Comparison of international experience and recommendations for China Nicholas Morris July 2008

Comparison of international experience and recommendations for China

Nicholas MorrisJuly 2008

Investor Compensation Schemes

Slide Slide 22

The importance of Investor Compensation

“Research [shows] large differences between countries in ownership concentration in publicly traded firms, in the breadth and depth of capital markets, and in the access of firms to external finance. ….. [which depends on] how well investors, both shareholders and creditors, are protected by law from expropriation“

Investor Protection: Origins, Consequences, Reform – Financial Sector Discussion Paper 1, World Bank

Stock markets – such as those in the UK and US – play a crucial role in economic growth

Investors and fund managers require that their money is safe before they invest – otherwise they will not

China needs strong investor protection to attract crucial funds for development

The Securities Investor Protection Fund is a key element of this protection

Slide Slide 33

Recent capital market reforms in China

Restructuring of securities companies– CSRC actions from 2004 onwards – liquidation, restructuring,

stricter supervision, capacity building– 104 securities brokerage companies now profitable, with strong

asset base Reform of stock issuance

– improving transparency, approval system, strengthening market discipline, market-oriented share issuance pricing

Liberalisation of fund management– Funds under management $448.5 billion 2007 (up from $10

billion 2002) Refinement of legal framework

– Amended company law and securities law, 1 January 2006

Data source: CSRC China Capital Market Development Report 2007Data source: CSRC China Capital Market Development Report 2007

Slide Slide 44

Key capital market events I Fast growth of stock markets

– Shanghai/Shenzhen 1,550 listed companies, market cap. US$4.48 trillion (140% GDP)

– Large scale profitable enterprises: eg Baosteel, Sinopec, ICBC, China Life, China Ping An Group, and Daqin Railway

– Highest IPOs in world – US$62.1 billion 2007 CSRC implemented stronger regulation

– Committee on administrative sanctions, Chief Inspectors office and new Inspection bureau

Capital markets opening to foreigners– Commitment to allowing foreign companies to issue RMB stocks and bonds– Credit Suisse and Morgan Stanley establishing investment banking joint

ventures (33% maximum holding)– Goldman Sachs and UBS already established


Slide Slide 55

Key capital market events II

First corporate bonds– Provisional rules for pilot issuance Aug 14 2007– Yanzi Power issued RMB 4 billion Sept 19 2007

Improved access for SME’s– Venture Board targetting high growth SME’s discussed at

Hangzhou meeting Nov 24 2007– “SME bundled bonds” (first in Shenzhen Nov 26 2007)

Housing Finance– Intra-government task force: urban/rural land policies,

urban planning, fiscal subsidies– Need to further develop credit information systems,

property registration, mortgage insurance


Slide Slide 66

Four International Investor Compensation Schemes

We compare the history, legal and regulatory structure, governance arrangements, operations and detailed rules of:

UK – Financial Services Compensation Scheme (FSCS) US – Securities Investor Protection Corporation (SIPC) Canada – Investor Protection Fund (CIPF) Ireland – Investor Compensation Company Ltd (ICCL)

The Irish scheme is included because it is an example of a scheme set up in response to the European Investor Compensation Scheme Directive (97/9/EC)

Slide Slide 77

History, regulation and legal basis for Capital Market

RegulationUK - FSCS US - SIPC Canada - CIPF Ireland - ICCL

History

1986 - SIB and 5 SRO's established 2000 - FSA established 2001 - FSCS and FOS established

1934 - SEC established 1939 - National Association of Securities Dealers (NASD) founded 1970 - SIPC established 2007 - FINRA established (SRO replacing NASD)

1968 - National Contingency Fund (NCF) 1969 - CIPF changed name

2003 - Irish Financial Services Regulatory Authority (IFSRA) established 2007 - IFSRA assumed responsbility for regulating stockbrokers under MiFID

Regulatory StructureFSA, Bank of England and HM Treasury share responsibilities across all sectors

Brokers and Dealers muct register with SEC and join SRO

Provincial Securities Commissions Securities firms must join SRO - Investment Regulatory Organisation of Canada (IIROC), formerly Investment Dealers Association (IDA).

Both IFSRA and ICCL are departments of the Central Bank and Financial Services Authority of Ireland (CBFSAI)

Legal basis Financial Services and Markets Act 2000

Securities Exchange Act 1934 Maloney Act 1938 Investment Company Act 1940 Investment Advisers Act 1940 Securities Investor Protection Act 1970 Sarbanes-Oxley Act 2002

Financial Institutions Depositors Compensation Act 1985 Financial Institutions Act 1996 Financial Consumer Agency of Canada Act 2000 Provincial Securities Acts and MOU with CIPF

Investor Compensation Act 1998 Consumer Protection Code 2007

Reason for establishment of Compensation Scheme or Company

Mid 1990's collapse of two banks, miss-selling of pensions, industry pressure

1968-70 decline in stock prices, failures of broker-dealers

1968 Three Investment Dealer failures

Required by EU Investor Compensation Directive 1997

Slide Slide 88

Governance and Organisation

UK - FSCS US - SIPC Canada - CIPF Ireland - ICCL

Governance arrangementsPublic company Board, Committees Memoranda of Understanding

