People's Bank of China Solicits Comments on the Measures for the Supervision and Administration of Financial Infrastructures

In February 2020, the People's Bank of China (PBOC), the National Development and Reform Commission (NDRC), the Ministry of Finance (MOF), the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) jointly released the Work Plan on the Overall Regulation of Financial Infrastructures (“Work Plan”). The PBOC shall take the lead and actively coordinate all work of the relevant regulatory authorities to facilitate the formulation of the relevant administrative measures for financial infrastructures according to the Work Plan. To implement the Work Plan, the PBOC issued the Measures for the Supervision and Administration of Financial Infrastructures (Draft for Comment) (“Measures”) for public consultation last month. The Measures aim to clarify the overall regulatory framework for financial infrastructures, improve the market entry and regulatory principles, and enhance the operational requirements and risk management. Below are some of the key provisions of the Measures:

I. Financial Infrastructure-Related Definitions

The Measures specify six types of Financial Infrastructures (FIs), i.e., (1) the financial asset registration and depository systems, (2) the clearing and settlement systems (including central counterparties engaged in centralized clearing business), (3) the trading facilities, (4) the trading repositories, (5) the important payment systems, and (6) the basic credit reference systems. Financial Infrastructure Operators shall refer to enterprise-type legal persons or public institution-type legal persons that are approved in accordance with the laws, regulations and relevant decisions of the State Council and the Measures to take charge of the construction, operation, and maintenance of FIs (FI Operators). The financial administrative departments of the State Council, namely, the PBOC, the CBIRC, the CSRC and the SAFE, shall publicize the list of FIs and FI Operators. Notably, the Measures distinguish the “financial administrative departments of the State Council” from the “financial regulatory authorities of the State Council”, specifying that the former refers to the PBOC, the CBIRC, the CSRC and the SAFE, while the later only refers to the CBIRC and the CSRC. Additionally, the national macroeconomic administrative departments as stipulated in the Measures refer to the NDRC, the MOF and the PBOC.

Particularly, the Measures specify that the finance department of the State Council (i.e., the MOF) shall perform the supervision and administration of FIs in accordance with the law. The finance department of the State Council shall, pursuant to the Guiding Opinions of the State Council on Improving the Administration of State-Owned Financial Capital, the Interim Provisions on the Responsibilities of Contributors to State-Owned Financial Capital and other requirements in relevant regulations, strengthen the regulation of state-owned financial capital in FI Operators funded directly or indirectly by the State or its authorized entities. It shall also work jointly with the relevant financial administrative departments of the State Council to formulate the financial management rules for FIs to collect the returns of state-owned financial capital in accordance with the law, unless otherwise provided by the laws and regulations.

II. Basic Principles for the Planning and Development of Financial Infrastructures

The Measures propose basic principles for the planning and development of FIs. The financial administrative departments of the State Council are required to carry out their responsibilities of systematic planning and direction, encourage orderly interconnection and promote moderate competition among FIs, require FI Operators to serve the overall situation, give priority to safeguarding the public interest and prevent FI Operators from excessively pursuing profits and taking risks. Particularly, the Measures stipulate that the State shall maintain absolute control over FIs that involve the financial security of the State and may cause risk contagion. We guess that FIs that have their IPO plans may have to put on hold in the context of the foregoing principles due to the uniqueness of FIs and their impact on the financial system.

III. Market Entry and Regulatory Principles

The market entry and regulation of FIs shall abide by the principle of “those who approve it shall regulate it and take relevant responsibility”. The Measures only apply to FIs established upon the approval of the State Council or the financial administrative departments of the State Council, while those established upon the approval of provincial governments shall continue to be regulated by the relevant provincial governments. The Measures also specify the market entry requirements for FI Operators and their senior officers and enumerate the application materials required for the establishment of the following FIs, i.e., the financial asset registration and depositary institutions, the clearing and settlement institutions, the trading facilities, and the trading repositories, as well as the approval procedures for reviewing the application upon the occurrence of certain events.

