China's commercial banks will soon be allowed to buy into trust and investment firms, a breakthrough in the segregated regulatory scheme in the banking, securities and insurance sectors of the financial industry.

The China Banking Regulatory Commission (CBRC) is expected to issue a regulation on administrative permission concerning trust and investment firms. This would make qualified commercial banks potential shareholders in trust and investment companies.

The banks would have to meet specific criteria in terms of capital adequacy, creditworthiness and profitability. The overall outward investment of the banks could not exceed 20 percent, according to a report in the Economic Observer newspaper on Monday. Securities, insurance, financial and leasing firms will also be permitted to invest in trust firms if they meet the same standards.

Such cross-holdings have thus far been off limits to Chinese banks, but regulations have gradually been altered to allow different types of financial firms to invest in each other, experts said.

Xia Bin, director of the Financial Institute of the State Council's Development and Research Center, predicted that authorities would gradually loosen controls as the market environment is changing.

But the experiment should be carried out with efficient regulation of the banks, which must also be prudent.

The new rule for trust firms would also set thresholds for foreign financial institutions, including commercial banks, to buy into domestic trust firms. These would be along the lines of a minimum US$1 billion of total assets and 8 percent capital adequacy, with sound credit rating and good internal control mechanisms.

The maximum ratio of stakes a single foreign financial institution could hold in a domestic trust firm would be capped at 20 percent.

The CBRC has already sent a draft of the regulation to experts and companies to solicit opinions, an official with a trust company in Shanghai told China Daily on Monday.

Several other regulations regarding the trust business are also expected, covering information disclosure and affiliated trade, he said.

The trust companies will be required to improve transparency and provide information disclosure, giving investors a clearer picture of their structure and performance.

"For investors, it is still hard to trace the shareholding structure of the trust firms and some irregularities may emerge due to the low transparency,"the official said.

Information disclosure becomes even more important if financial institutions are allowed to invest in trust and investment firms.

China's trust industry started to boom last year. Restructuring of the industry began in the mid-1990s, when a slew of default payment scandals and irregularities forced the authorities to close down many firms, leaving only 59 in business today.

The ban on banks investing in the industry was also a result of the market rectification.

Risk concerns still weigh heavily on the minds of regulators, although gradual innovation is encouraged.

As the trust companies speed up the issuance of new trust products, the need for regulation also becomes crucial.

Laws and regulations for the trust industry are considered insufficient.

Alarm bells have already been ringing for investors and regulators because of a default in repayment of a product by Jinsin Trust and Investment earlier this month. Although it was regarded as a special case, it has reminded many of the importance of investor education, risk management and information disclosure.

(China Daily July 27, 2004)