2023.01.29 XIE, Qing (Natasha)、ZHANG, Chi (Austin)、LUO, Danchen、ZHANG, Lin
On December 29, 2022, the China Banking and Insurance Regulatory Commission (CBIRC) issued the Measures for the Supervision and Administration of Custody Business of Commercial Banks (Draft for Comments) (the “Measures”) for public consultation. The Measures establish for the first time a unified rule on commercial banks’ offerings of custody and ancillary services, collectively defined as “custody business”, for a variety of financial products as well as investment portfolios derived from a variety of dedicated funding sources (dedicated funds) at the departmental rule level.
I. Higher-Level Legal Basis of the Measures
The higher-level legal basis referenced by the Measures include the Civil Code of the People's Republic of China, the Law of the People's Republic of China on Banking Supervision and Administration, the Commercial Bank Law of the People's Republic of China, the Guiding Opinions on Regulating Asset Management Business of Financial Institutions, and other laws and administrative regulations without explicitly referring to the Trust Law of the People's Republic of China. This may indicate that the Measures intend not to recognize trust relationships as the basic legal relationship of custody business. Notably, the Securities Investment Fund Law of the People's Republic of China is also not referenced as a legal basis of the Measures. Since the relevant laws, regulations, and departmental rules have detailed and comprehensive provisions for the custody of public funds, it remains to be seen how the overlapping or conflicting rules in the Measures and these existing provisions will be addressed.
II. Definition of Custody Business and the Scope of Custody Products
Custody Business under the Measures refers to the activities whereby a commercial bank, as an independent third party, accepts the entrustment of a property owner or its authorized agent to offer custody and relevant services for the products under its custody pursuant to the laws and regulations, as well as the custody agreement. It can be seen that Custody Business covers a wide range of activities and the custody of portfolio assets and ancillary services may fall under the regulation of these Measures.
Custody Products may include a variety of financial products as well as investment portfolios derived from a variety of dedicated funds, in which (1) financial products include various asset management products and other financial products stipulated by the financial administrative departments of the State Council. The foregoing definition indicates that financial products may include asset management products that invest funds in the form of portfolios and other financial products that are not asset management products but may be held in custody as explicitly stipulated by the financial administrative departments of the State Council; (2) dedicated funds include national social security funds, basic pension funds, enterprise annuities, occupational pension funds, money from insurance companies, and other funds held in the custody of commercial banks according to law. In other words, the products to which a commercial bank can provide custody service cover all types of financial products and investment portfolios derived from dedicated funds.
By a literal reading of the above definition, proprietary funds or funds managed by a qualified foreign investor (QFI) may be regarded as “other funds held in the custody of commercial banks according to law” as mentioned in the above item (2).
III. Separation of Custody Property
Examples of Custody Property include bank deposits and other funds, stocks, bonds, equities of non-listed enterprises, other debts, commodities, and financial derivatives. The Measures are in line with the Measures on Supervision and Administration of Wealth Management Business of Commercial Banks in respect to the separation of property of wealth management products. It stipulates that Custody Property shall be separate from the proprietary property of the commercial bank and the property of other products held in custody. When a commercial bank enters into liquidation procedures due to dissolution, deregistration, or bankruptcy pursuant to the law, the Custody Property shall not be deemed as its liquidated property. In addition, the Measures provide that a commercial bank shall create a separate accounting book and conduct separate accounting for each product under its custody, which ensures an effective separation of the Custody Property.
IV. Principles for Custody Business and Ongoing Requirements
Differing slightly from the principles provided by the Guidelines for Asset Custody Business of Commercial Banks issued by the China Banking Association in March 2019, the Measures set out the principle of “being in good faith, diligent, independent and prudent and ensuring risk isolation” for commercial banks engaged in custody business. They require that commercial banks ensure their management capacity matches the size of the assets under their custody, its business complexity, and the custody responsibilities they take, and to effectively prevent conflicts of interest and interest tunneling.
The Measures provide ongoing requirements that commercial banks need to comply with while carrying out custody business, such as risk indicators, internal governance, staffing, premises and systems.
