Complete Regulatory Overhaul of China's
Capital Market Underway
Eiichi Sekine
Senior Analyst,
Nomura Institute of Capital Markets ResearchI.

China Securities Regulatory Commission announces planfor regulatory framework

China's capital markets are expected to undergo a complete regulatory overhaul in2011. At a forum on corporate governance held by the Shanghai Stock Exchange on 4
December 2010, Shang Fulin, Chairman of the China Securities Regulatory
Commission (CSRC), announced a five-point plan for regulating China's capital
markets, as outlined below.

1. Promote a legal framework for capital markets at multiple levels
In order to build nationwide OTC markets with unified management andsupervision, and based on the expansion of trial OTC transactions in theZhongguangcun Development Zone, an area within Beijing with a concentration ofuniversities and startup firms, enact as soon as possible the Measures on the Listing ofUnlisted Limited Liability Companies1, while at the same time consider and enact theMeasures on the Oversight of Unlisted Public Companies (Figure 1).

Figure 1: Currently planned regulatory changes for China's capital markets
New regulations

Revisions

Measures on the Listing of Unlisted

Provisional Measures for the Issuance ofLimited Liability Companies

Corporate Bonds

Measures on the Oversight of Unlisted

Law on Funds for Investment in

Public Companies

Securities
Regulation on Administration of Futures

Futures Law

Trading

Date enacted

Effective date

14 August 2007

14 August 2007

28 October 2003

1 June 2004

6 March 2007

15 April 2007

Administrative Ordinance on theOversight of Listed Companies

Source:Nomura Institute of Capital Markets Research, based on data from CSRC

1

“Measures” is the term used for administrative rules and regulations.

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Nomura Journal of Capital Markets Spring 2011 Vol.2 No.4In addition, revise the Provisional Measures for the Issuance of Corporate Bonds,
which address those corporate bonds issued on a securities exchange by listedcompanies, in order to establish methods for issuance, optimize investor structures,standardize rules, and promote mutual interaction with the interbank bond market thatis run by the People's Bank of China.

2. Revise and establish new laws regarding mutual funds
China's Law on Funds for Investment in Securities, which was promulgated on 28
October 2003 and made effective from 1 June 2004 (Figure 2), will be completelyrevised. The plan is to reference the experience gained in other countries to build an
appropriate supervisory framework for privately placed funds that makes sense inlight of the demand for and current level of development of privately placed funds
within China.

3. Establish laws on trading futures
China's Regulation on Administration of Futures Trading was promulgated on 6March 2007 and went into effect on 15 April that year. Based on the overall
experience since this regulation went into effect, and from the perspective ofpromoting the long-term, stable development of the futures market, establish a newFutures Law aimed at clarifying the legal stature of the futures market while providing
a mechanism for managing risk through trading futures.

4. Establishing a legal framework for the oversight of listed companies
Newly enact the Administrative Ordinance on the Oversight of Listed Companies,
to strengthen the oversight of the controlling shareholders, and those effectively incontrol, of listed companies.
Figure 2: Overview of Law on Funds for Investment in Securities
Chapter 1
Chapter 2

General Provisions (Articles 1-11)
Fund Managers (Articles 12-24)

Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7

Fund Custodians (Articles 25-35)
Raising of Capital (Articles 36-46)
Trading of Fund Units (Articles 47-50)
Subscription and Redemption of Fund Units (Articles 51-56)
Operation of Funds and Disclosure of Information (Articles 57-64)

Chapter 8
Chapter 9
Chapter 10
Chapter 11
Chapter 12

Modification and Termination of a Fund Contract and Liquidation of Fund Assets (Articles 65-69)
Rights of the Holders of Fund Units and Exercise of the Rights (Articles 70-75)
Supervision and Regulation (Articles 76-82)
Legal Responsibility (Articles 83-100)
Supplementary Provisions (Articles 101-103)

Source:Nomura Institute of Capital Markets Research, based on the Law on Funds for
Investment in Securities

Complete Regulatory Overhaul of China's Capital Market Underway2

In addition, establish rules governing mergers and acquisitions that incorporate
market mechanisms. Likewise, promote research on rules governing the delisting oflisted companies.

5. Build a regime for providing oversight of, and enforcing the law in,
specialized capital markets
Referencing the experience of other countries and build a specialized judiciary
optimized to the demand for supervision, aimed at enabling effective supervision ofcapital markets at both the administrative and judiciary levels. In addition, establish a
judicial policy document2 governing the application of criminal and civil law, as wellas administrative actions, related to securities futures.

II. Focus on revision of the Law on Funds for Investment inSecurities
While heading up the Ninth International Forum on Mutual Funds in China held on
2 December, CSRC Vice Chairman Yao Gang laid out four areas of the securities
industry that the CSRC would be pursuing reform of3.

1. Reform of the Law on Funds for Investment in Securities
Reiterating what Shang Fulin had said earlier, the CSRC plans to completely revise
the Law on Funds for Investment in Securities and related regulations. The basic
approach to reform is to strengthen supervision and monitoring through stricter
standards of conduct, while loosening restrictions on investment services andpromoting innovation in those services. In addition, it will create uniform standards
for monitoring and supervising wealth management products, expand the scope of thatsupervision and monitoring to an appropriate level, and work to prevent and reduce
avenues of profit not subject to supervision and monitoring.

