Foreign Investments in Chinese Financial Institutions: Channels and Legal Framework Yingmao Tang Peking University Law School May 31, 2011 NYU Conference on Chinese Capital Markets

2 Table of Contents Introduction Major channels and related legal framework Important factors Future trends Conclusion

3 Introduction The last decade witnessed the success of international firms such as UBS in entering into the Chinese financial markets  In 2002, UBS became one of the first group of foreign investors approved by Chinese regulators to be a qualified foreign institutional investor (the “QFII”).  In 2005, UBS made a minority investment in Bank of China (the “BOC”) under a foreign minority investment program opened by the Chinese banking regulator in  In 2006, UBS acted as a co-lead underwriter for BOC’s historical USD11.2 billion initial public offering (“IPO”) in Hong Kong.  In 2006, UBS received a full license to conduct securities businesses in China after acquiring 20% equity interests in and control over a Beijing Securities, a Chinese securities company.

4 Major Channels and Related Legal Framework UBS is one of the lucky firms that have accessed to the following four major channels for foreign investments in Chinese financial institutions  The foreign minority investment program  The H share program  The foreign-invested financial institution program  The QFII program The legal framework has also been developed to regulate the above channels in the last decade

5 The Foreign Minority Investment Program What is the foreign minority investment program?  It allows a foreign investor to make an investment of no more than 25% equity interests in a PRC-invested financial institution. Notable examples of investment in banks include: Investment of USD3 billion by Bank of America for 8.5% equity interests in Bank of Construction in Investment of USD5 billion by Royal Bank of Scotland, Temasek and UBS for 16% equity interests in BOC in Investment of USD3.8 billion by Goldman Sachs, American Express and Allianz in for 8.5% equity interests in Industrial and Commercial Bank of China in  As of December 31, 2010, 32 PRC-invested commercial banks had received foreign investments of over USD38.42 billion.

6 The Foreign Minority Investment Program Legal framework for the foreign minority investment program  The Administration Rules regarding Investments by Overseas Financial Institutions in PRC-invested Financial Institutions issued by the China Banking Regulatory Commission in  The Administration Rules regarding Shareholding of Insurance Companies issued by the China Insurance Regulatory Commission in  These rules set forth the approval requirements for foreign minority investments on a case by case basis.  These rules also impose (i) restrictions on ownership limit by a single foreign investor (20%) in one financial institution; (ii) the aggregate ownership limit for all of the foreign investors (25%); (iii) a mandatory lockup of three years.

7 The H Share Program What is the H share program?  It is a program opened by the Chinese government in the 1990s to enable PRC-incorporated enterprises to offer shares to foreign investors and list those shares in Hong Kong.  Notable examples of Chinese financial institutions listed in Hong Kong through the H share programs include: Insurance: China Life, PICC, China Pacific and Ping An. Banking: ICBC (world’s largest IPO in 2006), BOC, the Bank of Construction, the Agricultural Bank of China (world’s largest IPO in 2010) and the Bank of Communications.  As of December 31, 2010, 165 PRC-incorporated companies were listed in Hong Kong. In 2010, Chinese enterprises raised USD35 billion capital through the H share program, accounting for about 20% of the total capital raised in stock markets in the mainland China and Hong Kong.

8 The H Share Program Legal framework for the H share program  The Special Rules regarding Share Offerings and Listing outside China by Joint Stock Companies promulgated by the State Counsel in  A number of regulations and rules promulgated by the China Securities Regulatory Commission in the second half of 1990s.  These regulations set forth the approval requirements of H share offerings and listings by the CSRC on a case by case basis.

