China new AM rules unlikely to quell surging WMPs
China’s new asset management product rules, which propose to restrict financial institutions from using their capital to compensate investors over failed investment products, are set to change how banks issue wealth management products (WMPs).
While some experts feel this will cause a diminishment in the country’s wealth management product industry over the long term, several others believe retail investor demand for yield will overcome the rules change, and means that volumes will continue soaring.
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.
The long-awaited document is by far the most comprehensive set of rules on China’s asset management business, and aims to solve a range of problems in the market. However, experts say bank WMPs are likely to be particularly affected, due to the new rules’ proposal to ban any an “implicit guarantee” on products.
Banks' WMPs are extremely popular in China. They are largely underpinned by high yielding and relatively risky corporate and local government loans. In effect they make up the largest part of the country's shadow banking industry.
China's banks had Rmb28.4 trillion ($4.3 trillion) in the products outstanding in June 2017, a tad down on Rmb29 trillion at the end of last year but an amount the constitutes roughly 27% of China’s asset management industry. This compared to the Rmb4.6 trillion the products in existence in 2011, according to a Deutsche Bank report.
Market experts say WMPs enjoy mass appeal because investors assume they will always receive their principal back, despite the products offering relatively high yields. They offer an average yield of about 4.6% today, much higher than the one-year deposit rate of 1.5%.
To date there have been few indications of banks not having paid the principal of WMPs back to their investors. But this will not last forever, particularly given the increasing levels of debt that exist in China.
“In the asset management, or wealth management industry in China, implicit guarantee is the root of all evil, because with implicit guarantee, risk and return cannot be normally priced,” Chen Shujin, a Hong Kong-based banking analyst at Huatai Securities, told AsianInvestor.
Xia Le, Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria SA, added that the proposed break on implicit guarantees is specifically targeted at WMPs issued by banks.
“The bigger the institutions, the higher their abilities to guarantee returns [because of the larger capital base], and banks are of the largest scale [among all the financial institutions],” he told AsianInvestor.
Impact on WMPs
Under the proposed new rules the WMPs would be marked to market and managed on a net asset value (NAV) basis. That is likely to cause banks to start posting losses on the WMPs as valuations in the products fluctuate. It could also lead to defaults. That has led some observers to believe the industry could drop in size.
“I think it (banks' WMP business) will definitely shrink. It may not be seen in the short run, but in the long run, it will for sure reduce in size,” said Xia.
He noted that investors will start to favour the products less because the ban on implicit guarantees will force banks to book losses and defaults. At the same time banks are likely to take less initiatives to develop the business further because they will face higher compliance costs under the proposed rules.
“Previously, regulators just told banks that they could not bail out [investors]. But this time around, it is compulsory. Regulators even urge market participants to report to them when they notice [cases of] guarantee returns,” Xia added.
The proposed rules would reward entities or individuals who blow the whistle on lenders offering implicit guarantees, while penalising such institutions. Additionally, the regulators would adjudge banks selling WMPs with implicit guarantees as having issued “products with deposit-taking characteristics for the purposes of regulatory arbitrage”.
In effect, such WMPs would be viewed as a form of depost, and as a minimum penalty the banks would have to place additional capital into their reserve requirement ratio (RRR). That would make it far less appealing to do so.
However, some other experts think that banks' WMP volumes will continue to grow, even without them providing an implicit guarantee.
“Regulators are not saying to ban the issuance of WMPs. They are still encouraging financial institutions to issue WMPs, but want to ban WMPs with the pressure of principal or return guarantee,” Liao Qiang, a senior director at S&P Global Ratings, told AsianInvestor.
It is quite likely that retail investors, which contribute to as much as 70% of the banks' WMP business, will continue purchasing WMPs without implicit guarantees. They typically have a limited understanding of the importance of changes in product rules, and still want to get good returns.
Banks will have to make average investors aware of the risks of WMPs priced on NAV basis, Liao said. But while they may have to do so, they will still be keen to develop their WMP businesses.
Chen of Huatai Securities also believed that WMPs are attractive to investors because of the yield level they offer. As a result, he argued that their popularity will remain even when the new rules become effective.
The upshot is that the AUM of WMPs could come under some pressure over the short run, with the outstanding volume falling slightly due to the announcement of the new rules, Liao said. But that’s not likely to last for long.
“2017 should be an adjustment year,” he said. “After the adjustment, over the medium term, WMPs will definitely increase in size. There’s no doubt about this. Down the road there will be more bank deposits shifting to WMPs.”