2. Establish governance of fund management (asset management) firms
It plans to build an incentive mechanism suitable to the investment industry whilestrengthening the supervision and monitoring of the shareholders and effective
controlling parties of fund management (asset management) companies. In order tostrengthen the control function within the Board of Directors, it will incrementallyincrease the proportion of the directors who are not shareholders, thereby giving agreater role to independent directors.
2

3

3

Judicial interpretations by China's Supreme Court are used as legal precedent, binding onlower courts, and thus viewed as having a legislative function.
It also proposed strengthening controls on insider trading.

Nomura Journal of Capital Markets Spring 2011 Vol.2 No.4

In addition, it plans to consider allowing participation in the investment industry by
joint stock corporations and partnerships, and to research employee stock ownershipplans aimed at providing long-term and effective incentive mechanisms, thereby
empowering the stable and long-term development of the investment industry.

3. Reform sales channels
It has proposed further expanding mutual fund sales channels, by adjusting rules
governing participation by companies specialized in sales and by promoting theestablishment of mutual fund sales companies by individuals with such sales expertise.
In addition, provide a suitable level of centralization of services for registering
open-end mutual funds by completing the backup project aimed at creating a central
repository of data on the registration of all fund management companies.

4. Product innovation
Provide an overall system for examination and approval of each mutual fundproduct, standardize the rules and contracts for mature products, simplify theexamination and approval procedures, and consider introducing a system forregistering products without need for examination. In addition, establish a mechanism
for evaluating and examining new products.
Consider supervisory approaches that are appropriate for each type of fundmanagement firm. Next, allow fund management firms that meet certain criteria toestablish specialized subsidiaries to handle services different from those performed by
the parent company, and run a trial of management at the group level.
On the administrative side, lower the barriers to developing wrap accounts4 andproducts for qualified domestic institutional investors (QDII), setting criteria by which
each company can operate based on their own style. Encourage those fundmanagement firms that meet the criteria to develop business internationally, and at thesame time encourage mutual funds based overseas to market within China on a trialbasis.

III. Implications for overseas investment firms
The CSRC's proposed capital market regulations and investment industry reforms
are quite significant for overseas investment firms interested in developing an asset
management business in China.
This begins with their bringing with them the experience they gained overseas. The
establishment of a comprehensive legal framework for China's capital markets will
4

Wrap accounts are also referred to as separately managed accounts. Zhuanhulicai inChinese.

Complete Regulatory Overhaul of China's Capital Market Underway

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probably increase the number of opportunities for overseas investment firms to relay
to China their experiences with regulations related to their home markets, as well aswith how those regulations were implemented. China is in the process of reforming its
Law on Funds for Investment in Securities in a way that encompasses a broader swathof funds, including privately placed funds, and there will probably be portions ofJapan's Financial Instruments and Exchange Act, both in approach and in systemdesign, that will be of reference for China. The CSRC has made it a priority todevelop China's privately placed fund industry, which is closely tied to fostering
growth of startup firms and new industries.
Second is to invigorate cross-border securities trading. Building a nationwide OTC
market is significant for foreign-capitalized private equity firms in that it will provide
them with more opportunities to sell their equity stakes on the market, in addition tothe Shenzhen Stock Exchange's ChiNext market. An easing of the standards for
qualified QDII products and the trial marketing within China of overseas-based
mutual funds should also increase overseas investment firms' sales of financial
products from their home country.
Third, overseas investment firms should be able to enter new asset management
segments in China. There is a possibility that with fund management firms
establishing specialized subsidiaries, product marketing channels being expanding,and rules governing the opening of wrap accounts being eased, new segments thatoverseas investment firms can get involved in will be created. In addition, withemployee stock ownership plans being given legal status under capital markets-related
legislation, overseas firms doing business in China can probably secure a more stable
legal basis by implementing such plans5.
Figure 3: Top 10 countries/regions based on mutual fund assets
End-March 2010
Rank

Note:
Source:Country/region

1USA

2
3
4
5
6

Luxembourg
FranceAustraliaIreland
Brazil78910UK
Japan
CanadaChina

End-June 2010

Total assets($ billions)
11,205

Rank

Country/region

1USA

2,321
1,727
1,254
885
803

23456

Luxembourg
FranceAustralia
Ireland
Brazil

732
681
608
345

78910

UK
Japan
CanadaChina

Total assets($ billions)
10,500
2,115
1,486
1,136
837
807
687
671556298

The International Investment Funds Association compiles data on open-end
publicly offered mutual funds.
Nomura Institute of Capital Markets Research, based on materials from theInvestment Trusts Association Japan

5For more on the current rules for China's employee stock ownership plans, see Eiichi
Sekine, Chuugoku de no Juugyouin Mochikabukai no Setsuritsu wo Meguru Doukou(Trends in establishing employee stock ownership plans in China), Spring 2009

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Nomura Journal of Capital Markets Spring 2011 Vol.2 No.4

China already ranks among the top 10 countries of the world based on the amountof assets held in open-end mutual funds (Figure 3). The CSRC also plans to promotethe "differentiation, specialization, and globalization" of fund management firms. The
key to further growth in China's asset management industry probably lies in thecomprehensive legal framework planned from 2011. Progress in establishing a legal
framework for China's capital markets remains an important news story.

Complete Regulatory Overhaul of China's Capital Market Underway

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