January 2013 A New Repurchase Agreement for the PRC Inter-bank Market 1 Introduction On 18 December 2012, the People s Bank of China ( PBOC ) announced its approval of the publication of the China Inter-bank Market Bond Repurchase Master Agreement 1 (the New Agreement ) by the National Association of Financial Market Institutional Investors ( NAFMII ), which NAFMII later published on 21 January 2013. Subject to a one-year transition period, the New Agreement is to replace the two existing repurchase agreements published by PBOC in 2000 and 2004 (based on pledge and title transfer approaches respectively). 2 How does it affect you? Contents 1 Introduction 1 2 How does it affect you? 1 3 Key Features of the New Agreement 1 4 Execution of the New Agreement 4 5 Transitional Arrangements 4 6 Conclusion 4 The New Agreement introduces a number of significant structural and substantive changes to its predecessors. Banks that do not enter into the New Agreement within the transition period will be locked out of the People s Republic of China ( PRC ) inter-bank market. It is therefore critical for market participants to familiarize themselves with the changes brought about by the New Agreement and plan for a smooth transition. 3 Key Features of the New Agreement The New Agreement adopts new document architecture and contains more sophisticated provisions on termination and default payment and calculation. Its key features are: > New document architecture: The New Agreement contains one set of general terms (the General Terms ) and two sets of special terms. The general terms apply to all the repurchase transactions documented 1 The New Agreement will be used to document bond repurchase transactions in the PRC interbank market. Bond repurchase transactions refer to repurchase transactions in respect of fixed income valuable securities that are entered into by market participants on a bilateral basis. The New Agreement does not apply to shares repurchase transactions which are carried out on the stock exchanges in Shanghai and Shenzhen. A New Repurchase Agreement for the PRC Inter-bank Market 1
under the New Agreement, irrespective of whether they are pledge repurchase transactions or title transfer repurchase transactions. The New Agreement has a set of pledge repurchase special terms (the Pledge Special Terms ) and a separate set of title transfer repurchase special terms (the Title Transfer Special Terms ) which govern pledge repurchase transactions and title transfer repurchase transactions, respectively. Contracting parties may also enter into a supplemental agreement to make elections, provide information or make any amendment to the General Terms, Pledge Special Terms or the Title Transfer Special Terms. There are two sets of supplemental agreements: one for pledge repurchase transactions (the Pledge Supplement ) and the other for title transfer repurchase transactions (the Title Transfer Supplement ). > Title transfer repurchase documentation forms a single agreement: Importantly, title transfer repurchase transactions documented under the New Agreement constitute one single and complete agreement. This allows a non-defaulting party to early terminate all the outstanding title transfer repurchase transactions if there is a payment or delivery failure under any title transfer repurchase trade. All title transfer repurchase transactions will be closed-out and netted upon early termination following an event of default or a termination event. This differs from its predecessor under which different title transfer repurchase transactions did not altogether form one agreement. > Pledge repurchase documentation does not form a single agreement: Interestingly, pledge repurchase transactions documented under the New Agreement do not form a single agreement with each other. If all the pledge repurchase transactions did form one single agreement, every time a new transaction is concluded or an existing one terminates, the pledge registration would have to be renewed. As this would create uncertainty as to the perfection of pledge interests especially in the context of bankruptcy proceeding for the pledgor, payment or delivery failure in relation to one pledge repurchase trade should only result in default under that particular transaction. > Additional events of default: In addition to payment or delivery failure, the New Agreement greatly expands the list of events of default to include some events similar to those under the internationally used Global Master Repurchase Agreement 2 such as admission of intention not to perform obligations, untrue representations, act of insolvency, and breach of non-payment obligations, as well as other events similar to those under the derivatives master agreement published by NAFMII, such as merger without assumption, cross-default, and default under specified transactions. 2 The Global Master Repurchase Agreement is published by the International Capital Market Association and Securities Industry and Financial Markets Association. A New Repurchase Agreement for the PRC Inter-bank Market 2
