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Practice and Exploration of the SIPF

Practice and Exploration of the SIPF. Basic Information of the SIPF Basic Functions of the SIPF : Risk Disposal of Securities Companies Basic Functions of the SIPF : Fund Raising and Management

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Practice and Exploration of the SIPF

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  1. Practice and Exploration of the SIPF

  2. Basic Information of the SIPF • Basic Functions of the SIPF: Risk Disposal of Securities Companies • Basic Functions of the SIPF: Fund Raising and Management IV. Extended Functions of the SIPF: Establishment of a Normal Investor Protection Mechanism in Combination of Monitoring, Evaluation and Service

  3. Basic Information of the SIPF(1) Background of Its Establishment Two major risks have occurred on China securities market since 2000. The first risk: During nearly four years (from June 14, 2001 to June 6, 2005), the Shanghai Stock Exchange (SSE) Composite Index fell to 998.23 points from 2245.44 points, down 55.5%.

  4. Figure 1-1: Jan. 2001—Jul. 2005 Shanghai Composite Index Run Chart

  5. Figure 1-2: Features of the First Risk The customers’ capital were invested to self-run or industrial sectors, thus to push industry risks to the edge of break-out

  6. In 2003, 84 out of all the 133 securities companies had significant liquidity difficulties. Notably, risks collectively broke out in 34 ones. • Because they were not permitted to conduct margin trading business, securities companies had little access to external financing in a legal way. Against this background, securities companies began to misappropriate clients’ funds for business activities, and even for the employee's salary expenses. At that time, there was a gap of RMB64 billion in customer trading settlement fund in the whole industry; the asset under illegal management reached RMB185.3 billion, including RMB13.4 billion of the misappropriated agent clients’ bond. • Because of the continued slump on the market, securities companies suffered losses for consecutive years and it was hard for them to make ends meet. Clients’ funds were hard to retrieve because securities companies misappropriated them for investing in self-operated or industrial areas for long. The crisis could break out at any moment in the whole sector. • Clients suffered serious losses owing to the continued market downturn.

  7. Figure 1-3: Mode of Risk in Securities Company Self-run securities business Securities company Settlement fund for securities trading of customer Bond buy-back fund of customer Industrial investment Abnormal fund of customer’s financing business Daily payment

  8. In the above context, the State Council agreed to set up a protection fund company to strengthen risk management of securities companies. China Securities Investor Protection Fund Corporation (SIPF) was established with a registered capital of RMB6.3 billion on August 30, 2005 and officially started business on September 29 of the same year. The SIPF is a non-profit institution.

  9. (2) Internal Governance • The board of directors, the decision-making organ of the SIPF, takes charge of its operation and management. It has nine directors, including one independent director. Specifically, the CSRC, the Ministry of Finance, and the People's Bank will appoint two directors respectively; the Securities Industry Association, the China Securities Registration and Settlement Company, the Shanghai Stock Exchange as well as the Shenzhen Stock Exchange will in turn appoint two directors; and the Ministry of Finance negotiating with the People's Bank recommends one independent director. The board of directors is responsible for the decision-making on important matters. • When it was initially founded, the SIPF’s main function was to dispose of risks for securities companies, and the design of its internal organizational structure was centered on risk disposal.

  10. Figure 1-4: Organizational Chart of the SIPF – Before Restructuring Chairman Vice Chairman Vice Chairman Executive Director Executive Director Executive Director Executive Director Executive Director IndependentDirector ClearingDepartment General Office Financial Department Legal AffairsDepartment Audit Department Asset ManagementDepartment Information and StatisticsDepartment

  11. (3) External Supervision • The CSRC should be responsible for regulating the operation of the fund company and supervising the raising, management and use of the funds. • The Ministry of Finance should be responsible for the state-owned assets management and financial supervision. • The People’s Bank of China should be responsible for confirming, supervising and examining the use of re-loans.

  12. II. Basic Functions of the SIPF: Risk Disposal of Securities Companies • Since the second half of 2003, the CSRC has been organizing the risk disposal of securities companies for nearly five years under the leadership of the State Council and with the support of the Ministry of Finance, the People's Bank and the judicial organizations. • As of the end of 2009, the SIPF used the State-owned funds to close down 26 high-risk securities companies and restructure 10 securities companies with liquidity problems. It also disposed of five securities companies in a market-oriented way. • In restructuring securities companies, the State-owned investment in the form of equity capital reached RMB18.21 billion and that in liquidity capital reached RMB2.76 billion. In closing down securities companies, the State-owned investment in the form of acquisition and direct investment from the State and the SIPF reached RMB35.88 billion.