9 Foreign-Invested Financial Institutions What is the foreign-invested financial institution program?  This program allows a foreign investor to hold more than 25% equity interests in a foreign-invested financial institution.  The maximum foreign shareholding ranges from 33% for securities companies to 49% for life insurance companies to 100% for property insurance companies and commercial banks.  Numbers of foreign-invested financial institutions as of December 31, wholly foreign-owned banks that had 223 branches, 2 joint venture banks, 90 branches and 216 representative offices of 185 banks. 54 out of 146 were foreign-invested insurance companies, among which 19 were property insurance companies, 28 were life insurance companies and 7 were re-insurance companies. Only 12 out of 106 were foreign-invested securities companies.

10 Foreign-Invested Financial Institutions  Small market share of foreign-invested financial institutions as of December 31, 2010 Foreign-invested commercial banks accounted for 1.85% of total assets and 1.79% of total loan balances of commercial banks in China. Foreign-invested insurance companies accounted for 5.19% of total assets and 4.37% of total premium of insurance companies in China. Foreign-invested insurance companies accounted for 16.31%, 17.94%, 7.88% and 8.23% of the markets in Beijing, Shanghai, Shenzhen and Guangdong, respectively. No market share data for foreign-invested securities companies but they appear to be not doing well except for GS, UBS and CICC.

11 Foreign-Invested Financial Institutions Legal framework and legal restrictions  Separate set of regulations were issued by the banking, insurance and securities regulators in the last decade. The Administration Regulation of Foreign-Invested Banks and the related implementation rules promulgated by the CBRC in The Administration Regulation of Foreign-Invested Insurance Companies of 2001 and the related implementation rules promulgated by the CIRC in The Foreign-Invested Securities Company Rule promulgated by the CSRC in 2002 and amended in  These regulations have incorporated China’s WTO commitments. Foreign-invested banks are no longer subject to restrictions on ownership, geographic expansion and RMB banking businesses. Foreign-invested insurance companies are still subject to foreign ownership restrictions or business restrictions. Foreign-invested securities companies are subject to more stringent restrictions.

12 The QFII Program What is the QFII program?  It is a program that allows foreign institutional investors to buy and sell shares of companies listed in China.  Many well-known players in world’s financial markets were approved by the Chinese regulators to be QFIIs in the last decade. Investment banks: Goldman Sachs, Morgan Stanley and UBS Commercial banks: HSBC and Standard Chartered Bank. Sovereign wealth funds: Temasek. Fund managers: State Street. University endowment funds: Harvard and Yale.

13 The QFII Program The development of the QFII program  The QFII program has been managed by the Chinese government in a very cautious way.  As of the end of 2010, the CSRC had approved 106 QFIIs, and 97 QFIIs received an aggregate investment quota from the SAFE of USD19.72 billion.  Due to the small size of the investment quota relative to the market capitalization of the Chinese domestic share market (RMB27 trillion or USD4 trillion), the market value of shares held by all QFIIs only accounted for 1.4% of the total market value of the PRC tradable shares as of the end of 2009.

14 The QFII Program Legal framework for the QFII program  The Provisional Regulation on Investment in Domestic Securities by Qualified Institutional Investors jointly promulgated by the CSRC and the People’s Bank of China in November 2002 and amended in August  The qualification of each QFII and the investment quota of each QFII are subject to approval by the CSRC and SAFE.  Each QFII is restricted from owning more than 10% of all the outstanding shares of a listed company, and the aggregate limit on ownership by all QFIIs in one listed company is 20%.

15 Important Factors Three factors have played important roles in shaping the development of the major channels and the legal framework for foreign investments in Chinese financial institutions  China’s entry into WTO in 2001  China’s financial reform  Interactions between China and other countries such as U.S. in respect to financial opening

16 China’s Entry into WTO in 2001 Regulations governing foreign-invested financial institutions incorporate China’s WTO concessions  China committed to allowing up to 100% foreign ownership in commercial banks, no geographic restrictions or restrictions on RMB banking businesses.  The above concessions are incorporated into the Administration Regulation of Foreign-Invested Banks and the related implementation rules promulgated by the CBRC in The timing of the promulgation of or revisions to the regulations appear to correspond to the timing of China’s entry into WTO and the timing of effectiveness of the concessions.  The Administration Regulation for Foreign-Invested Financial Institutions was promulgated in December 2001 on the eve of China’s entry into WTO.  The Foreign-Invested Bank Regulation was promulgated in November 2006 to replace the above regulation in anticipating the full effectiveness of China’s concessions in 2008.

