The practice of asset securitization in the People’s Republic of China (PRC) is at the stage of exploration and experimentation. Though the Chinese government has deliberated on the merits of structured finance for more than a decade, it has only been recently that they have begun developing the country’s securitization market at a deliberate pace.

In terms of the infrastructure support for securitized assets, the current systems of legislation, audit, taxation and credit rating are still not adequate to reliably support an asset–securitization market.

Legal issues on asset securitization

i. Legal issues regarding asset transfer and “true sale”
The main conflict between asset securitization and the PRC’s “Contract Law”, “Banking Law”, “General Provisions of Civil Law”, and “Mortgage Law” lies in the confirmation of asset transfer (contract variation). The laws mentioned above generally require that before one party transfers the right or duty in the contract to a third party, he must obtain the original counterpart’s agreement. This means that the sale of the asset must be approved by the original debtor, which brings tremendous cost when the number of the original debtors becomes large enough. “True sale”, which is the kernel technique of asset securitization, guarantees the isolation of securitized asset from the originator and any potential future claims against it. However, the absence of a clear definition for “true sale” in the current laws of the PRC sets obstacles for the implementation of asset securitization.

ii. The kind of receivables that can be securitized
The PRC market still lacks the diversity in terms of financial assets. From the few cases that have appeared in the PRC, the type of assets securitized is quite limited. The receivables securitized are mostly creditor’s future claims (known as future-flow securitization).

iii. Legal issues regarding the creation of a bankruptcy-remote special-purpose vehicle (SPV)
In the common model of asset securitization, the SPV must be totally independent to the originator and is the issuer of the security. Current PRC laws impose stiff requirements (such as minimum capitalization and multi-layered approval process) on the SPV to qualify security issuance. Restrictions on the scale and type of security issuance as stipulated in the “Securities Law” of the PRC also conflict with the diversity of asset securities.

iv. Regulation of investors
Since asset-backed securities are quite complicated, it is not practical for individual investors to make up a significant part of this market under the current investment environment of the PRC. On the other hand, PRC institutional investors are strictly limited in their investment strategies – hampering their ability to invest in an asset-backed securities market either.

v. Taxation problems
PRC tax policies greatly increase the financing cost of asset securitization. Withholding tax is applicable to interest payments from a non-resident SPV and the income of the SPV is taxable as an ordinary enterprise.

vi. Credit enhancement problems
The lack of a framework for independent third-party credit enhancement also hinders the fast development of asset securitization in the PRC.

Current practice

In the absence of a specific securitization law, securitization-type transactions have been completed via the PRC’s Trust Law (in 2001). The law provides the basis for the development of securitization-type transactions using trust structures. China Huarong Asset Management Company, a state-owned financial institution, was the first company to successfully securitize a portfolio of non-performing loans based on the Trust Law. The project was recognized as quasi-securitization. In 2005, the China Development Bank and China Construction Bank were selected for a pilot securitization of credit assets and mortgage loans, respectively. The People’s Bank of China (PBC), together with the China Banking Regulatory Commission (CBRC), jointly issued Administrative Rules for the Pilot Securitization of Credit Assets outlining registration procedures and regulatory requirements of asset originators and trustees as well as rules and regulations on issuance and trading of asset-backed securities in the interbank market.