  13. Make Plan China’s RiskDisposal Procedure of Securities Companies Disposal Mechanism Accounting Nature Identification Administrative Clearing Compensation Policy Bankruptcy Procedure Bankruptcy Liquidation Bankruptcy Liquidation

  14. CSRC Ministry of Public Security People’s Government Meeting MOF PBOC State Council Make Plan Draft Fund use plan made by SIPF as an appendix Risk Disposal Plan Submit

  15. State Council Five Group’s Linkage Special Case Group Disposal Mechanism Approved CSRC Organize Receiver Group Working Group Administrative Clearing Group Audit Team Judicial Protection Measure（ “Three Interrupts”）

  16. Account Nature Identification Account Classification Non-brokerage account Bankruptcy liquidation (exceeding RMB100 billion) Institution Brokerage account Compensate in full amount (more than 9 million accounts) 1. Account Brokerage account Personal debt Personal Buy at discount (more than 60,000 persons) Non-brokerage account Institutional debt in personal name Bankruptcy liquidation Accounts claimed by customers(depends on accounts classification) 2. Account Accounts unclaimed by customers (inactive accounts are about 2.8 million)

  17. Account Nature Identification Five-level Demonstration To study disputes beyond existing policy, and publish new systems. Ministerial meeting Led by SIPF to resolve all the disputes under existing provisions Interdepartmental meeting Settle dispute preliminarily Securities Company Risk Disposal Office of CSRC (Review aforesaid classification) (Classify all accounts) Working group Liquidation group

  18. Compensation Policy • The assets and fund in a customer account are the property of relevant customer. • The fund of a pooled wealth management product involving multiple customers will be distributed pro rata to these customers. 3. Protection fund: A. Fill the fund gap in a brokerage account in full amount. B. As to the part of the securities appropriated in the brokerage account, compensate personal accounts in full amount (in cash or securities), but does not compensate institutional accounts. C. Personal claims

  19. Bankruptcy Procedure Transactions are transferred to a securities company under normal operation Administration verification Group Intermediate People’s Court Ensure Submit application Account Clearing Basically Designate Receiver Declare the Bankruptcy Set up Creditors’ Committee

  20. Bankruptcy Liquidation (I) Participants in bankruptcy liquidation: 1. Institutional non-brokerage accounts, 2. Institutional debts in the name of individuals 3. SIPF (with the compensation fund as common claim) 4. The other claims not in SIPF’s coverage (II) The proprietary assets of the disposed securities company and the assets that can’t be identified to be customer assets can’t be used for investor compensation, but enter the bankruptcy liquidation.

  21. Table 2-1: Capital Used for the Risk Disposal of Securities Companies ① It includes RMB900 million of local governments’ investment.

  22. For the 26 securities companies that closed down by using State-owned funds, the SIPF should appropriate RMB12.1 billion to acquire individual creditor's rights, and RMB26.37 billion (including RMB570 million dormant account funds) to fill up the gap of customers’ securities trading and settlement funds. • RMB12.06 billion used for acquiring the individual creditors’ rights involves over 210,000 individual creditors, accounting for over 99% of the total acquisition amount. • RMB25.57 billion was used to fill up the gap of customers’ securities trading and settlement funds, involving more than seven million regular brokerage accounts, accounting for over 99% of the total recoverable amount. • RMB1.75 billion of customers’ securities trading and settlement funds, frozen or retained, was clawed back.

  23. In order to ensure the compliant and safe use of the State acquisition funds, until April 30th, 2010, the SIPF had organized and completed 92 audit inspections on 24 disposed securities companies. Staff from 64 accounting firms and law firms times had participated in those inspections for over 600 person times. • In the process of clearing checked company accounts, the SIPF checked all the normal brokerage accounts with a balance of over RMB1 million and all the verified individual creditors’ accounts with a balance over RMB200,000 one by one. • The SIPF also performed a spot check on key normal brokerage accounts with a balance of below RMB1 million and key individual creditors’ accounts with a balance of below RMB200,000. • Findings include: (1) The balance and principal in amounts that should be excluded from the scope of the State acquisition funds totaled RMB83 million. (2) A total of RMB982 million needs further approval on having the qualification of being acquired. (3) RMB1.558 billion of planned acquistion funds has problem with the calculation of acquistion amount (some items needs to be adjusted).

