Risk Management in Chinese Securities Companies

Post Purge Institutional Environment for Risk Management in Securities Companies

Post-Purge Policy Environment Characterized by Classified Regulation

After the purge of securities companies, a classified regulation system was established by the Regulation on the Supervision and Administration of Securities Companies promulgated by the CSRC. It functions through financial risk regulation and compliance regulation, and emphasizes both standardization and development. By changing the mechanism, approaches, and means of regulation, it guides and promotes the establishment of risk monitoring and control mechanisms with both self-discipline and checks and balances within the company.

Major Contents of Classified Regulation Securities company classification refers to the evaluation of securities companies and their classification into five categories and 11 levels by the CSRC based on the risk-management capability of each securities company. This is done in consideration of the company's market influence and in accordance with the provisions of the Securities Companies Classified Regulation Guideline (Trial), informally referred to as "the guideline." The CSRC and its regional branches conduct classified regulation of securities companies based on the result. The classification results also serve as the basis for determining the scope and priority of new business or product pilot projects.

Assessment Procedure In light of their own conditions, securities companies make self-evaluation according to the Securities Companies Risk-Management Capability Evaluation Indexes and Standards. Then, based on the assessment made by the securities company itself, a contingent sent by the CSRC will conduct a preliminary review and give evaluation scores accordingly. The preliminary review results will then be submitted to the CSRC, which revisits the review results from the contingent and determines to which category the securities company belongs.

Evaluation Factors Risk-management capability is the determinative factor in the classification of securities companies. The guideline has established 69 evaluation indexes in the following six categories: capital strength, customer interest protection, compliance management, legal person governance, internal control, and corporate transparency. This represents a securities company's ability to control and withstand potential risks.

Risk-Control Systems The Administrative Measures on Risk Control Indicators of Securities Companies encompasses liquidity risks, market risks, operation risks, and various business risks. Of these, the provisions on the absolute and relative indexes of net capital and their standards ensure that the business scope of a company is commensurate to its net capital level. The provisions on the calculation of risk capital requirement ensure that each business line of the company is supported by corresponding net capital.

This enables indirect control of the scale of each business and direct control of the scale of some high-risk business. It also establishes a mechanism that dynamically pegs the scale of each business line to the net capital level. In terms of routine supervision, capital sufficiency is emphasized to strengthen inspection of the securities company's risk control index generation process. Monitoring and warning are strengthened in relation to the implementation of risk control indexes by establishing a monitoring system. Regulatory measures are taken in a timely manner against companies whose risk-control indexes fail to meet requirements, thus forcing them to meet the risk-control index standards on a consistent basis.

Compliance Management System The Provisions for Trial Implementation of the Compliance Management of Securities Companies call on securities companies to establish such concepts as compliant operation, whole-staff compliance, and compliance from senior management. They advocate and promote compliance culture construction and raise compliance awareness among all employees. The provisions require securities companies to set up a compliance director position. This person is in charge of the review, supervision, and inspection of the company and its employees in terms of operation management and professional practice compliance. Securities companies are also required to establish a compliance assessment mechanism and a breach reporting mechanism and submit an annual compliance report to the regulators. The provisions make it clear that the result of the compliance management effectiveness evaluation conducted by the CSRC shall serve as an important basis for the classification of securities companies. A securities company that faces a breach of law or regulation should uncover the illegal or illegitimate act through effective compliance management, take positive corrective measures, hold the perpetrators accountable, improve its internal control mechanism and business process, and report the issue to the local securities regulatory commission in a timely manner. That company will then be exempted from liabilities or given a lesser punishment pursuant to law.

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