The Department of Natural Resources and the China Banking and Insurance Regulatory Commission (CBIRC) made considerable efforts to promote the business model of “property conveyance with the encumbrance of a mortgage,” but the results were unsatisfactory.

The complexity of the legal nature of this mode may be one of the major obstacles.

Here is Fnlegor’s explanation of the legal aspects to provide some clarification.

• Conveyance with Mortgage is a new concept in the Civil Code.

In the past, property burdened with a mortgage could not be transferred until the credit had been fully satisfied and the mortgage released.

The Civil Code completely changes the basic logic by allowing the transfer of property with an active mortgage. Article 406 means that the creditor may continue to hold a security interest over the property even after the ownership has changed. From the creditor’s perspective, the debtor remains the same, the collateral remains the same, and the only difference is the security provider, who is now the new owner of the property.

In other words, the buyer of the property takes the risk of the mortgaged property being disposed of by the secured creditor.

• 3 Ways to effectuate the conveyance of property with a mortgage.

The governmental bodies point out three methods to resolve this issue in their joint notice. The main issues for each method are how to establish the secondary mortgage and whether the original debtor should be changed. The following is an elaboration of each method.

1. Mode of mortgages co-existing on the seller’s side.

The process involves the seller, who has mortgaged their property in favor of their bank, purporting to sell it and setting a mortgage for the buyer’s credit bank as the secondary mortgagee to help the buyer obtain a loan over their future ownership.

The issue is that the buyer’s bank may only grant credit based on the collateral’s surplus value since their mortgage is secondary at the time of attachment. Although the prior bank’s mortgage may terminate upon full satisfaction, there is still a chance for business to go awry, such as the sales contract being canceled or the buyer becoming unable to perform further, which may expose the advanced line without full security.

The two mortgages by the seller differ legally, with the seller’s bank having a claim on the debtor’s own property, while the buyer’s bank has a claim on a third party’s property (the seller is the third party in relation to the buyer’s loan with their bank). Due to this difference, the buyer’s bank, which may not be familiar with the seller’s indebtedness, may be affected by potential claims on the property by the seller’s other creditors.

1. Mode of mortgages co-existing on the buyer’s side.

This mode varies in the sequence of transferring the title before setting the secondary mortgage for the buyer’s bank. This time, since the title has changed, the buyer becomes the mortgager for their bank, while the seller becomes a third-party security provider rather than having a claim on their own property (the seller is still the debtor, but not the property owner).

The risk for the buyer’s bank is reduced, while the risk for the seller’s bank is somewhat increased. Despite the seller’s bank’s mortgage remaining on the property and its priority remaining unchanged, the property owner has changed to a familiar one who, if overindebted, may have a negative influence on the bank.

1. Mode of debt assignment

Debt assignment differentiates from credit assignment in that the former requires consent from the creditor, while the latter does not. Additionally, the subordinate security may not be transferred accordingly due to the change of debtor, which increases the risk for the security provider.

Both mortgages are on the buyer’s side, as shown in Mode 2. However, as a result of debt assignment, the debtor of the seller’s bank changes to be the buyer.

By Qi Lyu

China is planning to establish a national financial regulatory administration (NFRA) to oversee the entire financial industry, except for the securities sector.

This article compares China’s proposed regulatory structure with the contemporary UK version.

1. In the UK, the Financial Services Authority (FSA) was removed as the sole prudential and conduct regulator due to its failure to protect the economy during the financial crisis. China is now planning to integrate one.

2. The current UK structure is a two-peaks plus one, comprising mainly of the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) after the enforcement of the Financial Services Act 2012.

China, on the other hand, divides the entire financial industry into two parts: the security sector and non-security sectors, with the former remaining regulated by the CSRC while the latter will be covered by the planned National Financial Regulation Administration.

3. The UK imposes the responsibility of all institutions and authorized persons on the PRA, with the primary objective of promoting the safety and soundness of PRA authorized persons. In contrast, in China, institutions that engage in regulated activities, apart from the capital market, are subject to authorization by the NFRA, as well as their authorized persons.

