ThePeople’s Bank of China, China Banking Regulatory Commission and ChinaSecurities Regulatory Commission jointly formulated the Administrative Rulesfor Pilot Incorporation of Fund Management Companies by Commercial Banks(referred to as Administrative Rules hereinafter). Officials of the threeinstitutions recently answered related questions. 

Q: Whatis the importance of allowing commercial banks to set up fund managementcompanies?

A: Thelaunch of the pilot program is an important step forward after the StateCouncil issued the Initiatives on Promoting the Reform, Opening up andStable Development of the Capital Market. The policy of allowing thecommercial banks to establish fund management companies is expected to yieldseveral positive effects. It will promote the long-term, stable and healthydevelopment of the capital market, raise the share of direct financing andpromote the coordinated development of direct and indirect finance, steadily speedup the reform of the commercial banks, maintain the stability of the financialsystem and improve the allocation of resources. 

China’sfinancial reform is in the transition from indirect finance to direct financeand from unitary banking system to diversified market structure. While takingsteps to reduce the share of indirect finance and promote the development ofdirect finance, equal importance should be attached to the reform of thecommercial banks to raise their competitiveness. In this regard, allowing thecommercial banks to establish fund management companies and develop fundmanagement business is an appropriate policy choice. At present, the corporatesector relies too much on bank loans to meet its financing demand, leading tounduly concentrated financing risks in the banking system. Development of thecorporate sector is also retarded because some enterprises with low capitalcannot get credit support from the banks. In addition, if market risk pricingand resource allocation are mainly done through banks, it is hard to achieveoptimal allocation of resources and stability of the financial system.Therefore, policies should be formulated to support the commercial banks toestablish fund management companies with diversified ownership by introducingforeign strategic investors. This not only conforms to the long-term trend ofthe development of the financial industry, but will also promote businessinnovation and diversified operation of the commercial banks. The indirectfinancing risk will become less concentrated and the commercial banks’international competitiveness will be improved.

In thelong run, China’s capital market and money market willdevelop in a mutually-promoting manner. With expanding market share and moretrading varieties, China’s capital market has broad development prospect.The growth of capital market will create good market environment and conditionsfor the commercial banks to develop their fund management business andestablish fund management companies. Meanwhile, the establishment of fundmanagement companies by the commercial banks will channel part of the savingsto the capital market, thus expanding the financing sources in the capitalmarket. With strengthened institutional investors, the long-term steadydevelopment of the capital market will be greatly promoted.

In fullconsideration of the development status of the fund management industry, theprogress of the state commercial bank reform and other factors such asregulatory coordination and macro-management of the financial sector, thePeople’s Bank of China, China Banking Regulatory Commission and ChinaSecurities Regulatory Commission decided to carry out pilot programs beforegranting permit to all banks for the incorporation of fund managementcompanies. With administrative rules formulated and pilot banks selected, thepilot program of incorporation of fund management companies by commercial bankswill be actively and steadily advanced. The issuance of the AdministrativeRules indicates that the pilot program has entered material stage.

Q: Whatare the main provisions in the Administrative Rules?

A: TheAdministrative Rules was formulated to govern the connected transactions andcross-market risks resulted from the incorporation of fund management companiesby the commercial banks as their shareholders. In particular, it sets detailedregulations on the segregation of banking business and fund management businessand on the respective responsibilities of the three regulatory authorities.Based on the principle of fair competition, the existing Administrative Rulesfor the Securities Investment Fund Management Companies fully applies to thefund management companies set up by the commercial banks in terms ofshareholder qualifications, management mechanism and business operations.

TheAdministrative Rules contains 29 articles in five chapters - GeneralProvisions, Application and Approval Procedures, Risk Control, Supervision andRegulation, and Supplementary Provisions. It mainly deals with issues concerningthe following three aspects: approval procedures for the incorporation of fundmanagement companies by the commercial banks; isolation of risks in the fundmanagement business from those in the banking business; respectiveresponsibilities and coordination of relevant supervisory authorities. TheAdministrative Rules only applies to incorporation of fund management companiesby the selected pilot commercial banks. The scope of application is subject tochanges made by relevant authorities in light of developments in the economicand financial situations and of the progress achieved in the pilot program.

Q: Howto properly understand the potential cross-market risk brought about by theincorporation of fund management companies by the commercial banks?

A:Allowing the commercial banks to set up fund management companies to someextent enables the commercial banks to conduct cross-sector business throughtheir subsidiaries. The related risks are manageable. At present, comprehensiveoperation of the financial sector mainly takes two forms. One is the legalperson mode, by which one legal person conducts two or more types of thebanking, securities and insurance business. This mode, which is typical in Germany and Switzerland,requires that the financial institutions have strong law awareness, good creditculture tradition and effective self-disciplinary mechanism. It is premature todevelop such a mode in China in light of China’scurrent situations.