  24. As of April 30, 2010, all the 26 securities companies resorting to the protection fund had entered into the liquidation process. At present, the 26 securities companies that closed down after using the State-owned acquisition funds have all entered into the judicial bankruptcy process. The SIPF serves as a member of the Creditors Committee of a total of 23 securities companies and serves as the Chairman of a total of 19 securities companies. • The formal declaration involved creditor’s right of RMB25.0631 billion in total, including a principal of RMB24.4345 billion and an interest of RMB628.6 million. • The preliminarily claim of creditor’s right was RMB5.7597 billion. • As of April 30, 2010, a total of 16 securities companies had implemented bankruptcy property distribution, and they had been compensated for RMB1.6325 billion in cash, 8,474,964 shares of Hafei Shares, 32,625,414 shares of the Harbin Pharmaceutical, 7,559,899 shares of Liaoning Chengda, and 14,008,381 shares of Double-Crane Pharmaceutical. As some pre-declared creditor’s rights had not been converted into formal creditor’s rights, RMB299.1 million in cash was escrowed correspondingly. SIPF managed the compensation of creditor’s rights worthy of RMB2.2 million in cash, 90,406 shares in Hafei Aviation Industry Co., Ltd and 348,032 shares in Harbin Pharmaceutical Group on behalf of the Ministry of Finance.

  25. The First Effect of Risk Handling : Promoting the Improvement of Legal System • Promoted the amending of the relevant provisions of the "Securities Law", the "Company Law", the "Criminal Law" and the "Bankruptcy Law". • The “Regulation on the Supervision and Administration of Securities Companies” and the “Regulation on the Risk Disposal of Securities Companies” were formulated on the basis of risk disposal experience. • The Supreme Court has consecutively held two nationwide symposiums about the trial of bankruptcy cases of securities companies. For the first time, the Supreme Court fully integrated the resolution of the financial sector risks into the judicial settlement channels, thus realizing an effective convergence of the administrative disposal of securities companies and judicial bankruptcy.

  26. The Second Effect of Risk Handling: the Goal of ‘Purchasing System with Money’ was Realized. • The trusteeship of customers’ trading settlement capital by the third party was used in the treated securities companies with high risk. • A new buy-back trading system for national debt was established, which specially adjusted the business procedure, made the respective responsibilities of customers, securities companies and registration settlement companies clear, set up a relative rule that could prevent the embezzlement of the customers’ national debt, and make the smooth conversion between old and new systems. • For assets management, some new rules were set up, including the trusteeship of customers’ funds by the third party, sufficient appearance of investment risk to customers and the regular information disclosure. • Comprehensive account clearance work to treated securities companies was carried out, and the system of true name used in account was initially set up. • A new system including true name used in account, special seat and scale control in self-run business was used.

  27. The Third Effect of Risk Handling: A Withdrawing System from Securities Company Market was Set Up. • An operative relative policy system, organizing form and working rule were gradually formed, and supporting measures and effective system for withdrawing from securities company market were established. The Fourth Effect of Risk Handling: A System Combining Classified Regulation and Supervision for Securities Company and Protecting Market-oriented Fund Collection was Realized. • Making classified regulation and supervision to securities company • Building a “unified standard, dynamic management and different charge” system for fund collection. • Realizing the significant change from the postmortem risk handling for securities company to prior prevention and reduction of securities company’s risk .

  28. The Fifth Effect of Risk Handling: Reset Industrial Reputation and Enhance Investors' Confidence • In less than two and half years from June 6th, 2005 to October 16th, 2007, Shanghai Exchange Index ascend from 998.23 to 6124.04, which has broken the record in the history. • This round of risk handling in securities companies, effectively neutralized industrial risks of securities companies, raised their awareness of operating in compliance with regulations and competency of resisting risks, so that Chinese securities market could be able to face the international financial crisis and create conditions for comprehensively advancing investor protection.

  29. III. Basic Functions of the SIPF: Fund Raising and Management • Main capital sources of the SIPF are: (1) in case that risk funds reach the upper limit on Shanghai and Shenzhen Stock Exchanges, 20% of the transaction handling fees shall be brought into the SIPF (the Fund); (2) all the securities companies registered in China shall pay 0.5-5% of their operating income for the Fund; (3) when issuing stocks, convertible bonds and other securities, interest income of applying for subscribing frozen capital shall be brought into the Fund; (4) according to the law, the Fund can recover proceeds from certain responsible parties and get repayment income from the bankruptcy and liquidation of securities companies; (5) donations from domestic and foreign institutions, organizations and individuals; and (6) other legitimate incomes. • In case of emergency, the SIPF can get special financing from the People's Bank of China, which offers re-loans, etc. • Securities companies shall pay for the Fund by certain percents based on their ratings and classifications. High-risk and low-rating companies shall pay a higher proportion.

