China Curbs Diversified Operations and Affiliate Transactions of State-owned Financial Institutions

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China’s Ministry of Finance (MOF) has issued a new directive to clean-up the operations of state-owned financial enterprises due to concerns over their use of financial holding structures and affiliate transactions.

MOF recently issued the “Directive Concerning State-owned Financial Institutions Focusing on Primary Operations, Compression of Tiers and Other Matters” (关于国有金融机构聚焦主业、压缩层级等相关事项的通知)

The Directive has the goal of “guiding state-owned financial institutions to focus on their primary operations, return to their original operations, ‘clean up the gate,’ and standardise the management and affiliate transactions of subsidiary companies at different levels.”

The move from MOF comes following concerns about the sprawling expansion of China’s state-owned financial institutions as well as their use of affiliate transactions.

“Certain state-owned financial institutions have engaged in diversified development in the recent past, and in actuality have created financial holding structures,” said Zeng Gang (曾刚), deputy-chair of the National Institution for and Finance and Development (国家金融与发展实验室) (NIFD), said to state-owned media.

“From a certain point this form of development is rational, but when the operations involved are too numerous or lack corresponding standardisation, it can lead to excessive risk.

“If [they] do anything that earns money, then there is no way for such institutions to perform their proper role. Additionally, when their operations are excess, this can create a large number of potential affiliate transactions internally.

“Not only is it easy to conceal risk in between financial tiers, it is also easy to create room for regulatory arbitrage, and reduce the effectiveness of macro-economic controls and regulation.”

Measures outlined specifically by the new Directive include:

  • Competitive state-owned financial institutions establishing industry catalogues based on their development strategies, and withdrawing from areas which diverge from their main operations and do not provide long-term financial returns,
  • Driving state-owned financial institutions to focus on core operations;
  • In principle state-owned financial institutions can only exercise control of a single domestic subsidiary with a given type of financial operations license;
  • State-owned financial institutions should establish internal risk separation mechanisms, and achieve effective separation of subsidiaries to prevent cross-holding of positions, interbank transactions, information sharing, and sharing of infrastructure;
  • State-owned financial institutions should strengthen regulation of affiliate transactions, and establish affiliate transaction reporting systems to ensure that they are lawful, compliant and transparent;
  • State-owned financial institutions are not permitted to conceal affiliate transactions or the actual destination of funds, and are not permitted to use affiliate transactions to engage in inappropriate channelling of interests or to avoid regulatory provisions;
  • State-owned financial institutions are not permitted to breach fair competition regulations or ruin the market order.

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