2020.09.03 XIE, Qing (Natasha)、QIN, Tianyu、FANG, Hao
On August 28, 2020, the China Securities Regulatory Commission (CSRC) issued the Administrative Measures on the Supervision of Public Securities Investment Fund Distribution Agencies (“Administrative Measures”), the Implementation Provisions of the Administrative Measures on the Supervision of Public Securities Investment Fund Distribution Agencies (“Implementation Provisions”), the Interim Provisions on the Administration of Marketing and Promotional Materials for Public Securities Investment Funds (“Provisions on Marketing and Promotional Materials”) (collectively referred to as the “New Distribution Regulations”) and the Explanatory Notes on the Administrative Measures on the Supervision of Public Securities Investment Fund Distribution Agencies and Supporting Rules (“Explanatory Notes”), which will be officially implemented on October 1, 2020.
Compared with the consultation paper issued on February 22, 2019 (“Consultation Paper”), the New Distribution Regulations made a few material changes. Below we have summarized the key points of the New Distribution Regulations.
According to Article 61, Item 8 of the Administrative Measures, unless explicitly stated as “private funds” or “private securities investment funds”, the funds under the Administrative Measures shall refer to public securities investment funds. Notably, the private funds referred to under the Administrative Measures include both non-public funds issued by private fund managers and private asset management plans issued by securities and futures operating institutions. At the same time, the Administrative Measures add a new definition of “private securities investment funds”, that is, private funds established in accordance with the Securities Investment Fund Law (“Securities Investment Fund Law”), which invest purely in standardized securities-type assets.
Pursuant to the aforementioned definition of “fund”, it is evident that the Administrative Measures regulate all types of products issued by relevant institutions under the supervision of the CSRC.
The Administrative Measures clarify the definition of “fund distribution”. Pursuant to Article 2 of the Administrative Measures, “fund distribution” refers to such activities including opening fund trading accounts for investors, marketing and promoting funds, handling the issuance, subscription and redemption of fund units, and providing inquiry services for fund trading accounts. Compared with the existing regulations, the Administrative Measures explicitly include both “opening fund trading accounts” and “providing inquiry services for fund trading accounts” in the scope of fund distribution activities.
No institution or individual may engage in fund distribution business without registration. Pursuant to the Administrative Measures, fund distribution agencies include (i) commercial banks, (ii) securities companies, (iii) futures companies, (iv) insurance companies, (v) insurance brokerage companies, (vi) insurance agencies, (vii) securities investment advisory institutions, and (viii) independent fund distribution agencies, all of which shall have obtained the qualifications for fund distribution and the License for Conducting Securities and Futures Business (“License”). Unlike the Consultation Paper, the Administrative Measures do not deem insurance brokerage companies, insurance agencies, and securities investment advisory institutions that engage in fund distribution business as a type of “independent fund distribution agency”. Besides, although the fund distribution agencies enumerated above do not include fund managers distributing products managed by themselves, Article 62 of the Administrative Measures specify that fund managers and securities and futures operating institutions distributing products managed by themselves shall also be subject to the Administrative Measures in terms of their business norms, internal control and risk management.
A “fund service institution” refers to an institution that engages in the services of payment, fund unit registration, provision of information technology systems and other services related to fund distribution.
On the foregoing basis, the Administrative Measures clarify the standards for the performance of duties by fund distribution agencies and fund service institutions.
The Administrative Measures and Implementation Provisions adjust and optimize the registration procedures for fund distribution agencies by implementing a “preparation-after-approval” system, and the application procedures are set forth as follows:
(1)If an institution wants to apply for the registration of the fund distribution qualification, it shall first submit application materials in accordance with the rules of the CSRC;
(2)The institution shall complete the preparation work for the fund distribution business within six months after completing the registration, as well as complete relevant company registration formalities (if necessary);
(3)The institution shall apply to the local bureau of the CSRC for onsite inspection and approval;
(4)After passing the onsite inspection and receiving approval, the institution may apply to the CSRC for the License.
An applicant may begin conducting the fund distribution business only after obtaining the License.
All types of applicants (including independent fund distribution agencies) shall apply to the local bureau of the CSRC in their place of domicile for fund distribution registration and the License.
For one thing, the Administrative Measures clarify the registration requirements for all fund distribution agencies, and unify the conditions required for financial institutions engaging in fund distribution business. And for another, the Administrative Measures distinguish the requirements between financial institutions and independent fund distribution agencies engaging in fund distribution business.
