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An Introduction to the Operation of Securities Investors’ Protection Fund of China (SIPF) Chen Gongyan Chairman of SIPF. Background of SIPF’s Establishment (I): Collective Breakout of Industry Risks.
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Chairman of SIPF
Owing to the continuous bearish securities market and the structural adjustment during the six months between the end of 2003 and the first half of 2004, illegal operation consecutively breaks out in a group of securities companies, and the industry risks take upon a collective explosion momentum. The illegal operation appears as follows:
◆Financial statements do not reflect realities, serious off-book operations;
◆Embezzlement of customers’ assets, illegal high-interest financing, huge fund gaps;
◆Inadequate contribution of share capitals, inexplicit identification of shareholders, ineffective corporate governance and internal control, negligence, misconduct and even malefaction by senior management members.
◆Finance of these companies are confronted with severe difficulties. The assets of some companies cannot cover their debt liabilities, and the capital chain is broken, giving rise to the danger of being run-on at any moment;
◆The settlement system is severely overdrawn, and the entire trading system is facing serious threats. The maximum overdraft on a single business day exceeds RMB17 billion.
On the issue of industry risk management, the traditional practice shows two characteristics:
This practice functioned effectively in maintaining social stability during the time when China was under the system of planned economy and at the initial stage when the market economy was first practiced. However, due to the fact that the government bought the bill for all problems occurring, the investors lacked of risk awareness, and the financial institutions were not bounded by the market constraint, which was prone to give rise to moral risks.
The second documents is the Management Measures of SIPF which came into force on July 1, 2005. The document regulated the raising, management and utilization of protection fund as well as the establishment and management of the institution. It constructed a basic framework for systems of the Chinese securities investors' protection fund.
Management Measures of Securities Investor Protection Fund prescribes:
Human Resources Department
Assets Management Department
Legal Affairs Department
Information and Statistics DepartmentOrganizational Chart of SIPF
The policies regarding purchase of customers’ securities transaction settlement funds: to purchase the full amount of principals and interest where the fund is embezzled.
The policies regarding purchase of individual creditor’s right: to purchase the funds at different discounts according to their respective time period and amount
1. According to the prevailing purchase policy, the purchase activities of SIPF must be based on identification of the account nature: i.e. to distinguish the brokerage accounts and non-brokerage accounts, and to distinguish the individual accounts and institutional account in case of non-brokerage accounts.
2. Account sorting is the basis for risk management of securities companies. Only through well-organized control of account sorting and discrimination can the administrative liquidation agencies, SIPF and the supervisory authorities review the fund purchase application and reimburse relevant fund in strict accordance with the pertinent policies applicable for various accounts and ensure the safety and compliant utilization of purchase fund. The disordered account management and huge amount of accounts to be sorted in the securities companies bring great difficulty to the sorting process. The account nature can be determined only after a series of procedures including reviewing the original account opening information and the transaction records. A total of 11.53 million accounts were closed during the risk management process, and more than 7 million accounts were identified as normal brokerage accounts.
3. The problems and difficulties in identifying account nature are that, (1) the nature of accounts in question are difficult to be identified and largely disputable among related parties, besides, there lacks a policy basis for determination of the account nature; (2) the name of some accounts are inconsistent with the actual ownership, and some accounts opened by institutions are held in the name of individuals or vise versa; and some accounts are in the middle status, for instance, the funds are provided by institutions though relevant accounts and contracts are signed/opened by individuals, or the funds are provided by individuals though the wealth management contracts and accounts are signed/opened by institutions.
1. To dispose the securities-related assets;
2. To purchase the individual creditor’s right and the customer securities transaction settlement funds;
3. To make arrangement for staff and customers;
4. To ensure that assets are all properly disposed in the process of administrative disposal;
5. To hand over all assets and related accounting materials to the court of bankruptcy;
6. To assist the local government in maintaining social stability;
7. To properly handle the applications for bankruptcy.
1. After verification and confirmation, the administrative liquidation institutions hand over relevant application materials to the organizations authorized by CSRC.
2. Organizations authorized by CSRC examine the application materials and issue written replies, agreeing to disburse protection fund to the custodian and liquidation institutions, and send the replies to SIPF together with the examination materials and applications submitted by the custodian and liquidation institutions.
3. SIPF examination. The applicant and the authorized organizations provide supplemental materials or explanations in conformity to the format and procedures required.
4. After an application is examined and approved, SIPF disburse relevant purchase funds; and send the written vouchers and certificates to the right claimer for subsequent formalities.
5. The application for, distribution and utilization of protection fund follows the principle of “special utilization, special account management and close operations”, and embezzlement of such fund is strictly prohibited.
1. To establish the system of preliminary verification and assist the authorized organizations in verifying the application materials. To fully exchange ideas before the formal application, with a view to remove most of the formality and procedural obstacles and facilitate the progress of purchase.
2. To apply for special finance in advance. Since the sub-loans are credited to the applicant’s account in 41 days on average, SIPF applies for a sub-loan of RMB2.4 billion in advance to avoid the postponement of payment arising from inadequate funds.
The Management Measures on Special Audit for Individual Creditor’s Right and Customer Securities Transaction Settlement Funds (Trial) which was promulgated by SIPF on May 22, 2006.