17 China’s Financial Reform China’s financial reform was started in the 1990s with an aim to strengthen the capital base and improve the corporate governance of Chinese banks and insurance companies. This reform typically contemplates disposal of non-performing loans, injection of capital by the government, receiving pre-IPO strategic investments from foreign investors and completion of IPOs and listing on international stock exchanges. The popularity of the foreign minority investment program and the H share program has a lot to do with China’s financial reform. For example, Bank of China received a capital injection from the Chinese government in 2003, received investments of USD5 billion from RBS, UBS and Temasek in 2005 and completed its USD11.2 billion IPO and listing in Hong Kong in 2006.

18 Interactions between China and Other Countries For example, strategic dialogs between China and U.S. have played an important role in shaping the development of the major channels and the legal framework for foreign investments in Chinese financial institutions. It was reported that UBS and Goldman Sachs were able to receive a full license to conduct securities businesses in China in 2007, a commitment that China did not make in connection with its entry into WTO in 2001, has a lot to do with the strategic dialogs between China and U.S.

19 Future Trends – “Returning Home” It refers to the increasing use by Chinese enterprises of the Chinese domestic stock markets to raise capital. Chinese enterprises have conducted “A+H” concurrent share offerings to raise capital from both the mainland China and Hong Kong compared to pure H share offerings in the past. It appears that the Chinese government has been controlling listings in Hong Kong through the H share program.  The number of HKSE-listed Chinese companies increased substantially from 52 as of 2000 to 143 as of  However, the number was slowly increased to 148 as of 2007, 153 as of 2008, 159 as of 2009 and 165 as of 2010.

20 Future Trends – “Returning Home” Implications of the “returning home” trend  The H share program will play a less important role.  Further opening of the securities market may be possible. QFIIs have been recently allowed to trade financial futures, a new financial instrument started in The Chinese government has indicated its willingness to allow non-PRC companies to offer and list shares in China.  Lifting ownership or business restrictions on foreign- invested securities companies may still be a challenge. The aggregate profits of over 100 Chinese securities companies are equal to the profits of only one international firm such as Goldman Sachs.

21 Future Trends – “Going Out” It refers to the expansion of Chinese financial institutions in countries outside China  Chinese commercial banks, insurance companies and securities companies have all expedited their overseas’ expansion process. ICBC now has over 400 offices in 28 countries. CITICS has been in discussion with CLSA, a French investment bank, to establish a joint venture outside China.  The general background is the increasing number of M&A activities by Chinese enterprises in the past few years. China has been reported to be the second largest countries in terms of overseas M&A activities.

22 Future trends –“Going Out” Implications of the “going out ” trend  It will have an indirect impact on the existing legal framework.  When Chinese financial institutions increase their expansions in other countries, these countries will likely ask the Chinese government to further open its own financial markets.  For example, it is reported that the chairman of the CBRC indicated in an interview that the Chinese government would be willing to increase the upper limits for foreign ownership in PRC- invested financial institutions if Chinese banks are able to receive approval to open branches in the U.S.

23 Conclusion Future of the major channels and the legal framework for foreign investments in Chinese financial institutions  The role of the foreign minority investment program and the H share program will be less important as China’s financial reform has been largely completed.  Foreign-invested financial institutions will grow but substantial changes to the legal framework regulating these institutions will be unlikely because further commitments by the Chinese government in the context of WTO appears to be far away.  There may be room for further opening of the securities market and the lifting of ownership restrictions on foreign minority investments, but the extent of openness will remain to be seen.

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