(1)Compared to the current regulations, the Administrative Measures raise the registration thresholds for fund distribution agencies, but moderately lower the same thresholds as compared with the Consultation Paper. For example, the Administrative Measures require that an applicant (i) has not been subject to major administrative supervisory measures within the past one year for engaging in similar businesses as fund distribution; (ii) is not currently in the rectification period due to major violations of laws or regulations, or being investigated by regulatory authorities due to suspected major violations of laws or regulations; and (iii) has no less than twenty personnel who have obtained fund practitioner qualifications.
(2)Article 8 of the Administrative Measures integrates and unifies the conditions that must be met to engage in fund distribution business for commercial banks, securities companies, futures companies, insurance companies, insurance brokerage companies, insurance agencies, and securities investment advisory institutions. It is worth noting that the Implementation Provisions specify that the subsidiaries of a securities investment fund management company (FMC) that specialize in fund distribution business must also meet the requirements under Article 8, from which it can be inferred that subsidiaries of FMCs that specialize in fund distribution business are not deemed a type of “independent fund distribution agency”.
(3)The Administrative Measures further raise the registration thresholds for independent fund distribution agencies. For example, under the Administrative Measures, an independent fund distribution agency is required to have net assets of no less than RMB 50 million rather than have a registered capital of no less than RMB 20 million. Meanwhile, the Administrative Measures clarify the requirements for shareholder holding more than 5% equity, controlling shareholder and foreign shareholder of an independent fund distribution agency.
For shareholders holding 5% or more equity of an independent fund distribution agency, the Administrative Measures adjust and refine the requirements from the Consultation Paper. Specifically:
(a)Regarding requirements for the capital strength of legal person shareholders or shareholders in the form of unincorporated organizations, the Administrative Measures reduce the net assets of no less than RMB 100 million, as stipulated under the Consultation Paper, to RMB 50 million, but further require that the shareholding structure of such shareholders shall be clear and describe every level of ownership through to the ultimate beneficial owners;
(b)Regarding work experience requirements for natural person shareholders, the Administrative Measures are more relaxed than the Consultation Paper, reducing the number of years of experience needed: more than five years (instead of ten years) of experience as management personnel of the securities and fund department or more than three years (instead of five years) experience as a senior executive of the securities and fund industry.
In terms of the controlling shareholders, the Administrative Measures raise the requirements for the capital strength and work experience of controlling shareholders:
(a)For a legal person shareholder or a shareholder in the form of unincorporated organizations, the Administrative Measures add several new requirements, namely, such shareholder shall (i) be consecutively profitable for the most recent three fiscal years, (ii) have net assets of no less than RMB 200 million, and (iii) have a good financial status and capital replenishment capabilities, as well as sound internal control;
(b)For a natural person shareholder, the Administrative Measures require them to have (i) personal financial assets of no less than RMB 30 million; and (ii) more than ten years of work experience as a management personnel of the securities and fund business department, or more than five years of work experience as a senior executive of the securities and fund industry.
Notably, the Administrative Measures impose a three-year lock-up period on controlling shareholders. Article 13 of the Administrative Measures prohibit independent distribution agencies from changing their controlling shareholders or de facto controlling relationships within three years from the date of obtaining the qualifications for fund distribution.
In addition, the Administrative Measures also clarify the governance requirements for a controlling shareholder, namely, a controlling shareholder is required (i) to formulate a reasonable and clear business plan for investing in an independent fund distribution agency, (ii) to have practical plans for improving the governance structure of the independent fund distribution agency, maintaining the independence of the independent fund distribution agency with respect to its operation and management, and promoting the long-term development of the independent fund distribution agency, as well as (iii) to formulate reasonable and effective risk disposal plans for the circumstances where the independent fund distribution agency is likely to be exposed to risks that may prevent it from normal business operation.
We note that the foregoing requirements for controlling shareholders to some extent align with the requirements for major shareholders of FMCs, which demonstrates a prudent attitude of the CSRC over the registration of independent fund distribution agencies.
With respect to foreign shareholders, the Administrative Measures for the first time list out the requirements for the foreign shareholders of an independent fund distribution agency, namely, (i) the foreign shareholder shall be a financial institution established and legally existing in accordance with the laws of the country or region where it is located, with experience in financial asset management or investment advisory business; and (ii) the securities regulatory authority of the country or region where the foreign shareholder is located has entered into a regulatory cooperation memorandum with the CSRC or other institutions recognized by the CSRC, and maintain an effective regulatory cooperation relationship with the CSRC.
