China’s insurance regulator is further encouraging local insurers to invest more in banks’ perpetual bonds by lowering the capital charge, despite concerns about their riskier nature.

The rules change means that insurers will likely invest more in a quasi-equity type of bond issued by banks to help them better match their liabilities and improve their returns. The trade-off, though, is likely to be more risk, industry analysts say.

The Chinese Banking and Insurance Regulatory Commission (CBIRC) relaxed its rules on January 24 to allow insurance firms to invest in banks’ tier-2 and perpetual capital bonds. Since this can strengthen the capital positions of banks, the aim was to better serve the real economy by enabling them to lend more to companies.

That gave insurers a new type of asset class to consider when seeking to lengthen their asset duration or getting a better yield from their financial bonds.

The CBIRC said on May 7 that it had set the risk charge for perpetual bonds issued by policy banks and state-owned commercial banks at 20%, in keeping with the current China Risk-Oriented Solvency System (C-Ross) regime.

But for China’s 12 joint-stock commercial banks it was trimmed to 23% from 30%.

The numbers are instrumental for insurers to assess the capital charge in such investments and, in turn, be certain that their solvency positions can meet the regulatory standard.

This shift downwards is an obvious indication from the regulator to further facilitate insurers to invest into these instruments, Eunice Tan, senior director on insurance ratings at S&P Global, told AsianInvestor.

“With lesser risk charges, there are more incentives on the table [to invest in bank perpetual bonds] and we believe the allocation towards this type of products will increase. We also expect life insurers, in particular, to be especially keen on this longer-duration asset class,” she said.

RISKIER NATURE

A higher exposure to financial institutions could come at a cost for insurance companies, due to an increasing sector concentration, Tan said.

“A stronger correlation with the banking industry will mean that insurers are likely to become more susceptible to risks faced by the banks and more sensitive to the macro-economic headwinds,” she said.

Perpetual bonds, also known as AT1 bonds or additional tier-1 bonds, tend to have higher yields than tier-2 bonds. They have no maturity dates and can technically pay coupons forever, although the issuing bank typically has the option call back the bonds or repay the principal after a specified period of time. 

Bank of China was the first bank to issue perpetual bonds in China. Since then, in January, a few other banks have announced plans to issue this type of debt instrument.

The yield on BOC’s Rmb40 billion ($5.9 billion) issuance was 4.5%.  

The yield for this type of hybrid instruments is higher than would be the case for plain-Vanilla financial bonds and it is likely that China’s joint-stock commercial banks would likely offer a higher yield than its policy banks or state-owned commercial banks.

Banks also have more of an option to defer the coupon and even write off the debt if in significant financial distress, Yu Liang, director for financial institutions ratings at S&P Global Ratings, told AsianInvestor.

Banks’ perpetual bonds are like subordinated debt and have loss-absorption features. It is capital banks draw upon when they incur certain losses, in which case investors can lose out on coupon payments, Fitch analyst Stella Ng said.

While the rules liberalisation may tempt insurers into the riskier bank capital instruments, they may not do so immediately. Ng argued, before CBIRC announced the risk charges in the perpetual bonds, that the insurers will be reticent about making such investments until a new phase of the China Risk-Oriented Solvency System (C-Ross) is finalised next year.