On September 12, 2014, China Securities Depository and Clearing Co., Ltd ("CSDC") promulgated the Service Guideline for the Title Transfer upon the Disposition of Pledged Securities (the "Disposition Guideline"). The Disposition Guideline enables the value conversion of relevant securities (i.e., the pledgor transfers the title to the securities to the pledgee to settle the secured indebtedness) by agreement between the pledgor and the pledgee at enforcement of the pledge.After the value conversion, the title of relevant securities will be transferred to the pledgee, settling the outstanding obligations owed by the obligor to the pledgee.
On January 30, 2014, CSDC promulgated the Service Guideline for the Adjustment of Securities Pledge Registration Status, which allows CSDC to adjust the status of securities pledge registration upon application and allowrelevant securities to be sold on open market (aka. "private sale") without releasing pledge registration of corresponding securities.The secured obligations can be settled with the proceeds from the private sale.
With the Disposition Guideline, private remedies (where court proceeding is not involved) provided by the Property Law and the Civil Procedure Law: i.e. value conversion, private sale and auction with mutual consent, are made accessible in practice.
I.Preconditions of value conversion
The Disposition Guideline stipulates that the following conditions must be met when disposition is involved:
- Relevant securities is deposited and cleared at CSDC
- Pledge registration is valid and has been valid for more than 1 year
- A disposition agreement for the pledged securities is entered into between the pledgor and the pledgee after the maturity of performance period
- Relevant securities are not restricted stock held by directors, supervisors, or senior management personnel
- Relevant securities are not frozen by any court
- If disclosure of information is required, such information has been properly disclosed
- If tender offer is required, relevant procedures are followed
II.Value conversion vs private sale
To some extent, if a share pledge agreement is entered into between the pledgor and the pledgee and a tripartite disposition agreement is entered into among the pledgor, the pledgee and the securities company who is the designated securities company of the pledgor (applicable to Shanghai market) or the custodial unit of the securities (applicable to Shenzhen market), the pledgee may take the self-help remedy and initiate a private sale without the cooperation of the pledgor when an event of default is triggered.However, the pledgee and the pledgor can only enter into a disposition agreement after an event of default is triggered and then make value conversion.
Notwithstanding the preceding paragraph, the option of value conversion benefits the pledgor by enabling the pledgor to settle obligations in time.The pledgee can also benefit from this expedited process. This means market risk (i.e.risks of adverse change in the price of securities) inherent in the time-consuming judicial procedure will be effectively mitigated.Additionally, this option allows the pledgee to obtain title over the securities directly.
III.Limit on the pricing of value conversion
In order to maintain the stability of the capital market and protect the interest of the pledgor, the Disposition Guideline specifically stipulates that the price in respect of the value conversion must be determined by reference to market price and shall not be lower than 90% of the average closing price of the corresponding securities in the past 20 trading days prior to the execution of the disposition agreement for the pledged securities.Therefore, the pledgee, with a strong bargaining power, may not be able to further lower the price unreasonably.
IV.Offshore pledgor can hold securities upon value conversion
The Disposition Guideline allows offshore investors, as the pledgee, to open an onshore securities account for the purpose of obtaining title of securities after value conversion and to sell such securities at the first time and there is no maximum holding period requirement.Therefore, offshore investors, in addition to qualified foreign institutional investors, foreign strategic investors and RMB qualified foreign institutional investors are further allowed to open an onshore securities account.This in effect opens a window for offshore investors and allows offshore investors, based on financing, to establish investment portfolio in the onshore capital market.
It is notable that such securities account opened in accordance with the Disposition Guideline functions only for the purpose of holding and selling securities obtained upon value conversion by agreement, and no other trading authority is granted in respect of such securities account.