China presents enormous opportunities for the wealth management industry. Since the opening up of China’s banking and other financial industries to foreign investments, foreign banks, securities companies, insurers and fund management companies have sought to establish presence in this market through the setting up of representative offices, branches, foreign direct investments and joint venture companies. 

As at the end of December 2005, there are hundreds of branches of foreign-owned banks in the PRC, four securities companies with foreign shareholders, close to twenty sino-foreign joint venture or foreign-owned insurance companies, and twenty sino-foreign joint venture fund management companies. 

In this issue, we focus on PRC trust and investment companies (“ITICs”), a type of non-bank financial institutions regulated by the China Banking Regulatory Commission (the “CBRC”) and a significant player in the China wealth management industry. 

Under the <Measures for Administration of Trust and Investment Companies> (the “ITIC Regulations”) issued by the People’s Bank of China (“PBOC”) on 5 June 2002, an ITIC may be approved by the PBOC to engage in a broad range of Renminbi and/or foreign currency business, a key one being to operate and manage funds or property (which may be movable or immovable property) entrusted to it. In effect, this enables a private fund industry to be operated by ITICs. 

Under the <Interim Measures on Trust Fund Management by Trust and Investment Companies> (“Trust Fund Management Regulations”) issued by PBOC on 26 June 2002, an ITIC can manage a commingled trust fund from not more than 200 ‘investors’ where each ‘investor’ entrusts not less than RMB50,000 (approximately USD6,200). There are no specific requirements or restrictions on the permitted investments of a trust portfolio. ITICs currently operate pooled trust portfolios that invest in listed equities, bonds, securities investment funds managed by domestic securities investment fund management companies, Chinese real estate and infrastructure. 

Unlike trusts under common law, a “trust” structure or arrangement under PRC law operates more as a contractual arrangement. Although an ITIC may manage a commingled trust fund from up to 200 ‘investors’, it may not engage in any advertisement when conducting trust management business. The CBRC has indicated that the trust fund business of ITICs is designed to be promoted by way of ‘private placement’ and not ‘public offering’, and should be targeted at ‘investors’ with a reasonable amount of risk knowledge and risk capacity.

An ITIC may also act as the promoter and key Chinese shareholder of a PRC securities investment fund management company which engages in retail investment fund business. Further, under the PRC Regulations on Enterprise Annuities, ITICs may apply to manage the investments of enterprise annuities (private corporate pension funds) subject to the approval of the Ministry of Labour and Social Security. 
Other possible scope of business of ITICs includes providing intermediary services such as consulting on corporate restructuring, mergers or acquisitions, project finance or corporate finance, accepting underwriting business for Treasury Bonds, bonds of Chinese policy banks or corporate bonds approved by the relevant departments of the State Council, and conducting custodian business (but not for retail securities investment funds, which role can only be performed by Chinese commercial banks under current laws and regulations).

While references are made to the PBOC in the ITIC Regulations, ITICs are in practice regulated by the CBRC. According to information obtained from the CBRC, there were about 60 ITICs in China established in different regional or provincial cities as at December 2005. 

Under the ITIC Regulations, an ITIC is required to have a registered capital of not less than RMB300 million (approximately USD37 million), and an ITIC that engages in foreign currency business must have registered capital not less than the equivalent of USD15 million (approximately RMB121 million) of foreign currency, or such other amount as the CBRC may determine. 

There has to-date not been any announced or known foreign investment in ITICs. We understand that the CBRC is prepared to consider applications from foreign investors to invest in ITICs, and may possibly accept foreign investors taking up a significant stake in ITICs for strategic investment purpose. Interestingly, as ITICs are not banks, these type of companies are technically not subject to the 20% foreign investment limit applicable to banks under China’s WTO commitment, and are also not covered by any other China’s WTO commitment. 

This is a follow-up to an earlier article: “China Wealth Management Opportunities – Setting Up a Representative Office“ published in our June 2005 newsletter (available on our website at www.deacons.com.hk/eng/knowledge/knowledge_227.htm).

For more information about the landscape and players in the China wealth management industry, you may visit our website: www.deacons.com.hk.

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Hong Kong REITs Update

November and December 2005 saw the Hong Kong real estate investment trust (“REIT”) market burst into life, with the listing of three REITs on the Stock Exchange of Hong Kong – The Link REIT (Hong Kong retail and car parks), Prosperity REIT (Hong Kong commercial) and GZI REIT (office buildings in Guangdong, PRC). These REITs are the first to appear in the Hong Kong market since REITs were permitted by the Securities and Futures Commission (“SFC”) Code on Real Estate Investment Trusts back in August 2003. Media reports suggest that the successful launch of the initial REITs has given encouragement for several more REITs to list in the first half of 2006.

