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Management of Risks Associated with Asset Management Business of Securities Companies

Stringent Internal Management and Internal Control System Stringent Business Separation Mechanisms Securities companies should effectively separate their asset management business from securities proprietary business, securities underwriting business, securities brokerage business, and other lines of business to prevent insider trading and avoid conflicts of interest. The same senior executive should not run asset management business and proprietary business at the same time. The same person should not be the division head of two divisions that engage in both types of business. The same investment sponsor should not handle asset management business and proprietary business at the same time. An investment sponsor of collective asset management business should not assume the role of investment sponsor for other types of asset management business.

Relevant Accounting Systems Asset management plans should have independent and complete account, review, reporting, and archiving management

Systems. Financing accounting of asset management plans should be the responsibility of dedicated personnel in the finance department. The settlement and custody department should take charge of the asset custody and clearing associated with asset management plans. It should be ensured that the risk-management department and the supervision and inspection department can effectively monitor the operation and management of collective asset management business to effectively prevent off-the-book operation, appropriation of collective asset management plan funds, and other illicit or illegal behaviors.

Provisions of Laws Observed and Responsibilities Clearly Specified If a securities company participates in a collective program, the fund owned by the securities company itself in the program should not be more than 5 percent of the total amount of the program and should not exceed CNY 200 million. If a securities company participates in multiple collective programs, the total amount of funds owned by the securities company in these programs should not exceed 15 percent of the company's net asset. Throughout the term of the collective program, the number of clients should be no fewer than two. The net asset value of the program should not be lower than CNY 100 million for 20 consecutive trading days. The securities of a single company held by a single collective program should not exceed 10 percent of the net asset value of the collective program. If a securities company is to invest client funds under its management in securities issued by a company, the amount of securities purchased should not exceed 10 percent of the issued amount. In the special securities account managed by a securities company, the shares of one single public company should not exceed 5 percent of the total amount of shares in the company, unless explicitly authorized by the clients. When the clients' holding of a public company's shares reaches 5 percent, purchase of any more shares of the company by the securities company for the clients through the special securities account should be subjected to approval of the clients of the asset management business before every transaction. Shares of the public company should not be transacted by the securities company without the clients' permission.

Optimization of Contract Design, Standardization of Contract Management

Improving Capital Liquidity Design A comprehensive market is still missing for the circulation of entrusted wealth management products. There is no way to base the price on market supply and demand or a price discovering mechanism. The precision pricing of products by the trustee during the circulation process is very costly. Therefore, asset management contracts should give consideration to the diversity of client needs, the limited term of entrusted funds, and the balance of incomes. In entrusted fund liquidity management, it is advisable to first sign a general agreement that specifies the total amount of entrusted funds, and then sign various subagreements separately that require the fund owner to inject a certain amount of capital into a special wealth management account in each of the several phases as specified. The capital will be invested in a phased manner. The assets will be gradually liquidated upon expiration of the entrustment term to pay the clients their money back. Based on the condition of the securities market, the expectations of the two sides and the performance of previously entrusted capital, the two sides may reconsider or revise the conditions of the subagreements.

Optimizing Contract Term Structure: Design of Reload Option Models The asset management business in China is characterized foremost by a time limit on the use of entrusted capital. How to extend the operation cycle of the asset under management is an important aspect of risk management in this business. The design of reload option models refers to the design of a reasonable wealth management covenant about reload options based on the principle of the option contract, so that the securities trader can play the role of a buyer. If the return from the assets under its management meets certain criteria, the securities trader gets to decide when a new wealth management agreement goes into effect and whether an existing wealth management agreement will be renewed. The securities trader may exercise its right when market conditions are favorable or there is a capital crunch for follow-up operations, or give up when the opposite is true. A precondition for the client to sign a reload option agreement with the securities trader is that it has abundant idle funds. As the seller of options, the client will receive discounts on wealth management procedure fees, additional services, or a fixed option premium.

Implementing Risk Evaluation and Monitoring

Gradual Adoption of Risk Management Techniques Risk management techniques can be adopted gradually and implemented in a series of steps. A risk management department can start by determining the investment scopes and investment proportion of wealth management products based on a study on client risk and return preferences. Based on those results, calculate the probability distribution pattern of the return from a wealth management product based on target market analysis and forecast. Depending on the characteristics of wealth management products and clients' development requirements, finalize elements of the wealth management product, such as call option scale and proportion and basic returns. Finally, calculate the management risk and expected return of the corresponding wealth management products. Based on the risk-return characteristics of the product and the development plan for the asset management business, evaluate the operation risks and expected return of wealth management products to determine the feasibility of the products.

If the product plan fails to meet the risk control requirement, the elements of the products will have to be adjusted and revised. Quantitative analysis should be conducted to adjust and advise the proportions of variable return assets and fixed return assets in the portfolio based on the fluctuation of the market. This is to ensure that after a period of time, the investment portfolio won't fall below a preset minimum target return for entrusted assets, which achieves the goal of maintaining and increasing the value of the portfolio.

Dynamic Monitoring of Risks Should Be Implemented Enhancing dynamic monitoring of risks through the design of key indexes includes the following items:

- Whether the asset management business is audited within the account

- The scale of entrusted capital and the percentage of net assets

- How well the entrusted capital is managed in a special account

- How the funds are deposited

- How the client and the company share risks, and the safety of the principal

- Whether the floating profit and loss of the entrusted asset are kept within the stop-profit/stop-loss scope defined by the company

- The percentage of the total amount of unsettled losses associated with the entrusted assets in relation to the net assets

- Remedy channels for losses in the asset management business and their impact on the capital chain of the company

- The way losses in the asset management business are processed by accountants

- The operation of asset management business accounts and whether any operation or entrusted investment is made outside the system of the company

- Guarantees offered to clients of the asset management business

- When a relevant index reaches the level of a risk, the securities traders can identify the risk and reduce losses.

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