Board of 7 Directors, 5 appointed by US President

Board of Directors and Committees, Industry and Public Directors

Chair and Deputy Chair appointed by CBFSAI, other Directors by Ministry of Finance

Organisation and staffing Executive Board, 6 Divisions, 211 staff

President, General Counsel, Operations and Finance, 28 staff President and CEO, 15 staff

‘Investment Service Providers Supervision’ workgroup within CBFSAI

Responsibilities Securities, Banking, Pensions, Insurance Securities only Securities (including futures and

options) onlySecurities, insurance, bonds, futures and options

Slide Slide 99

Funding and other arrangements


Funding and maximum

Compulsory levy on all firms as needed, to maximum of UKP4.4 billon(US$8.8bn). Funding arrangements revised 2008

Charges only $150 per year to firms Has funds of $1.5 billion and borrowing facility $1 billion If funds fall below $1 Billion, SIPC members assessed on percentage of net operating revenue

1987 Failure depleted NCF. Fees maximum 1% Gross Revenue per year, extra for firms with capital deficiency; Risk Review 2007, $100 million reinsurance policy acquired and new risk-based assessments on client net equity

New funding arrangements 2007 Target funding IRP10.16 million Twin Fund system for different categories of firm

Other compensation arrangements Lloyds General Fund

'Fair Funds' or disgorgement funds for each failure enforced by SEC

Federal banking, provincial and national insurance schemes for life, property and casualty

Deposit protection scheme Insurance compensation fund Credit unions compensation fund.

Advance payments?FSCS will pay if firms "unlikely to be able to pay", but only after validation

Funds provided in advance to Trustees; Direct Payment procedure for smaller claims

Often single payments to Trustee to transfer accounts and establish emergency payments system

None

Slide Slide 1010

Payment rules


Limits to payments100% first UKP30,000, 90% next UKP20,000 per customer (max UKP48,000)

$500,000 per customer, cash limited to $100,000

Cdn$1 million per account, any combination of cash and securities, after distribution from estate

90% of amount lost, maximum IRP20,000

Payments made for Default, inappropriate behaviour, misrepresentation

Only on bankruptcy, certified by SEC Only for insolvency Only for inability to return cash or

securities

Maximum time before payment 90 days, unless extended by FSA 3 months, longer if records inaccurate 4-8 weeks for auditing process Three months

Normal time limit for claims Accept within 90 days of offer, claim within 6 years of event

Subject to court and/or Federal deadlines - 60 days to 6 months

Within 180 days of date of bankruptcy

Claims must be submitted within 5 months of court ruling or financial regulators determination

Slide Slide 1111

Costs, asset allocation and exclusions


Treatment of costs Reasonable costs paid for insolvency Trustee costs paid Trustee costs paid Trustee costs paid

Customers assets Assigned to FSCS before payment

Trustee takes over assets during liquidation

Trustee takes over assets during liquidation No assignment of assets

Excluded claims> 5% shareholding, involvement in firm, contributory negligence, inadequate records

> 5% shareholding, involvement in firm - officers and directors, contributory negligence, inadequate records SIPC covers only custodial function - market losses from fraudulent selling are general creditor claims

> 5% shareholding, directors and contributory negligence

Not available to professional or institutional investors; firm must be member

Slide Slide 1212

Bankruptcy, claims and complaints


Interaction with bankruptcy FSCS determines defaultSIPC can trigger bankruptcy; will only investigate cases if listed by SEC

CIPF contacted by SRO based on "reportable event" CIPF approaches court to request appointment of Trustee

ICCL only involved after Court or Regulator determination

2006/7 Claims experience 31,200 claims No failures during 2007 No failures during 2007 No failures during 2007

Complaints and Arbitration Financial Ombudsman Service (FOS)

Referred to SEC FINRA handles investor complaints and is responsible for arbitration

Referred to IIROC, formerly IDAFinancial Services Ombudsman; appeal to High Court; formal complaints procedure

Slide Slide 1313

Rules, investor education and external compliance


Rules specified in Compensation Sourcebook in FSA Handbooks, FSCS website

SEC Rules of Practice; Claims Compensation Booklet; Securities Investor Protection Act 1970; SIPC rules

Coverage Policy document Investor Compensation Act, 1998

Investor Education Newsletter, website, brochures, free advisory service

Website, brochures, radio and TV public service announcements

Web portal, advertising policy for Members, annual report, trade shows, research report in 2008

Investor education through IFSRA

External compliance

European Convention on Human Rights European Union Investor Compensation Scheme Directive (97/9/EC).

N/A N/A

European Convention on Human Rights European Union Investor Compensation Scheme Directive (97/9/EC).