  30. Table 3-1: Type of Securities Company and Comparison of Payment Proportion

  31. Table 3-2: Funds Raised of the SIPF As of December 31, 2009 Unit: RMB100 mn

  32. IV. Extended Functions of the SIPF: Establishment of a Normal Investor Protection Mechanism in Combination of Monitoring, Evaluation and Service • The second risk • Over more than one year (from October 16, 2007 to October 28, 2008), the SSE Composite Index plunged to 1664.93 points from 6124.04 points, down 72.8%. The market risk broke out in the context of the international financial crisis. Different from the last crisis, none of securities companies had liquidity risks, but clients suffered a larger loss. Thus, during the course of this global financial crisis, it is not one of the main issues to dispose of securities companies’ risks. The biggest challenge is how to make investors get more in-depth understanding of stock market risks, enhance self-protection capacity, and make rational investments suited to their risk tolerance. The appropriate management of investors has become one of the important tasks of the SIPF in protecting investors. • With the functions extended, the SIPF has adjusted its internal organizational structure.

  33. Figure 4-1: Curve of Shanghai Exchange Comprehensive Index (from July 2005 till September 2009)

  34. Table 4-1: Profitability of Securities Companies in 2007-2009 Unit: RMB100 mn

  35. Figure 4-2: Organizational Chart of the SIPF – After Functions Extended Chairman Vice Chairman Vice Chairman Executive Director Executive Director Executive Director Executive Director Executive Director Independent Director Customer Transaction Settlement Funds’Control Center General Office Financial Department Legal AffairsDepartment XBRLApplication Center Investor Education and Service Center (Information andStatistics Department) Investor Survey Center Asset Management Department

  36. Figure 4-3: Main Components of Normal Mechanism

  37. (1) Market Monitoring Confidence monitoring: To predict the market status ASAP and put forward countermeasures and suggestions by monitoring the change in investors’ confidence. Capital monitoring: To timely detect activities that break laws or rules and safeguard the legitimate rights and interests of investors by establishing the surveillance system of trading settlement funds on the securities markets and monitoring the change in market capital. Information monitoring: To participate in monitoring information of various types of business entities on the securities markets, and establish standard, rational and open information disclosure system by using XBRL technology. Public opinion monitoring: To extensively collect investors’ comments on securities companies and investor protection via investor survey, investor call system and Internet search.

  38. Market Monitoring: Monitoring the Change in Investors’ Confidence SIPF monthly formulated investor confidence index to supervise market change. The confidence of investors had been in relatively pessimism in 2008, especially in August, at the lowest level of 36.3. But after August, the index is generally climbing. Now it is going toward an optimistic trend this year. Confidence index is climbing after getting down to the bottom in August 2008. Shanghai exchange comprehensive index arrived at the bottom at the end of October 2008. Confidence index arrived at the bottom two months earlier than Shanghai exchange comprehensive index. The upward trend of confidence index fully reflects market trend, with obvious feature of going ahead. The advance reaction of market confidence index is beneficial to stay calm and stable when proposing a set of steps to rein the stock market, and avoid over-radical actions.

  39. Market Monitoring:Monitoring the Change in Investors’ Confidence Figure 4-4: Comparison between Investor Confidence and SSE Composite Index Trends

  40. Market Monitoring: Monitoring the Change of Capital Flow in Market Under the united deployment of CSRC, SIPF has been building the surveillance and control system of customer’s capital in securities companies since last year. The system will support the regulation of securities, with an aim to supervise the capital flow in the market, to prevent customer’s capital from embezzlement, to timely disclose illegal actions of market dominance and practically protect legal interests and rights of investors. Necessity: deficiency shows in the operation of the entrusted system of the third party, especially the shortage of effective supervision on the customer’s capital in the whole market, so as unable to timely acquire the status of capital flow in the market. • The development and operation of surveillance and control system involves related regulation organizations, security exchanges, registration settlement companies, entrusted banks, settlement banks, securities companies, funding companies, association of securities industry and SIPF, each of which shall separately perform relevant obligation without change in its established responsibilities on the basis of reasonable division of work. • The system shall regard the accepted data from registration settlement companies, security exchanges and entrusted banks as the base, to compare the data delivered from securities companies, so as to find and prevent embezzlement and misappropriation. • The system can supervise the risks in the securities market via surveillance and analysis of capital flow, to disclose illegal actions of market dominance and other vicious incidents, which is helpful to take actions in protecting legal interests and rights of investors.

