To control credit risk, banks often require debtors to provide a guaranty when lending funds to enterprises. Enterprises acquire fund more conveniently and efficiently through such borrowing, which promotes further development of the enterprise. However, malicious or unreasonable guaranties that are beyond the capacity of the guarantor, such as guaranties in violation of laws provided by listed companies, can result in tremendous damages, as the eruption of the guaranty risk will drive the listed company into lawsuits and capital loss, and will also increase non-performing loans to banks, thus impacting the steady improvements that have been seen in the healthy growth of the finance market.

In order to prevent listed companies from risks arising from guaranties that are in violation of laws and prevent banks from credit risks, the Securities Regulatory Commission of the PRC, in association with the PRC Banking Regulatory Commission, issued the “Circular on Issues Regarding the Regulation of Guaranties Provided by Listed Companies” (the “Circular”).The Circular took effect on January 1, 2006, together with the newly amended Corporation Law and Securities Law.

The Circular partly modified regulations issued by the Securities Regulatory Commission with respect to the guaranty provided by a listed company in order to keep consistent with the principles of the newly amended Corporation Law. It also contains detailed provisions on issues relating to improving quality of listed companies issued by the State Council transmitting to the Securities Regulatory Commission. The Circular sets forth the following requirement to, respectively, listed companies, banking and finance institutions and related regulatory institutions:

I、Internal Decision-Making Process and Information Disclosure Obligation of Listed Companies

The Circular requires that an outward guaranty shall be discussed and approved by either the Board of Directors or at a Shareholder Meeting of the listed company. The purview of which types of guaranty can be decided by the Board of Directors or the body of shareholders at a shareholder meeting shall be defined in the company’s Article of Association. The Circular lists the following situations in which an outward guaranty must be approved by the Shareholder Meeting, and also shall be submitted to the aforesaid Shareholder Meeting for approval only after being discussed and approved by the Board of Directors:

1、An outward guaranty provided by listed company and its holding subsidiaries with the total amount exceeding 50% of the latest audited net assets of the aforementioned company;

2、An outward guaranty provided for the party whose asset-to-liability ratio exceeds 70%

3、Outward guaranty with the amount exceeding 10% of the latest audited net asset;

4、A guaranty provided for its shareholder, holding party or other affiliates of the listed company.

As for the guaranty which shall be approved at a shareholder meeting, the Circular specifically sets forth the vote-avoidance mechanism of affiliate shareholders, i.e. when discussing and voting for the guaranty provided for its shareholders, holding party or other affiliates of the listed company, such shareholder or shareholder dominated by such holding party cannot participate in the voting, and such approval requires at least 50% affirmative votes of other shareholders attending the meeting.

Regarding information disclosure obligations, the Circular has set forth more specific and strict regulations, which requires listed companies who provide outward guaranties to promptly disclose in designated newspapers or periodicals information about the guaranty that was approved by the Board and Shareholder Meeting.This rule also applies to guaranties provided by the holding subsidiary.

II、Standardization of the Review and Approval Conducted by the Banking Financial Institution

The Circular emphasizes that banking financial institutions shall review the documents of a guaranty in accordance with the Article of Association of the listed company.This is to decide whether such documents are sufficient and legitimate, as well as to review and check the decision-making process, information disclosure obligation fulfillment and guaranty capability and credit of the listed company, etc. It also requires the banking institution to perfect the internal control mechanism according to the guidance on work relating to granting credit conducted by commercial banks.

Such steps should help prevent the occurrence of illegal guaranties, using an established internal decision-making process and information disclosure obligation as a prerequisite when banks review and approve the guaranty.Also, clarifying the responsibility of banks when issuing the approval, will also help stem the flow of illegal guaranties, restraining people from seeking self-benefit by hiding the real credit information of listed company and providing guaranty to other companies.

III、Strengthened Supervision and Cooperation by Regulatory Institutions

In accordance with the Circular, the PRC Securities Regulatory Commission and the PRC Banking Regulatory Commission shall strengthen cooperation.This shall include sharing information, jointly establishing cooperative supervision and administration mechanisms, jointly strengthening the supervision and prevention of the illegal conduct of hiding credit information, providing guaranties in violation of law by listed companies and providing loans in violation of regulations conducted by the banking institution and imposing liability in accordance with laws, as well. Such cooperation demonstrates the determination of both the Securities Regulatory Commission and the Banking Regulatory Commission to uproot illegal guaranties of listed companies.

The Circular is aligned with the latest amendments to the PRC Corporate Law, and specifies the requirement for an internal decision-making process and information disclosure obligation of listed companies when providing guaranties for other companies.It also strictly defines the review and approval requirements and obligations of banking and financial institutions when granting loans with guaranties by listed companies.Further, it also clarifies the division of work and supervision obligation of the Securities Regulatory Commission and the Banking Regulatory Commission in regulating outward guaranties of listed companies.These measures are significant in stemming the illegal guaranty problems and lowering the guaranty risks of listed companies.

The Circular also relaxed some previously-forbidden provisions on problems relating to providing guaranties by listed companies.The Circular covers issues relating to regulating the capital inflow and outflow between a listed company and its affiliates, and certain problems of outward guaranty of listed companies.Listed companies were previously forbidden to provide guaranties for an existing shareholder or its affiliate or for a party whose asset liability ratio exceeded 70%, or to provide a guaranty in an amount exceeding 50% of the latest audited net assets of the listed company. The release does respect the self-determination right of listed companies in providing guaranties to others, and allows companies to improve their self-discipline functions. Overall, the Circular provides for increased development for listed companies with strict internal controls and high transparency, and also strengthens the internal decision-making process and information disclosure obligations of listed companies.

── Daicy Zhou