In 2006, SIPF organized the accounting and law agencies to provide 29 audit inspections for 22 liquidated securities companies, in 6 times of more than 340 person times; in 2007, more than 150 person-times from those 17 agencies were engaged in 23 special audit over 13 securities companies.
◆ All normal brokerage accounts with balance of more than RMB1 million were checked one by one, and key accounts with balance of less than RMB1 million were inspected on a sample basis.
◆Audit inspection was carried out on all of the identified individual creditor’s right in excess of RMB200,000 case by case; and key creditor’s right valuing less than RMB200,000 was inspected on a sample basis.
◆As for the calculation of purchase amount, the inspection and liquidation team discovered in the special audit report that RMB1,558 million of funds was improperly included into the purchase scope due to reasons such as not-accrued interest receivables, uncollected interest payables, freezing and withholding in juridical course or by banks.
1. After the risk fund of Shanghai Stock Exchange reaches the prescribed upper limit, 20% of the transaction commission will be included into the funds;
2. Securities companies contribute 0.5%-5% of their operating income to the funds;
3. In case stocks and convertible bond are issued, the interest income earned on the purchase funds in the freezing period;
4. The income legally obtained from implementing recovery measures on the liable parties and the compensation income obtained from the bankruptcy and liquidation process of securities companies;
5. Donations from institutions, organizations and individuals at home and abroad.
Borrowings from the People’s Bank of China;
Issuance of special bonds (Have not been used yet).
Note: The payment by securities companies was worked out as per the operating income of 2007, and RMB2,791 million was paid in the first half of 2007, and the rest will be paid in January 2008.
SIPF participates into the liquidation process as an ordinary creditor
To claim the creditor’s rights to the bankruptcy manager upon receipt of the notice;
To participate in the creditors’ meeting and the Creditors Committee, and exercise the function of supervising the bankruptcy manager as a creditor.
A membership company？
With the end of last round of securities industry risk and the implementation of a series of fundamental system reforms, the Chinese securities industry starts standardized development, and the possibility of compensation becomes much smaller. Therefore, SIPF shall not limit/focus its duties to compensation, and shall properly expand the functions:
1. To improve the purchase mechanism
The current purchase mechanism is established on the basis of account sorting, and purchases the debts at different discounts as per the nature of respective accounts. This involves a wide range of parties, lots of procedures and complicated formalities, costs heavy labor and material resources, and runs on complex legal relations. What conditions shall be satisfied if limit compensation is executed by accounts? And is it the right time to implement such a system?
2. Recommendation of administrative liquidation institutions or managers
SIPF performs a public-good function and is different from the commercial institutions in nature. Therefore, is it appropriate for SIPF to recommend the administrative liquidation institutions or managers?
3. To monitor the risks facing securities companies
Through risk monitoring, SIPF may collect and sort out the risk factors existing in securities companies, and change the post-event compensation to prevention beforehand, which is an effective supplement to the monitoring and supervision function.
1. To receive and respond to the investors’ complaints
Restricted by the defects in concepts, systems and legislations, the securities investors’ disputes are usually settled in a unitary manner in China. Many investors have lodged their complaints on the website or through e-mails or in-person visits to SIPF since the establishment of SIPF. The website of CSRC and SIPF (www.sipf.com) established a column of “Investors’ Message” to hear the investors’ complaints and suggestions.
Will the SIPF become one of the institutions resolving investors’ disputes (by reconciliation and arbitration)?
2. To educate and provide services to the investors
Education to securities investors is an important part of the long-term investor protection mechanism, and bears upon the development of securities market.
Investor education and services involve a lot of public-good affairs, and do not involve the use of compulsory administrative powers, therefore, SIPF is an ideal candidate to shoulder such a responsibility. Investor education is always related to the assistance services such as consulting and complaint handling. Due to the immature market economy system and law system in China, investors have not adapted to the market economy system, and sometimes behave irrationally and unilaterally. There needs to be a special professional agency between the regulators and investors to analyze and scrutinize the issues raised by investors.
Owning to the lack of a legal entity representing the interests of public securities investors, the infringement of investors’ interest are not prevented in advance, and the public-good function of securities investors are not plaid under certain circumstances. Is it feasible to assign SIPF the function of instituting public-good litigations in any of the following situations?
The shareholders and senior management members neglect the supervision over, or fail to raise correction advices or inquiries against the irregularities in the securities companies; or they bear responsibility for asset impairment, loss or disappearance in the securities company;
Shareholders cheat on contribution of share capital (inclusive of those who did not go through the registration formalities after contribution, or those who did not transfer the management and control right), withdraw the contributed share capital, viciously dispose of assets of the securities companies, embezzle assets of the securities companies, or bear liabilities to the securities companies;
Shareholders and senior management members are involved in activities such as deceit of the securities companies, viciously reduction of the securities companies’ assets and other activities that are against the interests of the securities companies;
Shareholders and the directors/senior management members appointed by them breach the liability of loyalty and diligence, neglect their duties or is involved in other irregularities;
The substantial shareholders and actual controllers impair the legitimate interests of the securities company, other shareholders or customers by leveraging on their controlling position.