Theother mode is financial group linked by capital, which can be further dividedinto two types. The first is financial holding companies that do not conductfinancial business directly but hold shares of the commercial banks, securitiescompanies or insurance companies. In China, CITIC Holding Company belongs tothis type. Since the market environment, legal basis and regulatory frameworkfor the operation of financial holding companies still need further developmentin China, it is hard to promote widespread adoption of this form inthe short run. The second form is for a financial institution to set up adifferent-type financial institution, such as a fund management company set upby a commercial bank. Under this mode, the commercial banks do not directlyengage in securities business. So it is relatively easy to control the risks.It is worth mentioning that allowing the commercial banks to set up fundmanagement subsidiaries will entail much less risks than allowing them toestablish securities brokerage or investment banking subsidiaries, because thelatter two types of subsidiaries may engage in transactions related to the accountsof individual stock buyers and sellers, securities underwriting and securitiestrading, while the fund management subsidiaries only conduct money managementbusiness entrusted by their clients on a voluntary basis. Most of the existingsecurities investment funds also rely on the commercial banks to sell the fundproducts without involving cross-account transactions or financingrisks.     

Toprevent illegal connected transactions between the commercial banks and their fundmanagement companies, the Administrative Rules provides for provisions on theoperation, staffing, investment activities and information sharing of the twoentities and issues regarding financing facilities and cross custody in case oflarge-amount redemption. China Banking Regulatory Commission and ChinaSecurities Regulatory Commission will, in accordance with the AdministrativeRules, formulate detailed regulations regarding connected transactions toeffectively prevent cross-market risks.

Q: Underthe pilot program, what forms may the commercial banks adopt to establish thefund management companies?

A: Inlight of the current situation of China’s financialreforms, the commercial banks may adopt two forms in the incorporation of fundmanagement companies. The First is indirect investment mode by which the fundmanagement companies are set up by institutions that have ownership relationswith the commercial banks. The second is for the commercial banks to directlyestablish fund management companies. Both forms are encouraged. Given that theexisting laws and regulations fully apply to the indirect investment mode, theAdministrative Rules mainly governs the incorporation of fund managementcompanies by the direct investment mode.

Thecommercial banks can set up new fund management companies or own an existingfund management companies by merger and acquisition. To set up a new fund managementcompany, it is important to ensure that the new company has sound governanceand qualified shareholders. For the merger and acquisition, existing orpotential risks of the companies to be merged should be clearly identified andtheir governance be improved. The Administrative Rules mainly aims at governingthe incorporation of new fund management companies. The establishment of fundmanagement companies by merger and acquisition is governed by theAdministrative Rules and other relevant documents issued by China SecuritiesRegulatory Commission.

Q: Whatare the respective responsibilities of the regulatory authorities regarding theincorporation of fund management companies by the commercial banks?

A:Regarding the application and approval procedures, the Administrative Rulesprovides that the commercial banks shall submit to the China Banking RegulatoryCommission relevant documents. Under the pilot program, copies of thesedocuments should be sent to the People’s Bank of China. The China BankingRegulatory Commission will, from the perspective of overall risk monitoring,review the qualification of the commercial banks and issue regulatoryconclusions. The commercial banks that have got the approval from the ChinaBanking Regulatory Commission, shall, in accordance with the AdministrativeRules for the Securities Investment Fund Management Companies and other relevantlaws and regulations, submit to the China Securities Regulatory Commissiondocuments relating to the incorporation of fund management companies forapproval. Under the pilot program, these documents should be copied to thePeople’s Bank of China.

The relevantregulatory authorities will coordinate with each other according tointernational practices. In accordance with the Law of the People’s Republicof China on Administrative Approval, Law of the People’s Republic ofChina on Banking Regulation and Supervision and Law of the People’sRepublic of China on Securities Investment Fund, China Banking RegulatoryCommission will be responsible for the consolidated supervision of the pilotcommercial banks, China Securities Regulatory Commission will oversee theoperation of the fund management companies, and the funds raised and managed bythe fund management companies will be subject to the supervision of the People’sBank of China while they are transacted in the inter-bank market. The StateCouncil requires the three regulatory institutions to make joint efforts tocarry out this pilot program.

Q: Whatsteps are expected to be taken in the future regarding the incorporation offund management companies by the commercial banks?

A: Atpresent, many commercial banks have submitted their application for setting upfund management companies. Taking into account of factors such as the operationconditions of the banks and their representativeness in the pilot program, thePeople’s Bank of China, China Banking Regulatory Commission and ChinaSecurities Regulatory Commission will select the pilot banks to set up fund managementcompanies in various forms. Review and approval process is expected to beginsoon.

To speedup the pilot program, we will draw up detailed rules governing the connectedtransactions and information sharing between the commercial banks and theirfund management companies. An effective risk monitoring system will also be setup. Investigation and Research regarding the pilot program will be carried outin accordance with the Administrative Rules and other relevant laws andregulations. Emphasis will be placed on the coordination among relevantauthorities to effectively conduct supervision and prevent risks. In the futurewhen necessary conditions are met, more banks will be allowed to participate inthe pilot program.