4. The FCA is designed to regulate UK banks for their conduct of business, consumer protection, and capital market. In contrast, China’s proposed NFRA will regulate both financial institutions and conduct, except for the security sector, while the consumer protection functions may be integrated with the previous part by the People’s Bank, the CBIRC, and the CSRC.

5. Given the potential regulation overlap between the PRA and FCA, a number of coordination mechanisms have been established, such as the statutory duty to cooperate, the duty to prepare a Memorandum of Understanding, cross-membership of boards, and veto devices for the PRA.

However, the situation in China is currently at the stage where only a framework has been submitted to the national legislature, with no further details disclosed.

By Qi Lyu

While the whole world began regulating personal data tightly, the environment in China was described as “uniquely restrictive”. China’s Personal Information Protection Law (PIPL) has been regarded as the Chinese version of the European Union’s General Data Protection Regulation (GDPR), while even stricter than the latter. The requirements by the law have impacted on the whole financial industry, where sensitive data is highly concentrated. The watchdog emphasised and scrutinized it as an annual focus and has in August launched a special 3-month project for the industry to self-correct itself. The Chinese financial world is being pushed to actively analyse, appraise, and execute the legal requirements. Here are their major concerns in operation.

1- The survival of new credit reporting agencies with personal data

Credit reporting agencies (CRA), as outside supporters, play a significant role in the process of banking due-diligence. But in China, only three agencies have so far been licenced to engage in personal credit reporting business. Except for the earliest one subordinating to the Central Bank, the other two are basically privately-owned, who suffer the toughest hindrances because of their incapacity to obtain individual consent before processing personal information. However, information processed by CRA is largely classified as sensitive data, which necessitates specific and prior consent for each processing purpose under the PIPL. For CRA newcomers, it is hard to find their lawful starting point to accumulate their personal database, let alone deliver it to financial customers.

2- The Possibility of cross-marketing within a financial institution or a group

Due to the sensitive nature of most financial personal data, financial firms are not allowed to process this data beyond their original service purpose. The restriction is based on the specific business rather than the internal legal entity or financial group, although it is permissible under GDPR. This would make the highlighted cross-marketing impossible. For example, you can not sell a wealth management product to your loan customer without first obtaining his ante-consent for such a category of product with a reasonable explanation of rationale and necessity.

3- The contradiction over the personal information archiving period

There are opposing viewpoints regarding the retention period of archives containing personal information. PIPL keeps the shorter the better principle as long as the process purpose is achieved, while the trend for the financial industry is the longer the better, with many financial institutions storing it permanently. China’s Anti-laundry Money Law requires at least a 5-year archive period after the completion of the financial transaction, as well as no less than 150 regulatory documents requiring various durations and varied calculations. The store period of PIPL derives from the consumer’s right to be forgotten and permits exemptions only to otherwise stipulations by law and regulations, while the foregoing files are most regulatory documents. Which concern prevails is undetermined.

4- The reporting duty to the regulators and notification duty to the customer

The PIPL specifies two strings of rather strict restrictions over the government: only legislation and regulations are authorised to stipulate processing personal information with consent, and even so, a notification is still needed by both the provider and recipient. However, the actual procedure works totally differently, as no notice has been given in the case of a regulatory requirement. Maybe the whole industry is waiting for the first customer complaint or lawsuit over this issue to make the practical rule clear.

5. The duty of security appraisal for cross-border personal data flow

The PIPL demands a (Cyberspace Administration of China)-led security assessment for cross-border data transfer to companies with a certain volume of personal information. Banks are obviously among them since their credit cards and debit cards support tonnes of overseas transactions every day. But should all 4000 Chinese banks take part in such an assessment, or should only be for those card settlement entities such as Unionpay, Master, or Visa? There has been no response, and no authority has claimed responsibility.