> New termination events: The New Agreement introduces two termination events, i.e., illegality and force majeure event. > More sophisticated termination calculation mechanics: The New Agreement prescribes various calculation formula and interest rates to determine the repayment amount and compensation amount depending on the relevant termination scenario. Considerations include whether the payment or delivery is due from the defaulting party, and whether the early termination occurs prior to the initial settlement date or the final settlement date or upon the final settlement date. These new provisions are far more comprehensive compared to their predecessors. > New self-help remedy for pledgees: For a pledge repurchase transaction, if a non-defaulting party is the reverse-repurchase party (i.e., it lends money to the counterparty and becomes a pledgee of the bonds), the New Agreement expressly allows the non-defaulting party to dispose of the bonds by auction or sale. This overcomes a current enforcement problem encountered by a pledgee who cannot direct the depository to change the bond register following disposal of the bond without the co-operation of the pledgor. The express recognition of a pledgee s right in the New Agreement greatly assists the pledgee who will be able to enforce the pledge independently of the pledgor. > Net settlement permitted for title transfer repurchase transactions: Following default on a title transfer repurchase transaction, the defaulting party may experience difficulties in returning the bonds to the non-defaulting party. The New Agreement allows the non-defaulting party to apply a net-calculation method as provided for in the Title Transfer Special Terms instead of the return-delivery provisions under the General Terms. This would improve the position of a non-defaulting party who owes any amount to the defaulting party under other title transfer repurchase transactions but a question remains as to the enforceability of this netting arrangement in a post-insolvency scenario. > Mandatory PRC governing law and dispute resolution: The New Agreement adopts PRC law as the governing law, and requires dispute resolution (which can be litigation or arbitration) to be carried out through proceedings in the PRC. Like the NAFMII derivatives master agreement, these governing law and dispute resolution provisions are mandatory and cannot be contracted out of by the parties. > Other provisions similar to NAFMII derivatives master agreement : The provisions on set-off, transfer, notice, telephone recording and confidentiality are generally similar to those in the derivatives master agreement published by NAFMII. A New Repurchase Agreement for the PRC Inter-bank Market 3
4 Execution of the New Agreement Like its predecessors, the New Agreement is open for execution on a multilateral basis, although the contracting parties must enter into each repurchase transaction bilaterally. One executed copy of the New Agreement must be filed with NAFMII. For effective execution, the legally designated representative or authorized representative must sign, and affix the company chop on, the New Agreement. It should be noted that the New Agreement becomes effective as between the executing party and all other market participants who have executed the New Agreement upon effective execution, and not upon filing with NAFMII. The Pledge Supplement and the Title Transfer Supplement can be executed on a bilateral basis and one executed copy must be filed with NAFMII. Any subsequent amendment to a supplement must also be filed with NAFMII. NAFMII is required to carry out service works in respect of the filing of executed New Agreements. NAFMII will maintain an updated list of market participants who have deposited their executed New Agreements with NAFMII. Market participants must report any dispute or event of default under the New Agreement to NAFMII. 5 Transitional Arrangements There will be a 12-month transition period for the PRC inter-bank market to adopt the New Agreement for all the repurchase transactions. The transition period commenced on 21 January 2013, the date of publication of the New Agreement. During the transition period, those who have not entered into the New Agreement can enter into new repurchase transactions under the predecessor agreements. Where both counterparties have executed the New Agreement, they must document new repurchase transactions under the New Agreement. Market participants are well advised to enter into the New Agreement. It is important to note that following the expiry of the transition period, those who have not done so cannot enter into new repurchase transactions in the PRC inter-bank market. Historical trades may continue to be governed by the predecessor agreements, or the parties may agree to migrate them to the New Agreement. 6 Conclusion Inter-bank repurchase transactions have served as a major tool for funding and money market investment by domestic and foreign-invested banks in the PRC. In 2012, over RMB140 trillion of pledge repurchase transactions and approximately RMB5 trillion of title transfer repurchase transactions were traded in the PRC. The New Agreement introduces a number of important changes from its predecessors in terms of structural features and substance. For banking A New Repurchase Agreement for the PRC Inter-bank Market 4
institutions to continue their repurchase activities on the inter-bank market, it is important to become familiar with the changes brought about by the New Agreement and plan for adequate legal and operational risk management and review measures. To better manage counterparty risks, banks may, in addition to the General Terms, consider entering into Supplements with their counterparties. A New Repurchase Agreement for the PRC Inter-bank Market 5
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