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RUEATRS/DEPT OF TREASURY WASHDC
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INFO RUEHSH/AMCONSUL SHENYANG 6989
RUEHGH/AMCONSUL SHANGHAI 6105
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UNCLAS SECTION 01 OF 05 BEIJING 021720 
 
SIPDIS 
 
SIPDIS 
 
DEPT PASS USTR 
USTR FOR STRATFORD, WINTER, ALTBACH, KARESH, ROSENBERG 
TREAS FOR OASIA/ISA-CUSHMAN 
USDOC FOR 4420/ITA/MAC/MCQUEEN, IA/LORENTZEN, HSU 
GENEVA FOR CHAMBERLIN 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV CH
SUBJECT:  DESIGNING A SYSTEM CREATING A BANKRUPTCY 
MECHANISM FOR FINANCIAL INSTITUTIONS 
 
REF:  BEIJING 19482 
 
¶1.  Reftel reported on Embassy discussions with 
Professor Li Shuguang on September 6 about China's new 
Law on Enterprise Bankruptcy.  As Director of the 
Bankruptcy Law and Restructuring Research Center at 
the China University of Politics and Law, as well as a 
member of the National People's Congress drafting 
group which prepared the new law, Li is a leading 
expert on China's bankruptcy regime.  During the 
September 6 meeting, Li told Emboff that China would 
need new regulations to apply the new law to financial 
institutions.  On September 18, Li published an 
article in "Caijing" (Finance) Magazine laying out 
nine areas where he believes regulatory clarification 
is necessary.  An unofficial Embassy translation of 
the article appears below.  The original Chinese text 
is available at 
http://caijing.hexun.com/text.aspx?sl=2324&id =1832111. 
 
¶2.  Begin unofficial Embassy translation of text of 
Professor Li?s 18 September Caijing article: 
 
Designing a Bankruptcy System for Financial 
Institutions 
by Li Shuguang 
 
On August 27 of this year, the new "PRC Law on 
Enterprise Bankruptcy" was passed by the National 
People's Congress, and it will go into effect on June 
1, 2007. 
 
Article 134 in the supplementary provisions of this 
law sets forth special regulations specifically for 
the problem of bankruptcy of financial institutions. 
In the nine months between the new "Bankruptcy Law's" 
passage and when it goes into effect, the new law 
gives the Central Government power to establish 
procedures for financial institution bankruptcies.  In 
my view, any "implementation measures (or regulations) 
on carrying out financial institution bankruptcy 
proceedings" should emphasize resolving the nine major 
problems listed below. 
 
¶1.  The definition and scope of "financial 
institution." 
 
At present, there is no law that provides a precise 
definition for "financial institution."  Generally, 
institutions overseen by the three main supervisory 
bodies, the China Bank Regulatory Commission (CBRC), 
the China Securities Regulatory Commission (CSRC) and 
the China Insurance Regulatory Commission (CIRC) are 
regarded as financial institutions.  Strictly 
speaking, this is not an accurate definition. 
 
Such a definition overlooks other, more important 
supervisory bodies -- the Central Bank and the State 
Administration for Foreign Exchange (SAFE).  The term 
"financial institution" should cover institutions 
subject to the supervision of these agencies. 
 
Some types of businesses supervised by financial 
supervisory agencies are not considered financial 
sector businesses.  For example, the futures industry, 
regulated by the CSRC, is considered part of the food 
and beverage industry.  However, the new draft "Law on 
the Management of Futures Trading" has, in practice, 
already classified futures trading as a financial 
sector industry.  So "financial institutions" already 
includes the futures and derivatives trading industry. 
 
Some institutions with financial assets supervised by 
government finance agencies, such as financial groups 
like CITIC Group and China Everbright Group, etc., or 
financial asset management companies such as Huarong 
Asset Management Co. and Cinda Asset Management Co., 
should be included in the category "financial 
 
BEIJING 00021720  002 OF 005 
 
 
institutions." 
 
In addition, financial organizations sponsored by the 
Ministry of Agriculture, such as rural financial 
markets and agricultural credit cooperatives, should 
also fall within the definition of "financial 
institution." 
 
¶2.  Who files for financial institution bankruptcy? 
 