According to the Guiding Opinions on Improving the Regulation on Systemically Important Financial Institutions (the “Guiding Opinions”) jointly issued in 2018 by the PBOC, the CBIRC and the CSRC, Systemically Important Financial Institutions refer to financial institutions that are large in scale, have highly complex structures and businesses, and are relevant to other financial institutions. They provide key and irreplaceable services in the financial system, and as a result, their incapacity to continuously operate due to major risk events will result in significant adverse impacts on the financial system and the real economy and may trigger systemic risks. Systemically Important Financial Institutions include systemically important banking institutions, systemically important securities institutions, systemically important insurance institutions and other systemically important institutions engaging in financial business as determined by the Financial Stability and Development Committee of the State Council (Financial Stability Committee). It is not clear in the Guiding Opinions whether FIs shall be determined by the Financial Stability Committee as other systemically important institutions engaging in financial business. For the first time, the Measures propose the criteria for determining Systemically Important Financial Infrastructures (SIFIs). According to the Measures, a FI shall be regarded as a SIFI where any FI satisfies part or all of the following criteria and is subject to the determination opinion issued by and the regulation of the financial administrative departments of the State Council according to their division of functions: 1) having a large amount of and widespread participants; 2) having a relatively high market share; 3) conducting complex businesses, and being closely relevant to financial institutions or being interconnected with other SIFIs; and 4) providing key services that are irreplaceable in the financial market, and their incapability to continuously operate due to major risk events may lead to a significant adverse impact on the financial system and the real economy. In terms of the division of regulatory functions, the Measures are aligned with the current regulatory regime and the financial administrative departments of the State Council shall be responsible for the regulation of SIFIs and their operators. The Measures further provide that the PBOC shall be responsible for the macro-prudential regulation, which means that the current regulatory regime does not change while acknowledging the macro-prudential regulation responsibility of the PBOC.

The Measures provide that the regulation should be in line with international standards, i.e., the construction, operation, and maintenance of FIs shall align with the Principles for Financial Market Infrastructure (PFMI) and other international standards while taking local situation into consideration. In 2013, the PBOC and the CSRC respectively issued Circulars on Relevant Matters Concerning the Implementation of the Principles for Financial Market Infrastructure (PFMI) (respectively, Yin Ban Fa [2013] No.187 and Zheng Jian Ban Fa [2013] No.42), requiring the operators of financial market infrastructures comply with the relevant standards of the PFMI and carry out self-assessment and evaluation according to the PFMI standards. The Measures reiterate pertinent principles and require that FIs should follow international standards while taking the local situation into consideration.

The Measures highlight that no entity or individual shall establish FIs or operate FIs in any manner, nor shall they use such names as “financial”, “exchange”, “trading center”, “registration and settlement”, “clearing”, “trading repository” or other names that relate to FI services or similar names without proper approval.

IV.  Cross-Border Delivery of Services by Overseas FIs

The PBOC, for the very first time, provides for the cross-border delivery of services by overseas FIs, which indicates that it will become more common in imposing market entry and administration requirements applicable to cross-border delivery of services in the financial sector. The Measures specify market entry requirements, conditions, and reporting obligations in cross-border delivery. Firstly, if the relevant laws and regulations permit overseas FIs to provide services to domestic institutions or individuals in a cross-border way, the financial administrative departments of the State Council shall implement the market entry administration according to the division of their functions and the relevant laws and regulations. Secondly, overseas FIs and their operators that provide cross-border services to domestic residents or institutions shall have been offering financial infrastructure services for more than three years, be subject to the comparable and comprehensive regulations of the corresponding authorities of their home countries or regions and have not been involved in any major risk events nor have been punished by the relevant regulators for serious violations. Thirdly, under the principle of regulatory reciprocity, the operators of overseas FIs shall report their business operation status to the financial administrative departments of the State Council and the relevant authorities according to their division of functions, and comply with the relevant business operation requirements, unless otherwise provided by the State. Specifically, the operators of overseas FIs shall report their compliant operating status in overseas markets, any regulatory authorization and exemptions, business licenses and permits they have obtained in overseas markets, the self-assessment reports they prepared according to the PFMI standards, and other information required by the financial administrative departments of the State Council.

