilities and profit entitlement in such global service arrangement and to report to CBRC on an annual basis.

Under the previous legal regime, FI Banks were not permitted to directly or indirectly assist foreign entities (including their parent banks) in selling financial products or providing financial services to Chinese clients in China. Offshore parent banks of FI Banks were also not permitted to conduct any profit-making activities inside China through their local presence (i.e. FI Banks). FI Banks have therefore been extremely cautious when providing assistance to the business of their parent banks in China (e.g. advising Chinese enterprises in their outbound investments) in order to mitigate regulatory risks.

The Circular now gives FI Banks express permission to collaborate with their offshore affiliates in order to offer integrated and specialised financial services to Chinese enterprises. This regulatory relaxation, in conjunction with the permission that FI Banks may conduct consultancy business without CBRC approval as mentioned above, should enable FI Banks to join their offshore affiliates in advising Chinese enterprises in their outbound investments, and to make profits out of these services.

However, it remains uncertain whether there will be parameters governing the scope and method of such services and how likely it is CBRC will question or challenge profit allocation mechanisms.

Foreign investors may set up wholly owned local FI Banks in China. However, as a general principle, foreign direct investment in China’s domestic banks is tightly controlled. Foreign shareholding in a domestic bank shall normally not exceed 20% by a single investor or 25% by all foreign investors collectively. Making investments into domestic banks by FI Banks have been rare and this may be due to the fact that regulations were silent on this pattern of foreign investment in the banking sector and also that FI Banks are normally too small in capital size to conduct any meaningful investment activity. Although the Circular expressly allows FI Banks to make onshore investments in domestic banks, a lot remains unclear, e.g. whether such investment is subject to shareholding restrictions and whether an FI Bank is subject to particular requirements on capital adequacy or otherwise in order to be approved for investment.

The Circular contains six short provisions and indeed only sets out a few high level principles relaxing regulatory restrictions on, and presenting new business opportunities to, FI Banks in certain respects. However, how these principles may be implemented will depend on detailed operational rules to be issued by CBRC and other regulatory authorities.