Article 134 of the new Bankruptcy Law provides that 
"when financial institutions, such as commercial 
banks, securities firms, or insurance companies, are 
in the situation described in Article 2 of this law, 
State Council financial supervisory agencies may apply 
to the People's Court to reorganize or liquidate the 
financial institution in question."  This raises the 
question of whether the financial institutions 
themselves can file for bankruptcy, and whether 
creditors can file for bankruptcy proceedings against 
them. 
 
Two considerations went into drafting this article. 
The first consideration was that non-state-owned 
financial institution bankruptcy cases need not 
necessarily go through the State Council.  The second 
was that in the current "Commercial Bank Law," 
"Insurance Law," and "Securities Law," bankruptcies of 
commercial banks, insurance companies and securities 
firms must receive authorization from the State 
Council as a prerequisite, companies which are not 
commercial banks, insurance companies or securities 
firms do not necessarily need to. 
 
The regulations do not prescribe financial 
institutions from voluntarily filing for bankruptcy. 
Implementation measures (or regulations) should be 
drafted so as to clarify which types of financial 
institutions must report to or receive approval from 
the State Council in filing for bankruptcy, and which 
do not. 
 
3)  Prerequisites for Financial Institution Bankruptcy 
Filings. 
 
The "implementing measures (or regulations)" can 
continue existing rules on prerequisites for financial 
institution bankruptcies, and at the same time expand 
their scope to include bankruptcy filings for futures 
trading companies, large trust companies, and large 
financial holding companies, requiring that the State 
Council approve their filings as well.  Bankruptcy 
proceedings for other small- and medium-sized 
financial institutions can be treated in the same way 
as corporate bankruptcies. 
 
4)  Administrating Bankruptcy Proceedings for 
Financial Institutions. 
 
Because of the special nature of bankruptcies of 
financial institutions, commercial administrating 
bodies or administrators do not necessarily have any 
special qualifications for taking control of the 
assets of bankrupt financial institutions or 
administering their affairs through bankruptcy 
proceedings.  They also lack experience in managing 
financial risks or financial crises.  A system should 
be considered in which liquidation groups, or 
administrating bodies are set up jointly by financial 
regulators in cooperation with commercial specialists, 
and in which individuals given responsibility for 
administering bankruptcies would be drawn from the 
ranks of experienced financial specialists.  So, 
"implementation measures" should specifically set 
forth the qualifications, method of selection, 
professional responsibilities and supervisory 
conditions for administrators of financial institution 
bankruptcy cases. 
 
BEIJING 00021720  003 OF 005 
 
 
 
5)  Reporting of Claims against Bankrupt Financial 
Institutions. 
 
Because China is in a particular phase of economic 
transition, commercial credit transactions tend to be 
relatively chaotic, and in the disorderly use of legal 
concepts, property rights, shareholders' rights, 
creditors' rights and renters' rights tend to get 
tangled together.  It is not clear what really can be 
considered debt.  For example, when a commercial bank 
goes bankrupt, is there a debtor-creditor relationship 
between the bank and its account holders?  If a 
securities firm misappropriates its customers' down- 
payments, is the customer whose funds were used in 
such a manner a simple creditor or a secured creditor? 
In terms of fundamental principles, these questions 
are debatable and it is sometimes hard to make clear 
distinctions. 
 
As another example, after the Central Bank, the CSRC 
and other agencies jointly issued the "Notice 
regarding the questions related to individual claims 
and customers' security trading settlement funds of 
securities companies," quite a few investors have 
different ideas.  There is no question that individual 
bank deposits, all types of financial bonds issued by 
financial institutions and held by residents, and 
settlement funds from customers' securities trades 
fall within the category of debt instruments.  As for 
property entrusted by residents to financial 
institutions for trading, and residents' negotiable 
securities deposited in relevant accounts, but 
misappropriated by financial institutions, different 
opinions exist about whether they should be considered 
as individual claims. 
 
In line with the development of China's financial 
markets and economy, new kinds of financial bonds will 
continually emerge.  I recommend that any 
"implementation measures" clearly delineate personal 
and institutional debts, but also give judicial 
institutions room to make precedent-setting rulings 
regarding the delineation of various types of 
financial bonds. 
 
¶6.  Reorganizing Bankrupt Financial Institutions. 
 
Because the social repercussions of the bankruptcy of 
financial institutions are relatively great, all 
countries encourage financial institutions to choose 
the option of reorganization when they go bankrupt, 
unless there is no other possible choice.  This 
process generally involves the government injecting 
capital, taking over the institution, placing it in 
the care of a trustee, refinancing through the Central 
Bank, or some similar method.  Of course, 
reorganization can also be left to the market. 
 
