China’s central government plans to combat risk in the country’s asset management sector by targeting the long-standing dilemma of “implicit guarantees” and use of financial products as reciprocal investment conduits by financial institutions.
On 17 November the People’s Bank of China released the draft version of the “Guidance Opinions Concerning Standardisation of Asset Management Operations by Financial Institutions (Draft for Solicitation of Opinions)” (关于规范金融机构资产管理业务的指导意见) in conjunction with several other central government authorities.
The central government hopes that the Guidance Opinions will provide regulators with a means of resolving the problem of implicit guarantees in the financial sector (刚性兑付) by outlining detailed official definitions and punitive measures such as heightened reserve requirements.
Under the new regulations asset management products will be restricted to a single layer of investment, and prohibited from use as channels for the asset management products of other financial institutions.
The ceiling on total leverage for publicly raised and private funds will be 140% and 200% respectively.
Senior politicians have long expressed concern about the implicit guarantees surrounding certain financial products and its potential to warp incentives, generate moral hazard and exacerbate risk in the Chinese financial system.
Wu Xiaoling (吴晓灵), chair of finance and economics committee of the National People’s Congress, has repeatedly drawn attention to the issue, stating back in 2015 that “implicit guarantees are the biggest impediment to the development of Chinese finance.
“Removing implicit guarantees for wealth management products and various bonds and stocks is the starting point for the healthy development of Chinese finance.”
Wu more recently said that the removal of implicit guarantees was the prerequisite for raising the efficiency of resource allocation, and that independently bearing risk is the keystone of all financial activity.
“Finance…is an agreement for the inter-temporal transfer of value…and bearing risk to obtain returns is the fundamental principle of financial operation.”
The most widely understand definition of implicit guarantees is asset managers employing their own funds to make payments for investment products that have sustained losses – for example banks using their own capital to make payments to investors.
The Opinions also outline two other definitions – the failure of asset managers to provide fair value measurements of products when new investors make purchases and old investors make redemptions, and the use of capital pools to maintain the liquidity as well as the principal and return of asset management products.
In order to pave the way for the removal of the safety net of implicit guarantees, the Opinions call for “strengthening of investor education, continually raising the financial knowledge level and risk awareness of investor, and transmitting the concept of ‘seller responsibility, caveat emptor’ to investors.”
The Opinions also calls for a shift from an “expected return model” to a “net value model” for asset management products, in order to help remove implicit guarantees by making use of fair value principles that more promptly and accurately reflect the risk and returns of underlying assets.
Pan Dong, vice-general manager of China Everbright’s asset management department, said to National Business Daily that it’s standard practice for Chinese banks to advertise expected rates of return on investment vehicles such as wealth management products.
“[Banks] provide expected rates of return, when [their] investment management hasn’t yet produced results,” said Pan. “For this reason, the Opinions consider this to be a form of rigid payment.
“In future asset management products will be the same as publicly offered funds, with net values that are made public each day.”
Chinese asset management products are currently worth around USD$15 trillion in total according to data from Bloomberg, including USD$4.4 trillion in wealth management products provided by banks, as well as USD$3 trillion in plans sold by brokerages, fund managers and insurance companies.