6. The cost of guaranteeing consumer rights

Many kinds of rights have been listed in the PIPL including but not limited to the right to inquire, to copy, to delete, etc. There was a related case that happened and scared the financial industry. A customer requested that a luxury e-merchant offer and copy all of the seller’s personal information, from historic orders to browser records, automated decision making, the names of SDK, the receipt name, and so on. The seller wanted to limit these to the customer’s profile column but was denied by the court. The seller also argued it would be a huge cost for the whole industry. The courts decided the customer’s rights prevailed. What if this occurred to a bank? The bank may not even be able to gather all the information it holds while sparsely stored. To fulfill this duty, the financial firm has to store all information in a centralized IT system and employ a suitable managerial scheme.

7. The ambiguity over each body’s regulatory scope

The PIPL legislative landscape features multiple authorities undetermined for the financial industry, which enables CAC (Cyberspace Administration of China), MIIT (the Ministry of Industry and Information Technology ), MPS (Ministry of Public Security), PBOC ( the People’s Bank of China) ,or each financial regulatory authority, or even all of them, to sanction a financial institution for the violation of PIPL. In the event of any unfinalized issue, say for instance, the appraisal of the legitimacy of a financial app, financial firms are always confused with whom to report to.

By Qi Lyu

The biggest legal challenge for China’s wealth management sector does not lie in suitability tests but in quasi-class actions.

I had the above recent discovery when I was preparing a training class for China Trust Society on the topic of consumer protection, where I found a top trust company was judged to be liable for 17 Tranche B holders for their breach of trust contracts. This was the Citic Trust. And as more case research is executed, more trust companies involved in such quasi-actions appear, with big names like Xinjiang Trust, Evergrande Trust,Minsheng Trust among them.

 I consider it over and come to aconclusion that the quasi-class actions based on breach of fiduciary duty may be more potentially threatening to Chineserising wealth management sector than the ambiguous term “suitability” .

Dutyof suitability is formally adopted at the judicial level by the widely-known “Jiu Min Ji Yao” (Memo of the National Conference for the Work of the Court in the Trial of Civil and Commercial Cases, issued by the Supreme People’s Court) in November 2019. The basic requirements for suitability are on financial institutions, including knowing your customers, knowing your products, and matching them well, which was performed rather strictly and produced some unanticipated losses on banks’ side. The whole wealth management sector is busy building their suitability-compliance devices to defend themselves.

However, the non-compliance with suitability requirements causes only a particular problem with individual customers, while the quasi-class actions could be a whole disaster tothe product issuer.

China has built her own version of class action in recent years in the securities market called the representative litigation regime, which does not cover the wealth management sector yet. The reason why it could be named as a quasi-one is that they share some common features: the basic facts are similar, the lawsuits are advocated by attorneys, and the judgments are under a uniform scale.

This set of Citic-Trust cases is a typical one, conforming with these points well:

Citic-Trust was challenged in a case for his two collective trust schemes for his violation of fiduciary duty and eventually lost the case after the appellate proceeding in 2018. The other 17 cases flooded into the court, led by the same attorneys in 2019, and received all judgments on November 29, 2019 with each reference to the prior sample decision.

The facts are as follows: Mr. Cai invested 1 million yuan into Citic Trust No.27 Scheme to be a Class B subordinate holder in May 2015. N0.27 was to investin the securities market. The procurement process is not completed in a vis-a-vis manner; rather, the related documents are delivered to the plaintiff by a third party with Citic Trust authorization and posted back and forth after each signing.Seven months later, No. 27 liquidated with a net value of 89 and 89.63 each on June 26 and 29t. The litigation arises

Given the precedent case on the same verdict, the reasoning and analysis all follow the former template:There aretwo kinds of duty violations in the trustee’s performance: the first string is not with specific operation; this regards not reminding  the product’s risk appropriately and did not making disclosure sufficiently; the other layer is closely related to the specific operation, where the trustee neither issues margin call before the forced closure nor liquidates timely, causing an enlarged loss. Mr. Cai  recovered  ¥153645.26.

All 17 cases were judged against the trustee with a calculated damage of nearly 15% of their investment, which could almost cure the investor’s loss on principal. The total Class B of N0.27 amounted to 87,900,000 with the unfortunate result that Citic Trust gained less than ￥140,000 under this product.