V. Scope of Custody Business and Custody Responsibility
Compared with the current rules for custody business, the most notable stipulation of the Measures is that commercial banks shall, based on whether they have de facto controls, divide custody property into two categories, i.e., (i) the assets of which commercial banks may have custody, and (ii) other assets. The term “de facto control” cover the following circumstances: (1) commercial banks open capital accounts for custody products and hold deposits and other funds of the custody products for safekeeping; (2) commercial banks participate in the control of securities accounts opened with the securities depository and clearing institutions for custody products and have access to the account information on any change of type and quantity of the securities assets such as stocks and bonds; (3) commercial banks may, pursuant to market rules and the custody agreement, control the trading process, fund transfer, and asset flow of the custody assets; or (4) other circumstances of “de facto control” stipulated by the CBIRC. For other assets that do not fall under any of the foregoing circumstances of “de facto control”, commercial banks shall not take on responsibilities such as property custody, asset valuation, and investment supervision, while commercial banks may offer so-called “administrative management services” through contractual arrangements, such as fund transfers, asset ownership verification, maintaining investment-related documents, and recording relevant information. We understand the foregoing definition of “de facto control” excludes custodian banks having custody of the equities of non-listed enterprises and certain types of non-standardized debts. This would mean that custodian banks do not need to take investment supervisory responsibility over these underlying assets when they are unable to obtain sufficient information.
The Measures reiterate and enhance the requirement to “open a separate account for each asset management product” provided by the Guiding Opinions on Regulating Asset Management Business of Financial Institutions. Specifically, the Measures require commercial banks to clearly identify the capital accounts of each custody product in their business systems so that the account name corresponds to the name of the custody products. Commercial banks shall be prohibited from opening any securities accounts in their own name with the securities depository and clearing institution for the custody products or opening commingled accounts for different custody products.
Article 21 of the Measures lists the responsibilities that commercial banks shall not undertake when offering custody services. This is a “negative list” that puts boundaries around the responsibilities of custodians and managers. In particular, it explicitly prohibits custodians from taking on management responsibilities following circumstances whereby a product fails to pay its investors. It prohibits custodians from taking on responsibilities relating to the loss of custody assets caused by force majeure events or losses not caused by the custodian’s error or fault, which narrows down the liabilities of custodians. Notwithstanding such provisions, it remains to be tested by judicial practice how commercial banks achieve a balance between performing their custody duties and reasonably discharging their liabilities.
VI. Requirements on the Management of Custody Business
The Measures provide requirements on commercial banks for the management of custody business. Commercial banks shall establish and improve their internal governance structure for custody business, establish risk management systems suitable to the size and complexity of their custody business, have sound internal management policies for custody business, have the custody business authorization under a unified authorization management mechanism, and establish a position balance mechanism and a process constraint mechanism. Notably, the Measures highlight the requirements on the independence of custody business and the enhancement of data protection. The Measures require commercial banks to strengthen the due diligence and management of custody products and external institutions, establish a list of the custody products and the relevant clients to manage and prevent risks arising from partners of custody business, and take effective measures to prevent improper related-party transactions and interest tunneling to enhance risk isolation.
The Measures specify marketing management requirements. Commercial banks shall prohibit their business partners, such as managers or distributors, from taking advantage of the brand or reputation of commercial banks to conduct marketing activities. If a business partner uses the name of a custodian bank to carry out improper marketing activities and fails to make rectifications, the custodian bank has the right to suspend the business partnership with them according to the Measures.
VII. Regulatory Principles of Custody Business
The Measures enhance the supervision and administration of commercial banks’ custody business from both a regulatory and law enforcement perspective. Firstly, the Measures take the compliance and prudence of custody business as an important basis for the regulatory rating of commercial banks and highlight the CBIRC’s and its branch offices’ ongoing supervision of custody businesses. The CBIRC and its branch offices may, in accordance with the laws and regulations, order commercial banks that violate the Measures while offering custody services to rectify their behavior within a specified time and may impose corresponding regulatory measures. If a commercial bank fails to satisfy the qualifications for custody business, is incompetent in its custody business, or fails to carry out its custody business in a prudent manner, the CBIRC and its branch offices may, according to the laws, regulations and principles of prudent regulation, suspend the relevant business of the commercial bank. Furthermore, the Measures authorize the banking self-disciplinary organization to implement self-disciplinary management pursuant to the law. With the authorization, the banking self-disciplinary organization may take measures such as issuing a warning or suspending or canceling the membership of the relevant member.
The Measures respond to pressing issues in the custody practices of commercial banks and add boundaries to the responsibilities of custodian banks. Considering that the Measures also apply to certain products regulated by the China Securities Regulatory Commission (CSRC), the CBIRC may need to further coordinate with the CSRC to address issues regarding the application of laws and potentially conflicting rules on custody business. We will continue to monitor the situation and keep our clients apprised of the latest developments.