  41. Strengthen market supervision: supervise change in market capital Figure 4-5: Illustration of Surveillance and Control System of Customer’s Capital Securities companies and other investment agents Shanghai and Shenzhen Security Exchange Capital account of customers Day-end transaction data Customer’s capital information Surveillance and control system Capital delivery of legal person Data of settlement Capital flow and balance of specific deposit account and administration account for customer’s transaction and settlement Data of change of customer’s transaction settlement Registration settlement companies Entrusted bank Securities company N Securities company N Risk warning Capital administration account of customers Account of settlement provision and customer capital in securities companies Special deposit account for trading settlement capital of customers in securities companies Regulatory organization Association of securities industry Capital flow between entrusted banking account of securities company and provision account of registration company Capital flow of entrusted banking account in securities company

  42. Market Monitoring: Participate in the Monitoring of Information of Market Agents Financial crisis shows that deficiency in highly transparent mechanism of information disclosure and lack of effective regulation, shall lead to huge risks that are hard to foreseeable to various investors participated in capital market, including general investors. CSRC is to liaison with related organizations to set up a comprehensive standard data system of interactive disclosure of information based on XBRL technique. It aims at establishing a comprehensive system of standard data report and delivery in China, to further increase the transparency and efficiency of disclosing capital market information, without changing the current framework based on all rights and responsibilities and XBRL-based technical support. SIPF is in the progress of developing XBRL-based data application system. The system will provide investors with more convenient, standard and comprehensive platform of information browsing, which is beneficial to raise the judgment of investors about the market and increase the level of reasonable investment.

  43. (2) Investor Services Chinese capital market is now in rapid development. The market feature of “brand-new and transit” determines the relatively uncertainty of current capital market in market environment and investor psychology. Besides, the market is lack of an internal regulation system. Thus, to set up a comprehensive investor-oriented service system is a necessary choice to foster qualified investors and promote stable development of the market.

  44. Concerning the characteristics of Chinese investors in securities market, to strengthen investor-oriented service is of utmost necessity. SIPF displays its own advantage in devotion to build up a multi-leveled and multi-faceted investor-oriented service system comprising of investor survey, investor education, and investor call response, so as to protect the legal interests and rights of small and medium-sized investors. Strengthen investor-oriented service Figure 4-6: Protection and Services System of Investors

  45. Investor Services: Investor Survey • Chinese securities investors show seven characteristics, according toSIPF’s investor survey. • Age structure: the investors are mostly comprised of the youth and the middle-aged • Education background: nearly 85% of investors are graduated from college or above • Career distribution: breadwinners account for the majority of the investors • Income distribution: employees with middle income account for the majority of the investors • Region distribution: less than 5% of investors live in the countryside or rural areas • Time to start up investment in securities: since 2007, the newly-added investors account for nearly forty percentage. • Stock assets: 85% of investors invest less than 300,000 yuan in stocks. 45

  46. Fig 4-7: Age Structure Fig 4-9: Vocational Background Fig 4-8: Educational Level Fig 4-10: Income Level

  47. Fig 4-11: Regional Distribution Fig 4-13: Distribution of Investors’ Stock Assets Fig 4-12: Time of Stock Market Entrance

  48. Investor Services: Investor Call • The SIPF has attached keen attention to responding to investor calls in the financial crisis and set up a sound call response mechanism. • Investor calls are mainly handled at the website of the SIPF (www.SIPF.com.cn). • From July 2008 to April 30, 2009, the call center had received 15,387 messages from the investors, including 3283 messages about business consulting and policy consulting, 3858 messages about suggestions, 8186 messages relevant to criticisms, complaint and report of unlawful practices, and 60 other messages, accounting for 21.34%, 25.08%, 53.20% and 0.38% respectively.

  49. Investor Services – Response to Investor Call Fig 4-14: Call Response Process Investor Inquiry and complaint for fund business Inquiry and complaint for accounting information Telephone, online message and email of SIPF Other Transferred to the Expert Board or other departments 保护基金公司 呼叫中心 Transferred to other departments or self-disciplinary organizations Preparation of response Response unavailable Response available Transferred to securities operation institutions Investor

  50. Investor Services: Investor Education • So far, over 80% of the securities investors in China have conducted offsite transactions on the Internet or through telephone, while over 10% of the investors resort to the traditional way of onsite transaction and most of these investors are aged individual investors. Therefore, investor education should focus on the majority of investors that conduct offsite transactions while attaching attention to individual investors • The SIPF attaches great importance to public education of investors: It launched five investor education projects in 2009: (1) to prepare a set of "Investors Guide", (2) to carry out an education project of securities companies’ sales departments, (3) to film a public education television series, (4) to develop a software of investor education, and (5) to organize a Securities Investor Protection Forum.

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