15 October 2010
A trust company is a unique financial institution in the PRC which manages entrusted funds through the issuance of trust units.
Recently, trust companies, with their flexibility in providing customised trust products to meet market demand, have increasingly drawn the attention of both foreign and domestic sponsors, as an alternative investment vehicle, to raise capital from PRC investors.
In particular, trust products for real estate investments have been on the rise. The aggregate amount of trust products for real estate investments issued during the first eight months of 2010 reached over RMB100 billion, more than double the total amount raised in 2009.
With origins dating back to 1979, trust companies have long functioned as an alternative source of finance. They developed rapidly in the 1980s as a result of the lack of regulatory constraints imposed. The number of trust companies reached over 1,000 in 1992.
However, since 2003, the China Banking Regulatory Commission (CBRC), the regulator of trust companies, has been implementing a number of major reforms to the sector.
In 2007, the CBRC issued the Measures on the Administration of Trust Companies and the Measures on the Administration of Trust Plan Using Pooled Funds of Trust Companies (Trust Plan Measures) with a view to transforming these entities from indiscriminate investment companies into companies accountable for the funds entrusted to them by investors.
Subsequent to these regulations, corporate governance structures of trust companies have dramatically improved so that most trust companies now have independent directors, audit committees and risk management committees. Trust companies are subject to on site evaluations by the CBRC that focus on corporate governance, risk controls, regulatory compliance, asset management competencies, solvency, capital adequacy and profitability. Those ranking poorly are subject to follow up evaluations.
A number of trust companies have been dissolved and most of the remainder have been restructured with new equity sourced from domestic, as well as foreign, investors (the latter may hold up to 20 percent of the trust company's capital).
Trust companies are able to assist real estate developers to finance the acquisition cost of land when bank finance may be prohibited or when quotas are exhausted and other sources of capital unavailable.
Senior ranking trust certificates entitle holders to a return of up to the coupon rate specified. The rights of junior ranking trust certificates (which are typically held by the developer) to excess returns beyond the capped coupon rate rank after the holders of the senior tranche.
The obligations of the trust company to holders of the senior tranche are capable of being extinguished by call options, exercisable at the option of the developer, to purchase the whole of (1) the senior tranche and (2) the trust company's interest in the project company.
If the holders of the senior tranche are not paid the amounts due, the trust company may enforce the security over (1) the project company's interest in the land or (2) the developer's interest in the project company.
Contrary to the amorphous nature of PRC regulations governing the operations of private equity funds (often in the form of limited partnerships), there is a fairly established legal framework for trust company products.
The 2007 Trust Plan Measures, revised in 2009, provide for prescribed disclosure to investors, the segregation of assets, the fiduciary duties of the trust company and various other requirements, as well as a safe harbour for placing to an unlimited number of high net worth individual investors investing in excess of RMB3 million in such trust products, and qualified institutional investors and up to 50 other qualified individual investors. When promoting trust products, a trust company cannot utilise the public media or market through non-financial institutions. Returns cannot be pre-determined. Any loss suffered from the deployment of entrusted funds must be borne by investors, unless such loss results from the trust company's misconduct.
The CBRC's Operational Guidelines for the Private Equity Investment Trust Business of Trust Companies (2008) further provide that a trust company promoting private equity investment trust products may specify and charge management fees and share profits, but profits can only be distributed to the trust company after the expiry of the term of the trust product if there is profit available for distribution.
With respect to the launch of investment products by trust companies which involve cooperation with banks, the CBRC has issued Guidelines on Business Cooperation (2008), as supplemented by Relevant Matters concerning Business Cooperation (2009) which, inter alia, limited marketing to high net worth individuals.
On 24 August 2010, the CBRC issued new capital adequacy rules, requiring trust companies, with immediate effect, to keep their net capital above RMB200 million. These measures require that a trust company's net capital should not be less than (a) the sum of its capital at risk and (b) 40 percent of its net assets.
It is expected that market demand for real estate investment trust products will continue, thus providing an alternative source for raising capital from PRC investors for real estate investments. However, given the difficulties of forming a trust company and the fact that the CBRC has virtually stopped issuing licenses for new trust companies, a sponsor, whether foreign or domestic, will have to partner with an existing trust company in order to utilise this RMB fundraising platform.
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