Comparison of international experience and recommendations for China Nicholas Morris July 2008

1. Investor Compensation Schemes Comparison of international experience and recommendations for ChinaNicholas MorrisJuly 2008

2. The importance of Investor Compensation “Research [shows] large differences between countries in ownership concentration in publicly traded firms, in the breadth and depth of capital markets, and in the access of firms to external finance. ….. [which depends on] how well investors, both shareholders and creditors, are protected by law from expropriation“ Investor Protection: Origins, Consequences, Reform – Financial Sector Discussion Paper 1, World Bank • Stock markets – such as those in the UK and US – play a crucial role in economic growth • Investors and fund managers require that their money is safe before they invest – otherwise they will not • China needs strong investor protection to attract crucial funds for development • The Securities Investor Protection Fund is a key element of this protection

3. Recent capital market reforms in China • Restructuring of securities companies • CSRC actions from 2004 onwards – liquidation, restructuring, stricter supervision, capacity building • 104 securities brokerage companies now profitable, with strong asset base • Reform of stock issuance • improving transparency, approval system, strengthening market discipline, market-oriented share issuance pricing • Liberalisation of fund management • Funds under management $448.5 billion 2007 (up from $10 billion 2002) • Refinement of legal framework • Amended company law and securities law, 1 January 2006 Data source: CSRC China Capital Market Development Report 2007

4. Key capital market events I • Fast growth of stock markets • Shanghai/Shenzhen 1,550 listed companies, market cap. US$4.48 trillion (140% GDP) • Large scale profitable enterprises: eg Baosteel, Sinopec, ICBC, China Life, China Ping An Group, and Daqin Railway • Highest IPOs in world – US$62.1 billion 2007 • CSRC implemented stronger regulation • Committee on administrative sanctions, Chief Inspectors office and new Inspection bureau • Capital markets opening to foreigners • Commitment to allowing foreign companies to issue RMB stocks and bonds • Credit Suisse and Morgan Stanley establishing investment banking joint ventures (33% maximum holding) • Goldman Sachs and UBS already established Data source: CSRC China Capital Market Development Report 2007

5. Key capital market events II • First corporate bonds • Provisional rules for pilot issuance Aug 14 2007 • Yanzi Power issued RMB 4 billion Sept 19 2007 • Improved access for SME’s • Venture Board targetting high growth SME’s discussed at Hangzhou meeting Nov 24 2007 • “SME bundled bonds” (first in Shenzhen Nov 26 2007) • Housing Finance • Intra-government task force: urban/rural land policies, urban planning, fiscal subsidies • Need to further develop credit information systems, property registration, mortgage insurance Data source: CSRC China Capital Market Development Report 2007

6. Four International Investor Compensation Schemes We compare the history, legal and regulatory structure, governance arrangements, operations and detailed rules of: • UK – Financial Services Compensation Scheme (FSCS) • US – Securities Investor Protection Corporation (SIPC) • Canada – Investor Protection Fund (CIPF) • Ireland – Investor Compensation Company Ltd (ICCL) The Irish scheme is included because it is an example of a scheme set up in response to the European Investor Compensation Scheme Directive (97/9/EC)

7. History, regulation and legal basis for Capital Market Regulation

8. Governance and Organisation

9. Funding and other arrangements

10. Payment rules

11. Costs, asset allocation and exclusions

12. Bankruptcy, claims and complaints

13. Rules, investor education and external compliance

14. Common features of international schemes • Only pay claims to clients of authorised or member firms • Check carefully whether the firm is in default or insolvent, or has breached regulations, before payment • Insist on the rights to assets being transferred (to FSCS, SIPC etc) before claims are paid, and be active in recovering funds • Where possible transfer the customer and his assets to another broker • Limit claims to individuals and small businesses • Exclude shareholders or those with influence in the firm, anyone who contributed to the problem and other specific types of organisation • Do not compensate for events which occurred before the scheme was set up • Appoint Trustees (or other officials) to ensure all processes are complied with and check all records • Reject applications if information provided by the claimant is found to be inaccurate or incomplete, or if there is suspicion of fraud • Have strict time limits for claims submission and acceptance • Set limits per customer and per claim, with detailed rules defining what is meant by a single customer