The Link REIT listing has already led to a change in the regulatory environment, following news that a hedge fund had acquired a significant interest in The Link REIT. That prompted the SFC to issue a notice on 15 December 2005 reducing the threshold for investors to disclose their interest in a REIT from a 10% holding to a 5% holding. The new 5% threshold is the same as applies to shares in Hong Kong-listed companies under Part XV of the Securities and Futures Ordinance. The SFC now requires that REITs incorporate by reference the relevant provisions of Part XV in their trust deeds.

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SFC’s Investigation into Selling Practices of Investment Advisers

In 2006, the SFC plans to conduct another investigation into licensed investment advisers. This follows a report issued in February 2005, in which the SFC noted industry practices that posed “serious regulatory concerns”.

It is timely, then, for investment advisers to review their adherence to the standards of conduct expected of them by the SFC. We set out below some of the practices that investment advisers should adopt to ensure regulatory compliance.

Investment advisers should:

• disclose conflicts of interest. The SFC is still considering whether to require investment advisers to disclose to clients the commission and rebates received from product providers.
• make recommendations that are reasonably suitable given their clients’ specific circumstances.
• know each client’s financial situation, investment experience, investment objectives and risk tolerance. It is advisable to have a record of such details as the client’s age, family circumstances (such as whether they have any dependents), employment and current assets and liabilities (including sector diversification) and to update this information regularly.
• understand the nature and quality of investment products and the experience and reputation of product providers.
• explain the basis of recommendations to their clients to help them make informed decisions. 
• prepare written financial plans including: a summary of the features of the recommended product, an explanation of the consequences of withdrawing the money before maturity, an explanation of the risks of the product and how these are consistent with the client’s risk profile, why the product is recommended and what other investments were considered and why they are not suitable.
• enter into a client agreement with each client, setting out the terms, obligations and scope of the services. The agreement should not include unreasonable waivers and disclaimers. An investment adviser cannot avoid the requirement to give reasonably suitable recommendations merely by requiring the client to declare that he or she has not relied on the investment adviser’s advice.
• implement systems to allow senior management to monitor and control the selling activities of sales staff.
• note that it is an offence to offer unauthorised financial products to the public, subject to certain exemptions. A mere declaration by the client that he or she asked to invest in a product, or that he or she is a professional investor, will not be determinative of whether a product was offered to the public.

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Proposed Amendments on QFII

The China Securities Regulatory Commission (“CSRC”) and State Administration of Foreign Exchange (“SAFE”) have, in recent months, issued consultation drafts of proposed amendments to the two major regulations governing Qualified Foreign Institutional Investors (“QFIIs”): <Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors> (<合格境外机构投资者境内证券投资管理暂行办法>) and <Provisions on the Administration of Foreign Exchange in Domestic Securities Investments of QFII> (<合格境外机构投资者境内证券投资外汇管理暂行规定>). According to the draft regulations, certain amendments are to be implemented.

Under the existing regulations, QFIIs are subject to relatively long investment lock-up periods. Under the proposed amendments, the lock-up period may be reduced from one year to three months for open-ended funds, insurance companies, pension funds, charitable funds and closed-end funds, and from three years to one year for other types of QFIIs. 

CSRC has also proposed to depart from the existing requirement for QFII to operate on a single account basis. Draft regulations are being introduced to allow a QFII to hold multiple sub-custody accounts and multiple securities brokerage accounts. This will allow segregation of assets between the multiple sub-custody accounts and permit a wider selection of brokers.

Finally, the proposed investment quota for individual QFII which can be applied for is expected to increase from USD $800 million to USD $1 billion in RMB. 

The proposed amendments to the two main regulations reflect the Chinese government’s on-going commitment to attract foreign investors. The existing QFII rules and requirements are rather inappropriate for open-ended funds. However, the changes proposed under the draft regulations are expected to be more attractive for open-ended funds.

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Deacons Profile

Patrice Choi recently joined us as an Associate to assist our clients with matters relating to investment products in Hong Kong and advising on regulatory issues. She has worked with two international law firms in Hong Kong, specialising in advising clients on corporate finance transactions, ongoing compliance issues for listed companies and general corporate and commercial issues. Patrice is fluent in Cantonese, English and Mandarin.

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The 4th Deacons FSPG Charity Golf Challenge 2006

With the enthusiastic support from all the participants and sponsors, the 4th Deacons FSPG Charity Golf Challenge 2006 was held on 20 January 2006 at Kau Sai Chau Public Golf Course. This year we raised HK$66,000 for the Hong Kong Community Chest.

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