What could be worse is that this may not be a unique case with Citic Trust, but with other trust companies with malpractices. Such a problem could even be an industry disaster since some are embedded in the present business model: For those products sold through intermediary firms, who take a heavy part of the remuneration, flaws in the exercise of suitability duty and informative duty are always inevitable. As to strict compliance with the duty to fully disclose and timely inform and liquidate, it may still be too professional for Trustcompanies who are used to doing channel securities business (pass-through business) while having to burden liabilities themselves.

In April, the State Council started to build a national unified market. In July the Supreme People’s Court affirmed to accelerate it with effectuate judicial services. Those are both great and long expected developments.

For SCF ( supply chain finance), a definite and clarified rule system is a requisite facility which at the present stage is mainly implanted from the U.S UCC-9 (Uniform Commercial Code Article 9) and incorporated the civil law system jurisprudence as well. Here are the most pressing 10  issues affecting the options of business models.

1-Drawing a line between true factoring and disguised lending

 Factoring and lending are both types of financing as well as bill acceptance, bill discount, and financing guarantee. They are usually covered by one credit line, which is intended to share a maximum amount security for all specific credits. They are not of the same nature, but are instead parallel notations subordinate to the terms of finance.

However, there is a new trend to pierce existing financing including factoring to be lending when all under the umbrella of one credit line. That is partially due to the recent popular substantial determining approach in trial practice, as well as the limitation of individual judge’s personal acknowledgment. But it is horrible for factoring, since the security interests may turn invalid accordingly when the nominal prime legal relation is judged void, where the recourse factoring, a typical transfer by way of security, may lose its cushion. The test line for the terms needs to be clarified.

2-Who owns the surplus value in case a non-recourse factor collects more 

A non-recourse factor may advance partial commercial AR but recover the whole, if all goes well. Then who is entitled to keep the gap, the seller or the factor? China civil code gives his answer for the latter despite it against the international factoring custom and domestic banking practice

That is not a simple formula as of recoup amount minus advance amount, instead, it is a explanation of basic legal relationship. What is full protection for bad debt,a basic factoring function? Is it a whole AR outright sale ,or a guarantee to the customer against payer’s credit risk which authorizes the factor to collect the whole but to keep the indemnity he suffered only.

3-What elements work in determining the certainty of future AR

Future Accounts Receivable (AR) value uncertainty is separate from the unidentifiable. The former is within the sphere of the creditor’s autonomy, while the latter denies it to be qualified collateral.

Here is a question: when an agreement on a subject, matter, and quantity is achieved,  is it sufficient for binding? Is the monetary debt under it qualified AR collateral as well? It seems a logical consequence. Then is the advertising fee under a one-year term agreement between Guangdong TV and Gree A.C. identifiable? Further, would allA.D. (advertising) fees that GD TV is going to receive in 2023 be considered? Is it a qualified collateral like a highway fee? The answer to thisquestion may determine the scope of the AR collateral.

4-How to enforce an AR collateral

When bringing an action in court for outstanding debt, what is allowed to attach? To notify the payer and wait for his active fulfillment, or to attach those desired assets with the AR amount at the creditor’s discretion, since the debtor is due to pay with all his assets for the AR eventually.

The extent andthe proceeding to enforce makes a huge difference when the creditor seeks a cure for default. The AR collateral itself is intangible and unattachable, whereas the payer’s whole assets may effectuate the credit substantially.

The effectiveness of AR enforcement affects the willingness to accept it as collateral.

5-Would Bona fide rule apply to the case of title transfer with possession retained

Sale-and-leaseback is a widely used subtype of financial lease, where the possession of property is unchanged with only the title transferred. The leasee capitalizes his assets this way effectively, while also getting space to commit fraud by selling the asset multiple times due to his possession status. The tough question is left to the court: who to protect? The former buyer or the latter one? What doctrine could the court rely on, and will the bona fide rule apply?