The Administrative Measures, as authorized by the Securities Investment Fund Law, improve the mechanisms for cessation of fund distribution business and revocation of fund distribution licenses, and specify that fund distribution agencies shall bear the obligation to cooperate with fund managers in properly handling the relevant businesses including investors’ redemptions and transfer of custody in case that their fund distribution licenses are cancelled or they have lost the capacity to operate.
The Administrative Measures draw on mature regulatory experience and implement license renewal arrangements for fund distribution agencies newly registered after the issuance of the Administrative Measures, while simultaneously providing that fund distribution agencies under any of the following circumstances shall not renew their fund distribution licenses, namely, (i) failure to meet basic conditions required for conducting fund distribution business, (ii) serious lack of compliance and internal control, and (iii) not engaging in public fund distribution business in substance. According to Article 52 of the Administrative Measures, the validity period of the license shall be three years from the date of issuance; if the license expires and the fund distribution agency does not fall under any of the foregoing circumstances prohibited from renewal, the license shall be renewed; the validity period for each renewal shall be three years.
Different from the Consultation Paper, the Administrative Measures adjust the restrictions on the business scope of independent fund distribution agencies by allowing fund distribution agencies to distribute private securities investment funds in addition to public funds; meaning that, after the official release of the Administrative Measures, independent fund distribution agencies may only engage in the distribution of public and private securities investment funds, and shall distribute neither other types of private fund than private securities investment funds such as private equity-type investment funds, nor private asset management plans issued by securities and futures operating institutions. Independent fund distribution agencies that currently distribute products in violation of the foregoing requirements shall make rectifications.
Pursuant to Article 12 of the Administrative Measures, the shareholders of independent fund distribution agencies, and the controlling shareholders and de facto controllers of such shareholders shall invest in no more than two independent fund distribution agencies, of which at most one independent fund distribution agency can be controlled by such shareholders and de facto controllers.
Part 4, Section 2 of the Administrative Measures puts forward specific requirements on the internal control and risk management of independent fund distribution agencies in terms of risk control, branch management, business scope, and operation of self-owned funds, reflecting the prudent regulatory attitude towards independent fund distribution agencies.
The Administrative Measures introduce a new dedicated section, titled “Internal Control and Risk Management”, which requires all fund distribution agencies to establish, improve and effectively implement internal control and risk management systems for fund distribution business in accordance with the principle of prudent operation. The Administrative Measures also require fund distribution agencies to designate specific compliance and risk control personnel to review the operation of the fund distribution business, internal systems, fund marketing and promotional materials, new products, new business plans, etc., to ensure the independence and effectiveness of compliance and risk control personnel in performing their duties, as well as to strictly prohibit compliance and risk control personnel from concurrently holding positions that conflict with their compliance duties.
The Administrative Measures use an entire section to strengthen the management and control of risks with respect to private fund distribution in terms of investor due diligence, product due diligence, risk disclosure, and management of conflicts of interest. It is worth noting that, compared with the Consultation Paper, the Administrative Measures further require a fund distribution agency to establish a special identification, evaluation and prevention mechanism for conflicts of interest in the private fund distribution business. Fund distribution agencies shall implement a strict conflict of interest assessment mechanism for private fund managers and private funds that have related party relationships with the fund distribution agencies; if the assessment indicates that relevant conflicts cannot be effectively prevented, the fund distribution agencies shall not distribute relevant products.
At present, some fund distribution agencies in the market provide investors with asset allocation services by distributing funds managed by affiliated private fund managers. The above restrictions may have certain impact on such business model. Accordingly, fund distribution agencies must demonstrate that they can effectively prevent conflicts of interest by establishing a comprehensive conflict of interest prevention mechanism, which as a consequence places higher requirements on the internal control of fund distribution agencies.
Regarding the practices where fund managers and fund distribution agencies cooperate with third-party online platforms that do not hold financial licenses to distribute fund products, the Implementation Provisions clarify the business boundaries and bottom-line requirements for cooperation between fund distribution agencies and third-party online platforms.
According to the Implementation Provisions, “third-party online platforms” refer to portals, applications and other online service platforms operated and managed by third-party institutions other than investors, fund managers and fund distribution agencies. The Implementation Provisions support fund managers and fund distribution agencies to conduct business through third-party online platforms, subject to the following requirements:
(1)The investors shall be clearly informed of the entity providing the fund distribution services (i.e. the fund manager or the fund distribution agency);
(2)Third-party institutions shall only provide information technology services and shall not intervene in any stage of the fund distribution business;
(3)Third-party institutions shall not collect, transmit or retain any fund trading information of investors;
(4)Fund managers and fund distribution agencies are the parties responsible for the provision of fund distribution services to the investors.