Slide Slide 1414

Common features of international schemes

1. Only pay claims to clients of authorised or member firms2. Check carefully whether the firm is in default or insolvent, or has breached

regulations, before payment3. Insist on the rights to assets being transferred (to FSCS, SIPC etc) before

claims are paid, and be active in recovering funds4. Where possible transfer the customer and his assets to another broker5. Limit claims to individuals and small businesses6. Exclude shareholders or those with influence in the firm, anyone who

contributed to the problem and other specific types of organisation7. Do not compensate for events which occurred before the scheme was set up8. Appoint Trustees (or other officials) to ensure all processes are complied with

and check all records9. Reject applications if information provided by the claimant is found to be

inaccurate or incomplete, or if there is suspicion of fraud10. Have strict time limits for claims submission and acceptance11. Set limits per customer and per claim, with detailed rules defining what is

meant by a single customer

Slide Slide 1515

Some relevant Chinese History

October 1992: State Council Securities Commission (SCSC) and the China Securities Regulatory Commission (CSRC) established

March 1995: Organisational Plan of the China Securities Regulatory Commission

August 1997: securities markets in Shanghai and Shenzhen under CSRC supervision

November 1998: National Finance Conference decided that local securities regulatory departments would be supervised directly, including those previously supervised by the People's Bank of China.

April 1998: SCSC and CSRC merged to form one ministry rank unit directly under the State Council

September 1998: Provisions regarding CSRC's Functions, Internal Structure and Personnel

Slide Slide 1616

China Securities Investor Protection Fund Co. Ltd. (SIPF)

Wholly State-owned financial institution established on approval from the State Council

Non-profit corporate body mainly in charge of raising, management and usage of the securities investor protection fund under the supervision of CSRC

SIPF was registered at the State Administration of Industry and Commerce on August 30th 2005

The State Council injected capital and the Ministry of Finance made a lump sum allocation of RMB 6.3 billion in registered capital

Slide Slide 1717

SIPF responsibilities Raising, managing and operating the securities investor

protection fund Monitoring and reducing the risks of the securities companies Repaying creditors (according to State polices) upon

securities company cancellation, closure, bankruptcy or administrative takeover/custodial operation by CSRC

Organizing and participating in the liquidation of the cancelled, closed or bankrupt securities company

Administering and disposing of the compensated assets and protecting the rights and interests of the fund

Proposing regulatory improvements to CSRC to improve the safety of investor's assets and the securities market

Establishing corrective mechanisms with the relevant authorities

Slide Slide 1818

Next steps for SIPF: recommendations

Considerable progress has been made in developing the administrative measures and rules for the Chinese compensation system

International experience can be used to consolidate these rules and develop a consolidated rulebook for the operation of the compensation system in China

Text from the FSA Handbook, from SIPA and from SEC and SIPC rules can be used as a basis for this work

Slide Slide 1919

Issues I Requirements for notification of SIPF, inter-relation between SIPF

and CSRC– Suggestion: develop detailed Memoranda of Understanding between SIPF

and CSRC (and possibly BOC and other relevant bodies) – as is usual in UK Detailed definition of which businesses are protected by SIPF.

– Observation: as the capital market develops, this will become increasingly important and the simple definition ‘broker-dealer’ may not suffice

Circumstances under which claims may be considered, including excluded categories and compensation limits.

– Observation: the UK limits compensation to individuals and sets the compensation per customer at quite a low level relative to US (or current practice in China)

Slide Slide 2020

Issues II Funding arrangements, including (a) the need for ‘emergency’

funding in the case of major failure and (b) regular levies from the Industry

– Suggestion: A detailed ‘Funding Review’ process, along the lines recently carried out in UK and including consultation processes, would be sensible.

Rationalisation of the assignment of claimants assets, and protective measures for reassignment etc

– Suggestion: Develop arrangements whereby SIPF becomes the sole custodian of assets during a liquidation to reduce inter-agency complexity

Consideration of an advance payments system along the lines of that in the US

– Observation: this could have considerable benefits for perceived security of investor assets in China’s capital markets.

Slide Slide 2121

Issues III Consideration of a ‘small claims’ or ‘direct payments’ system to minimise

administrative burden for smaller cases– Suggestion: develop and publicise detailed arrangements for smaller investors

Development, in collaboration with CSRC and the Chinese securities industry, of a ‘fair funds’ system which prevents the need for SIPF intervention

– Observation: this has been very successful in the US and has led to a reduction in the need for payments by SIPC, something that SIPF should have as a goal in the longer term.

Definition of time requirements for submission of claims, acceptance and processing of claims by SIPF

– Observation: this will assist in improving the efficiency of the Chinese compensation system and provide a basis for measuring and monitoring SIPF’s achievements

Strengthening SIPF powers in the case of fraudulent claims, inadequate records etc

– Observation: this is essential both to provide correct incentives in the capital markets and ensure efficient operation

Thank you

Questions and Discussion

Comparison of international experience and recommendations for China Nicholas Morris July 2008

Documents

Transcript of Comparison of international experience and recommendations for China Nicholas Morris July 2008