New regulation spurs D&O insurance demand in China

Shanghai_Pudong
Chinese companies are seeing an increased need to purchase directors’ and officers’ liability insurance (D&O) after China expanded corporate disclosure requirements and made it easier for investors to sue company directors.

On March 1, 2020, a revised People’s Republic of China (PRC) Securities Law came into effect with over 100 articles changed and alsonew chapters introduced on information disclosure and investors’ protection. The PRC Securities Law essentially establishes the legal basis of a registration-based initial public offering (IPO) mechanism. 

In the past, companies in China were subject to regulatory approvals by China’s Securities Regulatory Commission (CSRC) but under the new legal framework, stock exchanges have the power to examine and verify IPO listing applications, determine whether applications fulfil issuance and information disclosure requirements and can also provide comments on the content of information disclosure. There is a transition period, and currently this new mechanism only applies to IPOs on the Shanghai Stock Exchange Science and Technology Innovation Board (STAR Market).

The PRC Securities Law expands the enhanced information disclosure requirements not only for the securities issuers during the IPO filing but also for already publicly traded companies, as well as for bond issuers. The requirements aim to improve transparency for investors by requiring the issuer to disclose any information that could potentially affect the investment decision. The new rules also allow individual investors to band together in a US-style class action lawsuit to sue listed companies in China. 

Pointing to the fact that the Chinese securities market is set to become one of the largest in the world, and referring to the piloting of a registration-based IPO system, Senior Consultant at law firm Clyde&Co, Victor Yang, concluded in an article that it is reasonable to expect China to face more upcoming cases of joint securities litigation.

Some other features of the new regulation include:

  • Chinese companies face much more severe penalties under the new rules. The upper limit of penalties for issuance fraud for example increased to 20 million yuan ($2.9 million) from 600,000 yuan previously. Listed companies in China also face higher administrative fines and penalties in case of breach of the Securities Law. 
  • The law includes certain extraterritorial jurisdictions that give the Chinese regulator oversight over domestic companies listed overseas. If a Chinese company performed issuance or trading activities in an exchange or over the counter outside of China’s territory, they may be subject to reporting obligations under the new Securities Law.

In a recent example, the China Securities Regulatory Commission (CSRC) got involved in the scandal regarding alleged fraud at Luckin Coffee, a New York-listed coffee chain touted as China’s answer to Starbucks.

The regulatory overhaul has raised concerns at some companies over rising management liability risks and prompted a discussion about the need to better protect executives against uncertainty and potential lawsuits. As a result, inquiries for D&O insurance from Chinese companies have risen sharply. These inquiries are often driven by members of the executive or supervisory boards of Chinese companies who demand insurance protection to perform their roles. 

According to a May 12 Financial Times report, 72 companies listed in Shanghai and Shenzhen have announced plans this year to buy D&O insurance compared with just 23 in the whole of 2019.

D&O liability insurance policies can protect executives against claims arising from actual or alleged wrongful act in their official capacities. This includes damages awarded in civil courts, settlements and the potentially substantial defence costs, if an executive faces civil, criminal or regulatory charges.

Currently, the penetration rate of D&O insurance among China listed companies is very low at around 10%. This compares to around 90% in Hong Kong and the US, for example. 

The D&O market in China is still dominated by foreign insurers with just a few domestic players offering the product. As a result, wordings usually follow the international standard, but policies may require some adaptations to reflect the different legal system in China and adjudication language. 

For further information, please contact: 

Terry Tang, Senior Vice President - Greater China, Global Professional and Financial Risks 
T: +852 2250 2823
E: Terry.Tang@asia.lockton.com

Or: 

Melody Qian, Senior Vice President, Greater China, Global Professional and Financial Risks
T: +852 2250 2672
E: Melody.Qian@asia.lockton.com

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