The Futures and Derivatives Law of the People's Republic of China (FDL) requires overseas futures trading venues that provide domestic entities or individuals with direct access to their trading systems to register with the CSRC and be subject to supervision and administration by the CSRC, unless otherwise stipulated by the CSRC. Overseas institutions (including overseas exchanges and other overseas FIs) are required to obtain approval from the CSRC and shall be subject to the relevant provisions of the FDL if they engage in futures marketing, promotion or solicitation activities within the territory of the PRC. Domestic institutions shall also obtain approval from the CSRC if they conduct futures marketing, promotion or solicitation activities within the territory of the PRC for any overseas institutions. The registration requirements for overseas futures exchanges to offer cross-border services to China domestic clients and the approval process for overseas institutions to engage in pertinent futures marketing activities in China, however, have not yet been specifically formulated. After the promulgation of the Measures, it remains to be seen whether the financial administrative departments of the State Council will develop further provisions on the cross-border delivery of services by overseas FIs.

V.  Requirements for Operation, Risk Management and Data Security

The Measures provide operational guidelines for FI Operators with respect to the management of key business positions, technical specifications, emergency response systems, and disaster backup mechanisms. The Measures also provide specific requirements for the management of legal, credit, liquidity, business and operational risks faced by FIs and FI Operators and require FI Operators to monitor the overall operational risks of the market, maintain market order and enhance risk management.

Pursuant to the Measures, FI Operators shall, in accordance with the relevant regulations, maintain sufficient risk reserves in the forms of margins, general risk reserves or take other measures to cover losses caused by delivery defaults, technical failures, operational errors, force majeure events and other unidentified risk events. FIs shall firstly apply their revenue to ensure risk prevention, the operation and improvement of their venues and facilities, reasonably set up profit-retention regimes, and make long-term capital arrangements. FI Operators shall not reduce investment in risk management measures for the purpose of realizing additional commercial benefits and shall maintain necessary financial resources to ensure system efficiency and the security of operations and maintenance. Domestic central counterparties such as futures exchanges and the Shanghai Clearing House have to date established multi-layered mechanisms for default handling (including margin and risk reserves) as well as Default Waterfall, so that they can monitor their members’ risk status and mitigate the impact of the default of members via default handling procedures, to protect non-defaulting market participants.

The Measures specify that FI Operators shall keep confidential the business data and relevant materials of the participants of FIs, and other data and information generated from the provision of services, as well as provide facilities to participants to obtain in a timely manner any relevant data and materials.

VI.  Inspection and Appraisal Powers for Overall Regulation

The Measures grant inspection and appraisal powers to the PBOC. Based on the needs of overall regulation and the business relevance of FIs, the PBOC may work with the CBIRC or the CSRC (based on the division of supervision and administration functions) to carry out inspections on FIs and/or FI Operators. Inspections may cover aspects including 1) whether they meet the criteria of SIFIs; 2) whether they violate the principles of prudent operation or the relevant provisions of the fair competition review mechanism; 3) whether their financial status reasonably matches the risks and costs they bore; and 4) whether they comply with the macro-prudential regulation requirements of the PBOC. FIs and FI Operators are still subject to other regulatory activities performed by the departments of the State Council based on their existing division of functions. In addition, the PBOC may set up expert groups with the relevant financial administrative departments and finance departments of the State Council to jointly perform the assessment on FIs, while FI Operators shall conduct self-assessments on an annual basis.

Outlook

The promulgation of the Measures may effectively address the challenges encountered in the regulation of FIs by PRC regulators given the rapid development of the China financial markets, especially the increasingly active cross-border trading activities and rapid development of financial technologies. The Measures establish uniform regulatory standards on market entry and exit, daily operation, internal governance, risk management and other aspects of FIs. These standards are based on China's unique situation while are in line with international practices, aiming to improve China’s regulatory framework on FIs.