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China’s top regulators unveiled radical reforms for the country’s asset management industry this month, in a push by the government to defuse the investment risks accumulating across the Asian giant’s financial system.
The reforms, which are also designed to improve standards of investor protection and to set the asset management industry on a sustainable growth path, follow huge increases in debt and leverage that threaten the sustainability of the Chinese economy.
Retail investors in China have been ploughing money into lightly regulated or unregulated wealth management products that offer higher yields than bank deposits.
These wealth management products are issued by banks, insurance companies and other financial groups that are supervised by different regulators, which has led to massive growth in so-called non-standard credit assets or the shadow banking sector.
David Yin, a senior analyst at Moody’s, the credit rating agency, in Hong Kong, says, historically, financial companies were able to circumvent restrictions on their activities under the previous regime. But he says this should no longer be possible under new rules that will create a unified regulatory framework covering all asset management products for the first time.
“The guidelines classify asset management products by their fundraising method (public or private) and their investment scope, and will subject them to uniform requirements so as to reduce regulatory arbitrage,” says Mr Yin.
Asset managers will have to clearly distinguish products offered for sale to the general public from products marketed to qualified investors that meet minimum income and wealth thresholds. Products sold by private placement to qualified investors can invest in unlisted securities but products sold to ordinary retail investors must invest mainly in low-risk, highly liquid equity and fixed-income assets.
“The [new] guidelines will close many regulatory loopholes while leaving room for the orderly and sustainable growth of China’s asset management business,” says Lan Shen, an economist at Standard Chartered bank in Shanghai.
New leverage limits will also be applied, with a debt ratio (measured as total assets divided by net assets) set at 140 per cent for products sold to retail investors and at 200 per cent for products sold privately to qualified investors.
The asset minimum for qualified investors has been increased from Rmb3m ($454,000) to Rmb5m ($756,000).
Another important development is a prohibition on asset managers offering “no loss” principal protection products or promising a guaranteed rate of return. Asset managers will also be required to set aside 10 per cent of any management fees they collect as provision for potential losses.
“The new rules are likely to contain financial risks, curb excessive credit growth and improve the effectiveness of monetary policy,” says Mr Shen.
Asset managers will also be encouraged to invest in priority projects, such as the Belt and Road initiative, a vast infrastructure plan to connect China with other countries in order to boost trade, as well as regional development plans. Financial institutions have been given until June 2019 to comply with the new rules.
Daniel Celeghin, head of wealth management strategy for the Asia-Pacific region at Casey Quirk, the consultancy, says the new rules could mean a “huge hit” to the revenues of Chinese trust companies, so there is likely to be some resistance during the current consultation period with regulators, which runs until mid-December.
Beijing also announced this month that China plans to relax or eliminate foreign ownership limits in Chinese financial services groups, including asset managers.
Foreign companies will be allowed to own 100 per cent of a domestic fund management company by 2020.
Stewart Aldcroft, Asia chief executive of CitiTrust, the securities and fund services arm of Citigroup, the US bank, says this change, along with the new regulatory framework, could “completely transform” financial services businesses in China.
“This is without doubt the development that the major global players have been looking for, to control and own their own businesses in China,” says Mr Aldcroft.
Casey Quirk is forecasting that assets under management in China’s investment industry will grow to around $17tn by 2030, helped by the rising wealth of the middle class and the expansion of workplace retirement saving schemes.
China’s economy at a glance
Around half ($8.5tn) of the net new inflows attracted by investment managers globally by 2030 will go to Chinese companies, helping the country to become the world’s second-largest asset management market behind the US.
This growth presents a potentially huge prize for foreign companies. But Mr Celeghin cautions that it remains unclear just how large a role Chinese regulators will allow foreign managers to play.
He notes that the liberalisation of Japan’s investment markets has led to a decline in the share of the fee pool going to domestic managers over the past decade. China will instead look to the example of the US, where league-ranking tables remain dominated by local companies.
“China likes the US model. It wants to see more competition. But it also wants to make sure that its own players win,” says Mr Celeghin.
He adds that even if foreign managers believe they can offer better-quality investment products at lower fees, they will struggle to match domestic Chinese managers’ capacity and willingness to send teams of senior staff to help local distributors to meet client needs.
Other long-time Beijing watchers remain sceptical about the government’s willingness to encourage greater participation by foreigners in China’s financial industry.
“The financial commanding heights will not be ceded to foreigners,” says George Magnus, an associate at Oxford university’s China Centre.