International fund houses with Chinese joint ventures are having to consider whether to continue funding mainland ‘channel business’ or shift away from such activity, as a result of recently announced capital rules.
Channel business – largely packaged loans and debt financing – has grown rapidly to become a big chunk of the activity of Chinese fund houses’ segregated account (SA) subsidiaries.
Total SA assets have grown rapidly to Rmb9.84 trillion ($1.5 trillion) across 79 SA subsidiaries since they were given the green light in 2012 (see also table). The segment is now larger than China’s mutual fund industry, which had assets of Rmb7.8 trillion as the end of March.
But SA business will now be more tightly regulated amid increasingly close scrutiny of both shadow banking and the private fund industry in China. The new rules are expected potentially to lead to mass closures of such entities.
“The regulator intends to force the [asset management] industry to move into more actively managed business,” said a product manager at a SA subsidiary based in Shenzhen, who asked not to be named. “It does not mean we cannot continue the channel business, but such business is complicated and risky, and it cannot offer value for asset management services.”
SA subsidiaries can use their profits to boost registered capital, but small players will struggle, as their profits are thin so they will need parent companies and shareholders to inject further capital if the firm plans to continue its channel business. That’s a big ‘if’, given that the new rules will make such activities significantly more costly to run and the relatively low fees they bring in.
Hence foreign shareholders need to consider their SA subsidiaries’ future business strategies and decide on a long-term plan with their Chinese JV partners, said Ivan Shi, research director at Shanghai-based consultancy Z-Ben Advisors.
“Many SA subsidiaries will need to change business focus,” he added. “The new draft rules suggest the regulator intends to lead these subsidiaries’ business away from ‘channel business’, and to develop private equity-like business, which has lower risk and higher fee charges and requires better investment capability.”
But it may not be easy for SA subsidiaries to change business, since many do not have the talent and resources for active management, as they are less mature than trust companies, said the unnamed product manager.
Foreign fund houses also need to keep an eye on the regulatory risks of their SA subsidiaries, said Shi. The parent companies could be penalised for insufficient risk controls at the subsidiaries.
Any SA subsidiaries failing to meet the new proposed rules are likely to be banned from conducting new business for a certain period and asked to improve risk management and strengthen their operations, according to the China Securities Regulatory Commission (CSRC). In the worst-case scenario, they could have their SA subsidiary licence withdrawn.
Most SA subsidiaries have well-run operations, but a few have engaged in a substantial amount of high-risk channel business without sufficient capital and risk controls, said Deng Ge, a CSRC spokesman. Some SA subsidiaries have been blindly expanding their assets, he added, leading to disruption of industry development.
The regulator did not name any firms nor say when the new rules would be implemented.
|China's 20 biggest SA subsidiaries (Source Galaxy Securities, Amac)|
|2||Minsheng Royal AM||815.6||Minsheng Royal Fund||64|
|3||China Merchants Wealth||615.7||China Merchants Fund||219|
|363.9||Axa SPDB IM||30|
|7||Xinyuan AM||335.7||Xinyuan Fund||15|
|9||BoCom-Schroders AM||312.9||BoCom-Schroders Fund||64|
|10||CIB Wealth||294.4||CIB Fund Management||76|
|11||Tianhong Chuangxin AM||294.3||Tianhong||805|
|12||Citic-CP AM||290||Citic-Prudential Fund||37|
|13||ICBC-CS IM||260.9||ICBC-CS AM||420|
|14||China Southern Capital||243.7||China Southern Fund||348|
|15||Orient-minerva AM||203.9||Orient Fund||29|
|16||YouChoose Wealth||186.3||HuaFu Fund||16|
|17||Wanjia Gongying AM||173.7||Wanjia Fund||19|
|19||Harvest Capital||158.1||Harvest Fund||316|
|20||BOSC-Ruijin Capital||155.6||BOSC Asset||29|
Under the new proposals, the CSRC has raised the entry barrier for setting up an SA subsidiary: it must manage at least Rmb20 billion in assets (excluding money-market funds) and have at least Rmb600 million in new registered capital. For existing SA subsidiaries, the amount of net registered capital – equal to net assets minus risk assets – must be at least Rmb100 million.
Assets invested in financial securities – such as stocks, bonds, and money market instruments – will not be calculated as risk assets.
The CSRC had already suspended some SA businesses prior to announcing the new SA rules. This included, on April 15 this year, the new business registration of Mingsheng Royal Asset Management and two other SA subsidiaries. It also forced the three firms to adjust their business.
The regulator did not name the other two SA firms, but it had suspended the new businesses of both Shenzhen Rongtong Capital and Beijing Chance Capital for six months and three months, respectively, last November.
These three SA subsidiaries are among the top 20 players in the industry (see table).
The regulator did not give specific reasons but said some firms had breached rules set out in September 2014 as to the types of activity they could conduct.
Then on May 5, the Asset Management Association of China (Amac) banned Citic-CP Asset Management, a SA subsidiary of the joint-venture fund house between Citic Trust and Prudential group, from conducting new business for six months.
Amac had set out risk control requirements and guidance for Chinese fund houses and their SA subsidiaries in December, as reported.
The CSRC had initially encouraged fund houses to set up SA subsidiaries to expand investments in primary markets and to manage new types of asset classes beyond traditional long-only stocks, bond and money funds.
But most of these entities instead engaged in shadow-banking activities. This accounted for 73% of SA subsidiaries’ total assets as of the end of 2015, according to Amac.
Most of these businesses charged a management fee of 0.2% in 2014, whereas trust companies typically charge 0.55%, according to Amac.