China proposes tightened rules on structured notes

The guidance (《证券公司收益凭证发 行 管理办法（征求意见稿》) is open for comments until 8 February after the Securities Association of China (SAC), a regulatory body under the China Securities Regulatory Commission (CSRC) sent the circular to local security houses on 13 January, SRP has learnt.

The rules apply to private notes issued by security houses, known as ‘beneficiary certificates’ in China, which are classified into fixed income and floating income by interest payment. The former account for over half of the issuance in the country while the latter namely structured notes have grown rapidly in the past three years.

In 2021, there were approximately 44,100 beneficiary certificates issued by security houses in China, which accumulated traded notional of CNY1.02 trillion (US$150.5 billion).

As of the year-end, around 16,000 beneficiary certificates were live with an outstanding balance of CNY414.2 billion, according to the SAC.

Following the trial regulations on beneficiary certificates (《证券公司

开展收益凭证业务规范（试行）》) introduced in 2014, the new guidance comprising six chapters introduces new specific measures on debt financing instruments mostly around issuance eligibility, sales practices and risk management, according to the proposal seen by SRP.

Under the new rules, issuers must adopt a tiered management on the outstanding balance of their beneficiary certificates, which will be effective in six months. Specifically, the balance shall not exceed 60%, 50%, 40%, 30% and 20% of the firm’s net capital if the issuer’s latest rating is A, B (BBB), B (BB), B(B), C or below by the CSRC, accordingly. The proportion is set at 60% for all issuers as required by the 2014 regulations.

Issuers will be required to scale down its outstanding balance within six months and stop issuance until its balance meets the requirement if there is a rating downgrade next year.

For structured notes, the underlying assets will be required to be priced at fair value and have ‘reasonable liquidity’ covering stocks, equity indices and commodities. Products in this category shall not be tied to private asset management products (资管产品) or over-the-counter (OTC) derivatives, such as private funds, asset management schemes.

At the same time, the coupon offered by fixed income notes must not exceed 140% of benchmark interest rates, according to the proposal.

In addition, issuers must hold a derivatives trading license and meet the regulation’s criteria on core risk management indicators including net capital, risk coverage ratio, liquidity coverage ratio and net stable funding ratio over the past two years.

Under the new rules, security houses will be prohibited from issuance if it has failed to ‘deliver repayment of beneficiary certificates, severely defaulted on other debt, or severely breached other legal obligations’.

The minimum investment duration for structured notes will be seven days and the first knockout observation date must be seven days or longer after the strike date.