A New Era for China Investors
Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management, J.P. Morgan Asset Management
The final version of the new rules for China’s CNY 100trn asset management industry has now been published by the Chinese financial regulators. In this Executive Interview, Aidan Shevlin, Head of Asia Pacific Liquidity Fund Management, J.P. Morgan Asset Management, explains the implications of the new rules for the industry, and for corporate treasurers, whilst outlining practical steps for rethinking liquidity management practices in the country.
What are the new asset management industry rules? When do they come into force in China, and what will their broad impact be?
Officially known as the ‘Guiding Opinions on Regulating the Asset Management Business of Financial Institutions’, the new regulations represent a comprehensive restructuring of China’s asset management industry. Introduced by the new Financial Stability and Development Committee (FSDC), the rules are designed to reduce financial risks, simplify products and increase investor protection.
The new rules came into force on 27 April 2018. As of now, all newly created Asset Management Products (AMPs) must comply with the rules; while existing AMPs have until the end of 2020 to be fully compliant.
These regulations signify a major change in how financial institutions will operate. As a result, there will be important implications for banks and fund managers, as well as knock-on effects to investors, issuers and markets. Corporate treasurers may therefore have cause to rethink their liquidity management structures in China, as well as reassessing the counterparty risk of their banking partners in this space
China’s AMP rules: need to know
In brief, the new rules are designed to: limit shadow banking activities; ban expected return and principal guarantees; harmonise regulatory standards; and reduce regulatory arbitrage.
Historically, shadow banking was the broad term for all non-time deposit products issued and managed by commercial banks and financial institutions, including wealth management products (WMP), trust products (TP), asset management plans and so on. The new regulations specifically define Asset Management Products (AMPs) as an umbrella term for all these instruments (with a few exceptions such as private funds and pension products).
Under the new rules, all public AMPs must be managed on a mark-to-market net asset value (NAV) basis (there are some exceptions for amortised NAVs) without offering expected returns or implicit guarantees. AMPs will have strict rules on leverage, layering and risk reserves; in addition they must be managed by a segregated asset management business and have a separate custodian.
The new rules stipulate that publicly-offered AMPs, which make up the majority of existing products, can only invest in standard assets (SAs). Typical standard assets are tradable fixed income instruments or equity shares. Non-standard assets (NSAs) are essentially all other assets.
According to the new rules, qualified investors can still buy privately offered AMPs that invest in NSAs, but there are strict rules regarding the type of investors, pricing of the NSAs and type of investments that private AMPs can put money into. As such, it is worth seeking specialist advice on this topic where appropriate.
Why were new regulations needed for the shadow banking sector and what were the Chinese authorities looking to achieve?
A confluence of factors has led to the introduction of these new rules – but clamping down on China’s shadow banking industry has been one of the major drivers. Shadow banking in China is a by-product of past financial regulations and interest rate liberalisation, as borrowers and lenders sought to circumvent rules to achieve access to capital at more market-driven interest rates.
It is not hard to see why shadow banking became so popular: investors benefited from very attractive and stable yields with principal guarantees, while financial intermediaries like commercial banks were able to take assets off-balance sheet and generate profitable fee income; and finally these products offered financing to issuers who were perhaps unable to access other sources of funding. Between March 2015 and September 2017 the amount of shadow banking products outstanding doubled from CNY54.2trn to CNY107.6trn . At their peak in Q4-2015 wealth management products – the largest individual asset class, representing a quarter of assets - grew by 56%y/y .
But in some ways, these benefits were too good to be true. There was a distinct lack of transparency around the underlying assets in many shadow banking products, and in recent years some of these opaque assets turned out to be very poor quality. In addition, the use of leverage and layering created a complex web that touched almost every part of China’s financial industry. While certain banks performed bail-outs where necessary, this only fuelled further investor interest, since they assumed that their WMPs were ‘safe’ – triggering concerns about moral hazard.
By the end of 2017, the shadow banking sector had ballooned to US$12.3trn, representing approximately 93% of China’s GDP and approximately 63% of all bank loans . The Chinese authorities realised this behemoth need to be contained while also eliminating misconceptions about principal guarantees and establishing stronger links between risk and return. To this end, the new rules are a big step in the right direction. In fact, the AMP rules are one of the most significant changes ever in the history of China’s shadow banking industry.
1 Source: JPMorgan as at 31st March 2018
2 Source: Bloomberg Data as at 31st March 2018
3 Source: UBS report as at 30th April 2018