The Implementation Provisions require third-party institutions to file with the CSRC in accordance with the Securities Investment Fund Law and the Administrative Measures on the Information Technology of Securities and Funds Operating Institutions, and also clarify the filing requirements for fund managers and fund distribution agencies engaging third-party institutions.
The Implementation Provisions for the first time put a cap on client maintenance fees, that is, for the number of fund units distributed to individual investors, the agreed ratio between client maintenance fees and fund management fees shall not exceed 50%; for the amount of fund units distributed to non-individual investors, the agreed ratio between client maintenance fees and fund management fees shall not exceed 30%.
Client maintenance fees, i.e. trailing commissions, act as an incentive for fund distribution. In current practices, fund managers heavily rely on third-party agencies for distribution. The proportion of trailing commissions varies according to the capabilities of distribution channels, and the trailing commissions of some distribution channels (e.g., banks) may be as high as 70-80% of the fund management fees, which puts a lot of pressure on small and medium-sized FMCs. We expect that this time by putting a cap on trailing commissions, the pressure on FMCs arising from excessive trailing commissions may likely be eased to some extent.
The Administrative Measures abolish the pre-filing requirements for marketing and promotional materials, and change it to an internal review and archival mechanism implemented by fund distribution agencies. The Provisions on Marketing and Promotional Materials, which were issued along with the Administrative Measures, detail the provisions on fund promotional materials in terms of performance data, shareholder information, and preparation of special promotional materials. It is worth noting that Article 15 of the Provisions on Marketing and Promotional Materials expressly provide that fund marketing and promotional materials shall not use content prohibited by the Advertising Law, the Anti-Unfair Competition Law, and the Anti-Monopoly Law. It follows that if the fund marketing and promotional materials violate the foregoing rules, in addition to the regulatory measures taken by the competent regulatory authorities, the CSRC may also take corresponding administrative regulatory measures.
It is noteworthy that although the new regulation eases the burden to some extent of filing and approval imposed on fund distribution agencies, but imposes more strict regulatory requirements on fund marketing and promotional materials. Fund managers and fund distribution agencies are still advised to strictly review the promotional materials to avoid relevant compliance risks.
The Implementation Provisions specify the mandatory provisions of a distribution agreement. In addition to the provisions regarding the continuous services for fund investors and the division of responsibilities with respect to anti-money laundering, the Implementation Provisions also insert provisions on the division of obligations and responsibilities between a fund distribution agency and a fund manager with respect to information disclosure services, and performance of due diligence obligations regarding anti-terrorist financing and non-resident financial account tax-related information, and explicitly require the distribution agreement to provide for the continuous service arrangements for fund investors when the business of the fund distribution agency terminates.
The Implementation Provisions clearly stipulate that when a fund distribution agency promotes a fund product to investors, the fund risk level referred to by the distribution agency shall not be lower than the fund risk level determined by the fund manager. We believe such requirement will solve the investor suitability problem caused by the inconsistency in the fund risk level of the same product as respectively determined by the distribution agency and the fund manager.
We notice that the Administrative Measures remove the provisions under the Consultation Paper that allow fund managers and fund distribution agencies to provide fund portfolio distribution services to fund investors. We understand that fund portfolio distribution services are by nature the same as the fund investment advisory services which are currently in a piloting stage, and thus shall be subject to the relevant provisions of the Administrative Measures on Securities and Fund Investment Advisory Services (Consultation Paper).
Apart from the foregoing provisions, the Administrative Measures put emphasis on the bottom-line requirements for fund distribution behaviors, refine the requirements for disclosure of fund distribution expenses, continuous service for clients and other investor protection and service requirements, and promote a long-term evaluation mechanism for fund distribution business. The Administrative Measures, as a whole, demonstrate a regulatory trend of strict supervision and prioritization of investor protection.
In order to ensure the successful implementation of the New Distribution Regulations, the Implementation Provisions specify the grace period for some regulatory requirements:
1. Two-year grace period granted under either of the following circumstances (1) when shareholders of an independent fund distribution agency do not comply with the Administrative Measures, and (2) when an independent fund distribution agency engages in distribution businesses other than distribution of public funds or private funds. With respect to the latter circumstance, an independent distribution agency shall reduce existing businesses in an orderly manner prior to expiration of the grace period, and once the grace period expires, it is only allowed to continue services with respect to such existing businesses for fund units that have already been acquired by investors.
2. One-year grace period granted for matters such as staffing, information technology systems or distribution documents that a fund distribution agency shall rectify according to the new regulation.
We will continue to monitor the situation and keep our clients apprised of any important developments.