The launch of new regulations governing the asset management sector is expected to have a far-reaching impact upon the Chinese financial system.
On 27 April China’s financial regulators officially launched the “Guidance Opinions Concerning Standardisation of Asset Management Operations by Financial Institutions” (关于规范金融机构资产管理业务的指导意见), as part of broader efforts to contain risk in the financial system.
The release of the draft version of the Opinions last November caused trepidation in both the banking and asset management sectors, due to concerns that Beijing’s targeting of the implicit guarantees that undergird many Chinese investment vehicles could compromise financial stability.
The regulations are receiving heavy play from China’s domestic press in the wake of their launch, with a headline article from the state-run Xinhua News Agency highlighting five key aspects of the rules that warrant attention.
- The transition period for the new regulations has been extended to the end of 2020
The transition period for the new regulations was a key source of concern for Chinese financial institutions following the release of the draft version in November last year.
“Given the maturities and market scope of outstanding asset management products, as well as the maturity and scope of their investments, the officially released opinions propose the establishment of a transition period in accordance with the principle of the ‘old replacing the new,'” said an official from the People’s Bank of China (PBOC), the Chinese central bank.
“The transition period has been extended from 30 June 2019 to the end of 2020.”
While new products issued by financial institutions must comply with the new regulations during the transition period, old products may still be issued in order to “continue” outstanding products whose investments have not yet matured, as well as maintain required liquidity and market stability.
2. The smashing of implicit guarantees and strict control of risk remain imperative
One of the chief goals of the new asset management regulations is the removal of the perception amongst Chinese retail investors that wealth management products issued by banks enjoy “implicit guarantees”, creating a potential source of moral hazard.
The new regulations clearly define “implicit guarantees” as including “guarantees of the principal and interest of products in breach of net valuation principles,” “the adoption of the rolling issuance method to guarantee principal and interest,” as well as the “independent raising of funds to make repayments or entrust other institutions with proxy repayment.”
PBOC has made clear its determination to punish the promotion of implicit guarantees for asset management products.
“If implicit guarantees arise in relation to depository financial institutions, they will need to make up their reserve ratios and pay deposit insurance fees,” said the PBOC official. “Licensed non-depository financial institutions will be subject to lawful correction and sanction by financial regulators and the People’s Bank of China.”
Financial institutions are strictly prohibited from making any form of “advance payment” for asset management products that are struggling.
“[We will] guide financial institutions in changing their expected yield model, strengthen regulation of net valuation of products, as well as clarify calculation principles,” said PBOC.
3. Strict standardisation of investment in non-standard assets
China’s financial regulators have expressed concern that too many of the funds raised via asset management products are being invested in “non-standard” assets that are low in transparency and lack liquidity, or are vehicles for engaging in regulatory arbitrage and fuelling shadow banking activity.
The new regulations stipulate that asset management products must abide by the relevant quotas and liquidity requirements of financial regulators when making non-standard investments, while also requiring that they strictly match maturities.
“The goal of this is to prevent asset management operations degrading into covert lending, contain shadow banking risk, shrink financing chains, reduce financing costs, and raise the efficiency and level of service for the real economy,” said the PBOC official.
4. Standardisation of asset management product leverage
According to PBOC the leverage levels of asset management products will be strictly controlled in order to “preserve the stable operation of the bond, stock and other financial markets, and contain the formation of asset price bubbles.”
The new rules set a ceiling on leverage ratios of 140% for open public offerings, 200% on closed public offerings, 140% on graded public offerings and 200% on private asset management products.
They also prohibit financial institutions from engaging in pledge financing using products entrusted for management.
5. Removal of multi-tier nesting, restrictions on conduit operations
The surging growth of China’s asset management sector in recent years has seen “multi-tier nesting” of products emerge as a major problem, with regulators concerned that this is increasing the complexity of products, raising the cost of private financing, as well as exacerbating market volatility.
The new asset management rules prohibit multi-tier nesting of asset management products alongside “conduit operations,” and limit nesting levels to a single tier.
They also unify regulatory standards for asset management products, requiring that regulators apply equal entry standards for asset management operations and give equal treatment to asset management products, in a move which is expected to “get rid of the motivation for multi-tier nesting at the source.”