Chinese insurers have been ordered to ensure that their capital investments into public-private partnership (PPP) schemes do not turn out to be debt exposures, as authorities worry about the potential for abuse in such schemes.

The new circular, which comes after another set of investment instructions from the Chinese Insurance Regulatory Commission (CIRC) issued earlier this month, mark an effort to increase investing standards, following earlier official efforts to get insurers to invest more into PPPs.

The new rules will force insurers to place more oversight on how to invest into PPPs. It will likely mean they have to accept lower rates of return because of the ban on implicit guarantees, and increase due diligence efforts to avoid falling afoul of the new rules.

The instructions were issued via a joint circular from the CIRC and the Ministry of Finance (MoF) on January 18. They aim to strengthen insurance companies’ sense of responsibility, ensure they utilise their capital safely and efficiently, and seek to prevent local governments debt risk, according to the circular itself.

It follows a rapid increase in investments into PPPs. China officially encouraged PPPs in June 2015, and the CIRC started letting insurers invest into PPP projects in July 2016. The number of PPPs reached 6,806 planned projects with investments estimated at Rmb10.2 trillion ($1.53 trillion), according to a national database compiled by the China Public Private Partnership Center (CPPPC), under the Ministry of Finance.

China's insurers have been active participants, allocating over Rmb4 trillion to support “big real-economy projects” as of August 2017, according to according to the CIRC. Under ideal circumstances, insurers’ capital is invested directly into PPP projects. However, sometimes insurers invest through channel businesses, which are effectively multi-layered investments conducted by asset management subsidiaries. 

“An insurers’ asset management [subsidiary] may initiate an equity investment plan. It then invests into other channels, for example in other investment plans or trust plans. Through these multi-layered investments, it may ultimately invest in local governments’ PPP projects,” Melody Yang, partner at law firm Simmons & Simmons, told AsianInvestor. 

These businesses typically rely on implicit guarantees and local governments acting as guarantors, meaning the investments are debt-like in nature. These have often been needed, as PPP projects themselves have been criticised for offering unstable or low returns over long time horizons. Other unsettled issues surrounding the projects include a need for greater clarity around ownership and investor protection in the event of disputes with local authorities.

Rising concerns

The central government has become increasingly concerned that indebted local governments are effectively borrowing more under the guise of introducing social capital from insurers.

This is a particular problem given the channel business structure, the complexity of which makes it very hard for end-investors such as insurers to understand the risks they are exposed to. Yang of Simmons & Simmons said some asset management divisions have little choice but to resort to channel business because they lack the active investment management skills and capabilities to scrutinise PPP projects. They often rely heavily on the investment plans of other asset management companies or trust companies that use PPP projects as their underlying assets, she said.

The CIRC and MOF are now seeking to better regulate insurers' investment practices and weed out implicit guarantees, while curbing shadow banking activities, she added.

The CIRC’s latest rules makes its position clearer and offers more specifics and than its earlier instructions (see box at end of article for more details). Insurers can still buy local government bonds under the new rules, but they cannot provide illegal financing to local governments through asset management subsidiaries or PPP schemes, said Yang.

PPP investments through channel businesses are regarded as non-standard credit assets, which are characterised by higher yields and limited risks from implicit guarantees. However, the new rules are set to ensure institutional investors cannot continue to earn as good returns, an insurance analyst in a securities firm who declined to be named told AsianInvestor.

The likely outcome is that insurers and their asset management divisions have to conduct more time and effort to fully understand what they are investing into, reducing the easy use of channel businesses, while they will not be able to enjoy the de facto guarantees and stated levels of return that such investments once offered. That is likely to make these investments less compelling and more expensive to conduct. 

The circular is the second to be issued by the CIRC this month to regulate insurer investment activities, as part of an effort to tighten regulations on institutional investors following the 19th Party Congress in October. On January 5, the insurance regulator issued rules to prevent insurers’ asset management subsidiaries from making “fake equity, real debt” investments.

It also follows a consultation paper* of comprehensive set of asset management rules from the People’s Bank of China and the three financial regulators in November, which sought to instill more order into the asset management industry.

Highlights of the new rules

1. Support legal investments

  • Insurers are encouraged to buy local government bonds, but they are strictly prohibited to provide financing to local governments illegally and to demand local governments to provide guarantees illegally.
  • Local governments are not allowed to raise debt in a disguised way. They cannot provide any form of guarantee for any unit or person involved in insurers’ investment business.

2. Properly handle the risk of existing debt

  • Insurers should check every single local government debt investment one by one to see if they are legally compliant.

3. Regulate the activities of investment financing platforms

  • When insurers provide loans to investment financing platforms, the latter should proactively declare that they are not the financing vehicles of local governments.
  • But when the investment financing platforms’ repayment of debt involves fiscal capital, insurers should fully evaluate the local governments’ fiscal affordability by studying their regional economic and financial strength and the feasibility of the investment project.

4. Prudently start innovative business

  • When insurers start private funds, equity investment plans and PPP investments, the investment returns should match the corporates’ business profits or returns of the equity investment funds. They cannot demand local governments or financing platform companies pay fixed returns or receive implicit guarantees through other means.

*The People Bank of China (PBoC), China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC), China Insurance Regulatory Commission (CIRC) and State Administration of Foreign Exchange (SAFE) jointly released a consultation paper on regulating asset management products on November 17.

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