Securities Regulator Intent on Tackling Shadow Banking Channels

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Channel business is the next target for Chinese regulators intent upon deleveraging the economy and curbing rampant growth in the shadow banking sector.

The China Securities Regulatory Commission has flagged plans to crackdown on what are referred to in China as “channel businesses.”

This refers to the use of non-bank financial institutions by banks as intermediaries or conduits, in order to dodge regulatory constraints on their lending practices and channel funds into investments that provide higher yields for a corresponding heightened level of risk.

Given its explicit remit the China Banking Regulatory Commission has thus far taken the lead in cracking down on both banks and non-bank financial institutions that engage in imprudent or reckless operations, as the government strives to tamp down on systemic risk by deleveraging the economy.

CSRC is the regulator entrusted with pursuing a crackdown on channel operations in the Chinese economy, however, given that two of the main entities involved in the sector are securities companies and fund managers.

The securities regulator already declared at a meeting in mid-May that these companies should stick to their designated business operations, which is the management of assets “prudently and diligently,” instead of performing asset management and investment at the behest of banks via channel business.

In recent years CSRC has allowed loose regulation to abet the flourishing growth of these non-bank financial institutions, in order to provide credit markets with an alternative to traditional banks.

An unfortunate byproduct of this policy has been an increase in risk for the financial sector, with the emergence of a number of players who are highly adept at regulatory arbitrage or engage in disingenuous forms of business such as channel operations.

While channel business was essentially non-existent at the start of the decade, it saw a huge boom from 2014 and 2016 on the back of banks chasing higher yields using the funds of depositors, as well as shunting loans off their balance sheets in order to avoid regulatory requirements with respect to capital adequacy and restrictions on investment in certain vulnerable sectors.

Channel business emerged as a highly lucrative business for non-bank financial institutions given the exorbitant fees that conventional banks were willing to pay for an effective conduit.

Figures released by the Asset Management Association of China indicate that Targeted Asset Management Companies (TAMC), which are mutual fund subsidiaries that engage in channel operations, had 2.33 trillion yuan ($330 billion) in assets under management in 2014.

This figure surged 141% to 5.37 trillion yuan in 2015, before leaping to 7.47 trillion yuan in 2016 for a year-on-year gain of 39.1%.

Securities firms are also major players in channel business, with their assets in the sector surging to 12.38 trillion yuan in 2016, for a year-on-year gain of 39.8% Channel business assets accounted for 71.5% of total assets under management.

The securities watchdog has since shifted course completely, with one source close to the regulator telling Caixin that “its top priority now is to stop turning a blind eye to what’s been going on and to force securities firms to do what they are supposed to do.”

CSRC said in an official statement released on May 19 that securities firms and mutual funds would be held accountable for any undue risk they create as a result o finsufficient controls or poor management, and that any “black sheep” who engage in gross malfeasance will be removed in order to “ensure a sustainable and healthy development of the securities and fund management industry.”

On the same day CBRC spokesman Zhang Xiaojun said that the regulatory agency it would launch a “comprehensive ban” on channel operations, emphasising that banks would be forbidden from “transferring” asset management responsibility.

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