15. Some relevant Chinese History • October 1992: State Council Securities Commission (SCSC) and the China Securities Regulatory Commission (CSRC) established • March 1995: Organisational Plan of the China Securities Regulatory Commission • August 1997: securities markets in Shanghai and Shenzhen under CSRC supervision • November 1998: National Finance Conference decided that local securities regulatory departments would be supervised directly, including those previously supervised by the People's Bank of China. • April 1998: SCSC and CSRC merged to form one ministry rank unit directly under the State Council • September 1998: Provisions regarding CSRC's Functions, Internal Structure and Personnel

16. China Securities Investor Protection Fund Co. Ltd. (SIPF) • Wholly State-owned financial institution established on approval from the State Council • Non-profit corporate body mainly in charge of raising, management and usage of the securities investor protection fund under the supervision of CSRC • SIPF was registered at the State Administration of Industry and Commerce on August 30th 2005 • The State Council injected capital and the Ministry of Finance made a lump sum allocation of RMB 6.3 billion in registered capital

17. SIPF responsibilities • Raising, managing and operating the securities investor protection fund • Monitoring and reducing the risks of the securities companies • Repaying creditors (according to State polices) upon securities company cancellation, closure, bankruptcy or administrative takeover/custodial operation by CSRC • Organizing and participating in the liquidation of the cancelled, closed or bankrupt securities company • Administering and disposing of the compensated assets and protecting the rights and interests of the fund • Proposing regulatory improvements to CSRC to improve the safety of investor's assets and the securities market • Establishing corrective mechanisms with the relevant authorities

18. Next steps for SIPF: recommendations • Considerable progress has been made in developing the administrative measures and rules for the Chinese compensation system • International experience can be used to consolidate these rules and develop a consolidated rulebook for the operation of the compensation system in China • Text from the FSA Handbook, from SIPA and from SEC and SIPC rules can be used as a basis for this work

19. Issues I • Requirements for notification of SIPF, inter-relation between SIPF and CSRC • Suggestion: develop detailed Memoranda of Understanding between SIPF and CSRC (and possibly BOC and other relevant bodies) – as is usual in UK • Detailed definition of which businesses are protected by SIPF. • Observation: as the capital market develops, this will become increasingly important and the simple definition ‘broker-dealer’ may not suffice • Circumstances under which claims may be considered, including excluded categories and compensation limits. • Observation: the UK limits compensation to individuals and sets the compensation per customer at quite a low level relative to US (or current practice in China)

20. Issues II • Funding arrangements, including (a) the need for ‘emergency’ funding in the case of major failure and (b) regular levies from the Industry • Suggestion: A detailed ‘Funding Review’ process, along the lines recently carried out in UK and including consultation processes, would be sensible. • Rationalisation of the assignment of claimants assets, and protective measures for reassignment etc • Suggestion: Develop arrangements whereby SIPF becomes the sole custodian of assets during a liquidation to reduce inter-agency complexity • Consideration of an advance payments system along the lines of that in the US • Observation: this could have considerable benefits for perceived security of investor assets in China’s capital markets.

21. Issues III • Consideration of a ‘small claims’ or ‘direct payments’ system to minimise administrative burden for smaller cases • Suggestion: develop and publicise detailed arrangements for smaller investors • Development, in collaboration with CSRC and the Chinese securities industry, of a ‘fair funds’ system which prevents the need for SIPF intervention • Observation: this has been very successful in the US and has led to a reduction in the need for payments by SIPC, something that SIPF should have as a goal in the longer term. • Definition of time requirements for submission of claims, acceptance and processing of claims by SIPF • Observation: this will assist in improving the efficiency of the Chinese compensation system and provide a basis for measuring and monitoring SIPF’s achievements • Strengthening SIPF powers in the case of fraudulent claims, inadequate records etc • Observation: this is essential both to provide correct incentives in the capital markets and ensure efficient operation

22. Thank you

23. Questions and Discussion