China’s new AM rules may favour foreign fund houses

May 3, 2018

By allowing private funds in asset management products and banning implicit guarantees, China's newly unified regulations are likely to be welcomed by WFOEs.

China’s new AM rules may favour foreign fund houses

Private funds in China will be allowed to receive investments from privately raised asset management products issued by licensed entities, the country's unified new regulations show.

That is potentially welcome news for foreign fund managers at a time when many are flexing their muscles to sell private funds to wealthy Chinese investors and Beijing's top brass have stepped up pledges to open up the Chinese economy.

Jointly issued by China's main financial regulators* last Friday (April 27), the new rules have immediate effect and replace a system by which asset management products (AMPs) issued by banks, insurers' asset management arms, or securities firms were previously subject to different rules.

Since private fund managers are not officially licensed financial institutions, private funds were not explicitly covered in the asset management rules drafted in November last year, casting some doubt on whether private funds could be included in an AMP's underlying assets.

AMPs are pooled investment products issued by licensed financial institutions, including banks, trust companies, and securities firms. In China, these entities have to obtain their respective licenses from the China Banking and Insurance Regulatory Commission and the China Securities Regulatory Commission (CSRC). Private fund managers, in contrast, have to register with the Asset Management Association of China (Amac) – a self-regulatory organisation supervised by the CSRC.

In the draft rules, AMPs were only defined as those issued by licensed financial institutions, Melody Yang, partner at law firm Simmons & Simmons, told AsianInvestor. But in the final version, it specifies that privately raised AMPs can invest in private funds – for instance, trust plans with assets privately collected from high-net-worth individuals can invest in private funds, she said.

“This means there will be more channels for distributing the private funds … there will be greater support for the inflow of private funds,” Rex Lo, managing director of business development at BEA Union Investment, told AsianInvestor.

As of the end 2017, private funds in China held assets totalling Rmb11.1 trillion, accounting for about a tenth of the country's asset management industry (see table).

The new rules are good news for wholly foreign-owned enterprise (or WFOE) eyeing the private fund market in China, a Shanghai-based analyst at a consultancy firm who declined to be named, told AsianInvestor.

AMPs have always invested into private funds but private fund managers were concerned that capital inflows from other AMPs would be banned when the draft rules were released. This overhang has now been cleared, he said.

There are 11 WFOEs currently with a private fund management (PFM) license in China since Fidelity became the first WFOE to get the license in January 2017. The latest one is Italy’s AZ Investment Management, which completed the necessary registration with Amac in February.

BEA Investment Union has an investment management WFOE in Shenzhen and it aims to obtain the PFM license in the fourth quarter.

An Asia-based recruiter predicted that the number of investment management WFOEs could well more than double from the current 25 to over 50 by the end of 2018.

IMPLICIT GUARANTEES AND NSCAs

In seeking to reduce systemic risks within the Chinese financial system and curb shadow banking, the newly unified asset management rules could also favour foreign fund managers in other ways, by providing a more level playing field for showcasing their skills.

For example, under the new regulations implicit guarantees are banned and AMPs will have to mark-to-market and disclose their net asset value using a fair value accounting method in most cases.

With the elimination of implicit guarantees and the requirement that asset values be marked-to-market, foreign fund managers will be better able to demonstrate their investment management capabilities, Lo of BEA Union said.

The issue of implicit guarantees – whereby investment returns if not outwardly guaranteed are at least perceived to be – is particularly relevant for wealth management products (WMPs) issued by banks in China, as these deposit-taking institutions are seen to be cash-rich and are thus able to compensate investors when WMPs fail to deliver the stated returns.

“In the asset management, or wealth management industry in China, implicit guarantees are the root of all evil, because with implicit guarantees, risk and return cannot be normally priced,” Chen Shujin, a Hong Kong-based banking analyst at Huatai Securities, previously told AsianInvestor.

The final rules also give a more detailed definition of the non-standard credit assets (NSCA) that AMPs can invest in. NSCAs have tended to underpin shadow banking activities in China.

In future, NSCAs will have to be centrally registered and independently custodised. They need to be fairly priced, have sound liquidity mechanisms, and be traded on exchanges approved by the State Council, among other criteria.

In addition, NSCAs are not a strong area for foreign fund managers, so stricter restrictions here might help too, Lo said.

Newly issued AMPs have to comply immediately with the new rules, while existing ones have a grace period of 1.5 years until end 2020.

*The rules were jointly released by the People’s Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission and State Administration of Foreign Exchange.