 Actually, most Chinese jurists are against protecting the prior transaction, since the former buyer chooses the business model knowing the possession status may misleadingly indicate the ownership, so it is his turn to burden risk when a third party is involved in bona fide. However, the conflicting two transactions are of the same structure, and the only difference lies in the latter’s luck, with no actual risk having occurred. How to make a reasonable risk allocation? This could be a general issue, not limited to financial leasing but all sales retaining possession transactions, such as sales + consigning.

6-How to rank securities over warehouse receipt and over inventory related.

China has no separate warehouse receipt law, where the related issues are mainly governed by a specific chapter on warehousing contractin the Civil Code. Meanwhile, China is accelerating atransferable warehouse receipt system.

Then, what if the owner grants the receipt to bank A as security interest while granting regard to inventory to bank B? The related judicial interpretation by SPC provides the priority by timing date, which differs from UCC-9’s style as of locking up inventory into receipt at its issuance.

A derivative issue is: What if the fixed inventory charge was converted into a floating charge? In China, inventory is expressly listed as qualified collateral for floating charge, but warehouse receipt is not, although the underlying asset is identical. Would the prior floating charge cover the later attached receipt pledge?

7-What is the perfection manner for digital warehouse receipt, registration or possession?

China has built a centralizedmovable registration database, which may facilitate a perfected system for warehouse receipt. The rule regarding digital receipts, on the other hand, is dependent on whether the receipt is defined as having a certificate or not. The one with a certificate is perfected by possession, while the other is by registration. Who can define the issue of with or without a certificate? The receipt issuer.

 That may cause confusion when the issuer offers variant explanations to various bailors, which has occurred inQindao Port event and the recent Foshan aluminium commodity event, and obviously, could occur again. The key point may not be economic efficiency, but economic interests over separate but sparse digital systems.

8-Any Necessity to further divide goods into inventory and equipment

It is closely related to PMSI (purchase money security interest) device. China requires a perfection deadline of within 10 days after delivery. It is uniformed without further discerning inventory from equipment, in contrast to UCC’s requirement of 20 days for equipment and before the delivery date for inventory.

The Chinese PMSI version suits the equipment better. Potential risks may emerge in the case of a highly fluid inventory. In the event that a bank spots another PMSI held by the seller retaining PMSI at his registration but after his advance, the seller may enjoy the priority based on the timing sequence, which is hard for a bank to expect before his advance.

9-How to determine the priority among consecutively attached while conflicting existed PMSIs

A supply chain usually includes many links, and each link unpaid fully may set a PMSI, which means several PMSIs could co-exist over the same batch of movables. Take a car, for instance. If the engine supplier, the manufacturer, and the dealer all retain their titles and perfect it, the car is subject to several valid PMSIs provided the creditor has not paid off. Who might enjoy the PMSI first?

  In another circumstance, if all prior PMSIs die in the ordinary course of business rule when titles are transferred, only the final PMSI survives. But if so, how could the former parties be protected for their unsatisfied credits.

10-The relation between fixed charge over the movables and account receivables from the sales of the movables 

A regular question raised in supply chain finance is which style is better, over goods or over AR. Given China’s security over goods does not cover the proceeds from its sales, both could co-exist separately. Take Gree AC as an example again. A dealer grants Bank A security over AC inventory while granting Bank B security over AR.  Who ranks as superior when the dealer defaults? By timing first rule or by ordinary course of business rule, the result may be absolutely contrary.

 In the case of a floating charge, could the security agreement provide to cover the after-acquired sales proceeds? If so, does this mean that a security over changing ARs can be perfected only once, even if the AR does not fall under a qualified category of floating charge?

 These 10 questions are among the hottest ones in supply chain practice. Clear and unified answers play a crucial role in developing the business.

By Qi Lyu

Reports on recent Chinese mortgage boycott has been overoptimistic on risk contagion between RMBS (Residential Mortgage Backed Security) and Chinese housing market.

They listed at least two grounds. First, the RMBS market, with the volume of ￥1200 billion occupies only 3 per cent share of total residential mortgage loans stock market.

