New asset-allocation rules for Chinese insurers are misleading, says Z-Ben

Local and foreign asset managers reacted eagerly to the late-July release of provisional guidelines giving Chinese insurers – whose investable assets total RMB4.2 trillion ($617 billion) – more flexibility over what they can invest in. But while a step in the right direction, the proposed changes are not as significant as they seem, says Shanghai-based consultancy Z-Ben Advisors.

Moreover, the addendum to the provisional guidelines issued last week, entitled circular 66, doesn't make things any clearer, remarks Z-Ben in a note published on Friday.

The China Insurance Regulatory Commission (CIRC) put the rules in place to liberalise existing guidelines. Specifically, they will provide insurers more flexibility in asset allocation – between stocks, equity-centric funds, and non-equity funds – and increase the maximum allowed exposure to other asset classes, such as lower-grade corporate bonds and infrastructure bonds.

The newly raised overseas asset-allocation threshold is 15% of an insurer's total assets (as of the end of the previous quarter). But that figure is misleading, because actual foreign investments by insurers will be limited by the qualified domestic institutional investor (QDII) quota issued by the State Administration of Foreign Exchange (Safe). The total QDII quota stood at $16.3 billion (RMB110.4 billion) as of June 30.

The latest CIRC circular only clarifies that insurers can invest in offshore stocks, bonds and mutual funds, and that investments into any other offshore financial instruments will be governed by yet-to-be-issued regulations, says Z-Ben. So unless Safe increases QDII quotas for insurers, “these new guidelines do not imply that some Rmb690 billion ($105 billion) will suddenly be made available for offshore investments”.

Meanwhile, the latest CIRC circular raised the combined exposure of stocks and mutual funds to 25% from 20%, adds Z-Ben, but the granular detail finds that the combined allocation of direct equities and indirect equity exposure through mutual funds will remain limited to 20%. (Previously, insurers were permitted to allocate up to 10% into equity mutual funds and 10% into stocks.)

The consultancy goes on to explain why this is the case. The new rules will now permit insurers to choose for themselves whether a targeted exposure to equities should be achieved via directly investing into the stock market or indirectly through exposure to equity mutual funds. Insurers would then be allowed to allocate an additional 5% into mutual funds, so long as the exposure is achieved from non-equity funds.

Moreover, insurers can now invest up to 15% in equity-centric funds, provided they limit their allocation towards stocks and non-equity funds to 5% and nil, respectively. Alternatively, they can invest 10% directly in stocks, 10% in equity-centric funds and an additional 5% in non-equity funds. Or they can invest up to 20% directly in listed stocks and another 5% in non-equity funds.

Therefore, the maximum equity exposure for insurers is still limited at 20% under the new rules.

What is noticeably missing from the latest CIRC rules is whether insurers will be allowed to invest in QDII mutual funds – at present they cannot -- and if so, when.

This brings both good and bad news for local fund managers, adds Z-Ben. There is a handful of small insurers that still cannot invest directly in listed stocks and whose exposure to mutual funds (both equity-centric and non-equity) is limited to 10%. With the new rules, they can increase their combined fund allocation up to 15% of their assets, potentially generating additional inflows for fund managers.

However, the fact that insurers can now invest up to 20% directly into listed stocks could have negative repercussions for fund managers. Ever since insurers were allowed to establish their own investment management subsidiaries, most have worked to internalise all aspects of the investment decision-making process, including stock picking.

And, according to CIRC data, insurers collectively maintained the 10% maximum exposure to stocks over the past two years, while total exposure to mutual funds averaged only 7%. In addition, insurers cut their fund exposure deeper in 2008 than they did their direct stock investments, suggesting a stronger preference to keep equity allocation in-house.

On the positive side, however, most industry players expect the CIRC to allow even greater flexibility in the allocation of insurers assets going forward, such as exposure to private equity and private funds (China's version of hedge funds).

Still, Z-Ben says it hopes “the future issuance of rules and guidelines are more black and white and not various shades of gray”.

*The Provisional Guidelines on Insurance Asset Applications.