Corporate asset securitization: policy evolutions and legal obstacles

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Asset-backed securities (ABS) refers to financing through a structured conversion of illiquid assets capable of generating future cash flows into securities in equal shares that are marketable and tradable on financial markets.

Currently, asset securitization in China mainly consists of credit asset securitization, corporate asset securitization and asset-backed notes. This article elaborates on policy evolutions and legal obstacles with corporate ABS, which has seen rapid growth recently.

Policy evolutions

In October 2004, the China Securities Regulatory Commission (CSRC) issued the Circular on Issues Related to the Pilot Programme of the Engagement in Asset Securitization Business by Securities Companies, choosing credit asset securitization as a specific type of asset securitization to be piloted in the mainland.

Corporate asset securitization policy evolutions and legal obstaclesFrom 2005 to 2008, a total of nine corporate ABS products were issued, while the CSRC only issued the Guidelines for the Pilot Programme for the Engagement in Corporate Asset Securitization Business by Securities Companies (for Trial Implementation) as a guiding regulatory document.

After the US subprime mortgage crisis, the CSRC restarted its examination and approval process on the issuance of corporate ABS in 2011, and issued the Administrative Provisions on the Asset Securitization Business of Securities Companies, and the Administrative Provisions on the Asset Securitization Business of Securities Companies and Subsidiaries of Fund Management Companies in 2013 and 2014, respectively, establishing the independent legal status of special-purpose vehicles (SPVs) and laying the legal foundation for the further development of corporate ABS.

In December 2014, the Asset Management Association of China (AMAC), which is under the CSRC, issued the Administrative Measures on the Recordal of Asset-Backed Specific Plans, introducing a record-filing system for corporate ABS, and expanding and further clarifying the scope of issuers and underlying assets, leading to a rapid growth in this product. According to data from Wind, a financial data provider in the mainland, corporate ABS issuance increased by 359% year-on-year in 2015, with declining issuing rates.

Legal obstacles

Corporate asset securitization policy evolutions and legal obstacles- tablesThe core transaction structure of corporate ABS is illustrated in the chart on the left:

The core of corporate ABS is that the originator transfers underlying assets to an SPV, as a result of which the SPV holds ownership of the underlying assets, and the originator and the debtor can no longer exercise any right with regard to the assets, so ensuring the SPV’s independence in asset management.

However, there remain legal obstacles for corporate ABS – some of which concern the legal status of SPVs, the definition of “real sale”, the effectiveness of “bankruptcy remote”, the bankruptcy of SPVs and the contradiction between over-collateralization and bankruptcy remote – which can, or possibly can, make “bankruptcy remote” invalid for corporate ABS. This article offers a brief analysis of the relevant problems.

First, SPVs cannot be bankruptcy-remote entities in the true sense as CSRC regulations have no right to grant them legal entity status. For example, if an SPV is an asset management scheme, registration of changes cannot be effectively implemented in the “real sale” stage.

The current practice that an originator redeems the underlying assets if registration or delivery is still not possible when a certain indicator is triggered has, in fact, circumvented the issue of ownership change, and put the qualification of a “true sale”, and so the effectiveness of “bankruptcy remote”, at risk.

Second, “true sale” is a key prerequisite for “bankruptcy remote”. While true sale has been well defined in common law jurisdictions, the absence of such definition in China has made the effects of bankruptcy remote uncertain for asset securitization products. This could also lead to “fake” bankruptcy and “real” debt collection. For example, some asset securitization products are based on the right to receive gains from underlying assets, but this right represents the legal relationship built around the contractual agreements between the originator and the SPV, and is not a statutory right.

Such legal uncertainty has resulted in the current controversy of whether the assignment of a contract constitutes a “true sale”. Also, in the case of debt assignment, debtor notification in compliance with the Contract Law would substantially increase the costs of asset securitization; however it remains unclear whether such assignment would be a “true sale” if the debtor were not notified.

Legal protection

As the regulations on corporate ABS are gradually put in place, the market has seen greater recognition and interest in this product.

However, the uncertainty from existing legal obstacles could eventually hurt investors. Given that the corporate ABS market has further developed, China’s legislature and regulators should amend or update relevant laws and regulations accordingly to remove these legal obstacles, taking market trends and demand into account.

Only if laws and regulations can provide investors with sufficient protection will they choose to create wealth rather than engage in short-term speculation, thus contributing to a financial market that is effective and prosperous in the long run.

Jeffrey Quan is a senior partner at ETR Law Firm. He can be contacted on +86 20 3718 1230 or by email at [email protected]
Rose Mo is a trainee lawyer at ETR Law Firm. She can be contacted by email at [email protected]