And more important, the overall default rate remains rather low.However, this opinion deserves more considering, when facing such violating disputes over the liability distribution among the defaulted developers, the financing banks and the furious mortgagees.

The judicial position, especially the approach performed by the six circuit court, Supreme People’s Court in the now prominent leading case is doomed to have material influence to the RMBS business.

Seven issues are related.

1. Would the emerging RMBS be forced to make structure adjustment 

In 2021,the incremental residential mortgage assets has amounted to ￥1400 billion with newly issued RMBS expanding to￥499.3billion, which means almost 1/3 volume of housing mortgage was transferred off the banks’ book through RMBS. That is the strongest surge in ABS section by 17% increase in RMBS. If the final loss rate in RMBS turn out to be unpredictable, unmeasurable and uncertain, questions may be raised as whether this channel still workable for banks’ balance-sheet management and the securitization products still marketable. This most powerful part in ABS market may have to restricted its business to the finished project mortgage assets with proper security perfection.

However, as the data shows the rate of pre-mortgage registration in existing RMBS is no more than 30%, the surplus 70% may not be qualified for the RMBS any longer until perfection of the security interests in the estate, which may postpone four years to remove from banks’ book on average.

2. Would the three basic principles for mortgage rating accordingly change

RMBS has long been recognized as good assets for satisfying three rating rationales: debtors dispersed, low default rate and security interest over real property, which, however, could all be overturned once the developer defaults. The present circumstance has proved it not only a theoretical possibility: the boycott of the mortgage repayment, instead of resistance individually, the lack of willingness to repay, rather than the capability, the unfinished property unready for mortgage perfection, are all in breach of the original assumed rating logistics for RMBS. The remedies against the real estate developer is meaningless.

3. Would any legal liability come out against the intermediary services providers

Issuing RMBS requires law firm’s legal opinion, as well as that of accountants. However, before the present mortgage event, it is never heard of any of them supplying with qualified opinion and specific due diligence on the delayed property projects. Had a RMBS project actually trapped by such defaulted mortgages and eventually are only entitled to recover from the developer with the borrowers released, would the intermediary firms be liable for their professional services? The case of Wuyang Bond still reminds the industry of the tragedy of law firm and accounting firm being both thrown out of the boat.

4. Could the share reserved by the originator stop the risks splashing out

Regulatory requirement for RMBS originator is to reserve at least 5 percentage of total risky assets. Some study thinks the current buffet cushion is sufficiently safe as of nearly 10% on average. But, there are 2 misunderstandings: first, the risks to each project is determined individually with nothing to do with average risks. And second, the statutory buffet cushion for issuer is only 5%. Unless a higher rate is held by the originate bank itself at his discretion, other subordinate holders are also investors.

5. What do the final RMBS investors look like

Restricted by the low liquidity in Chinese market, RMBS is mainly invested by two parts, banks and banks wealth management products on investors’ behalf. The consumers of bank WMP are typically of low risks perception and preference, who may actually burden the risks of loss which intended to place on deep-pocket banks. Imbalance may arise between the protection for consumers of residential apartments and that for financial products consumers.

6. How could bank trustee measure the related product net value

It becomes a disturbing issue for WMP (wealth management product) to measure net value when RMBS contained. Without an efficient secondary market, the related regulatory requirements allow the trustee bank to value MBS by its historic cost and to adjust timely when finding circumstances changed. What matters is when to adjust is professional and reasonable, at the time of finding package covered delayed projects, or being served with final judgment against only the defaulted developers while exempting borrowers? It appears solely discretional but tested seriously with diligence duty for bank trustees.

7. How to make information disclosure on the related WMP

When valuating risks, a product largely invested to RMBS is generally categorized as fixed-proceed labelling low risks. However, what if the product, subjects to the strict judicial policy, distributed to the perspective investors who consequently suffer loss? Will the trustee bank be decided negligent for not- knowing his own product?

Further, in the course of standardized disclosure, is the trustee bank liable to share the precise data of those affected products to make up leeway for investors. Any potential claims against the bank asserting its malpractice?