I recommend that any "implementation measures (or 
regulations" require that:  1) During the period of 
reorganization, the debtor must not manage its own 
assets, but rather should be taken over by the 
government, placed under the care of a trustee, or 
assigned to a specially designated administrator, in 
order that the government can guide the reorganization 
process.  2) The period of time to prepare a 
reorganization plan for a financial institution should 
be longer than for other enterprises.  I recommend 360 
days.  3)  Financial institutions' creditors should be 
divided into different kinds of categories than in 
ordinary bankruptcy cases.  In general, individual 
creditor?s rights should be separated from financial 
claims.  The particular characteristics of creditors 
and shareholders, such as depositors, holders of 
securities, holders of futures, and holders of 
insurance policies should be given consideration, and 
at the same time, the problem of protecting the rights 
 
BEIJING 00021720  004 OF 005 
 
 
of claims of employees of financial institutions 
should be given appropriate consideration.  The 
implementation and supervision of the reorganization 
plan should receive close attention after its passage. 
 
7)  Monetization of Assets of Financial Institutions. 
 
In financial institution bankruptcy cases, there are 
essentially two types of assets -- tangible and 
intangible -- which need to be monetized.  The 
intangible assets of financial institutions mainly 
include their operating license trading rights, as 
well as their so-called "license plate" (their brand 
name), their marketing network and marketing 
operation.  These are a financial institution's main 
assets, and their value is considerable. 
 
In order to better carry out the monetization of the 
assets of financial institutions, any "implementation 
measures" should set forth that:  1)  The value of 
intangible assets must be assessed, not just tangible 
assets.  2)  The monetization of a financial 
institution's assets, the disposition of its operating 
license, its brand name, and the settlement of the 
entitlements of its employees should be considered all 
together, and listed in the conversion plan of 
insolvent assets.  3)  The assets of a financial 
institution should be monetized openly, through the 
mechanism of an auction based on the principle of 
competition. 
 
8)  The Special Nature of Allocation of Assets in 
Financial Institution Bankruptcy Cases. 
 
In financial institution bankruptcy cases, Western 
countries have established a principle of "limited 
repayment," also known as "creditor's discount."  This 
means that when a financial institution goes bankrupt, 
a limit is set on individual claims, below which the 
creditor is repaid in full, but above which the 
creditor only receives a set proportion of their 
claim.  In setting a ceiling, one must consider such 
factors as this country's phase of economic 
development, the investment capacity of investors, and 
society's ability to bear the burden.  In the past two 
years, in dealing with the troubled securities firms 
Dapeng Securities and China Southern Securities?and 
the D?Long Group crisis, the People's Bank of China 
and others used rules and methods based on purchasing 
individual?s claims at a discount, in an effort to 
appropriately solve the problem of the who gets 
priority in repayment among individual creditors, and 
treated all non-secured institutional creditors as 
regular creditors.  This type of principle can be 
rolled into any "implementing measures (or 
regulations)." 
 
9)  Guaranty Funds for Investors in Financial 
Institutions. 
 
According to the existing regulatory framework, three 
major types of guaranty funds should be prepared for 
the bankruptcy of financial institutions:  a 
depositor's insurance fund, an insurance holder's 
guarantee fund, and a security investor's guaranty 
fund.  I believe that the first two will be set up and 
designed in the same way as the already existing 
protection fund for securities investors.  But the 
problem is that these three funds do not provide 
protection for all bankrupt financial institutions. 
As a result, in preparing "implementation measures" it 
is worth considering whether the three funds should be 
combined into a single Financial Institution Investors 
Guaranty Fund, or as separate guaranty funds. 
 
I believe, since each fund collects contributions in a 
different way, and from different sources, the 
principles and purpose of payment may vary, the 
 
BEIJING 00021720  005 OF 005 
 
 
establishment of such funds should be handled in a 
flexible way.  We could create three large funds, or 
establish different funds for futures investors and 
other types of investors, and set clear regulations on 
the source of funding, coverage, function, 
supervision, etc., and gradually increase the overall 
scale and reserve ratio of each fund over time. 
 
END UNOFFICIAL EMBASSY TRANSLATION TEXT. 
 
RANDT