China's financial regulators proposed sweeping rules to curb risks in the country's $15 trillion of asset management products as leaders move to tighten supervision and break an implicit guarantee that's driven investment into such vehicles.
Financial institutions should offer yields based on the net asset value of the products they issue, to reflect the risks and return of the underlying assets, instead of offering a guaranteed principal repayment or rate of return, the People's Bank of China said in a joint statement with other financial regulators on Friday. Firms that fail to comply with that rule will be punished with measures such as additional reserve requirements, they said.
President Xi Jinping and his top economic deputies have vowed to make controlling financial risks their foremost priority, a pledge renewed at the Communist Party's twice-a-decade leadership congress last month. Since April, regulators have stepped up efforts to curb the threat that excessive leverage in the financial system poses to economic growth.
"At the very minimum, this step reconfirms the clear signals sent at the 19th Party Congress that financial deleveraging in the form of more regulations is a policy priority and will intensify," said Yao Wei, chief China economist at Societe Generale in Paris.
The draft rules were released for public consultation and firms will be given a grace period until June 30, 2019, to comply.
The new rules will be applied to the 29 trillion yuan ($4.4 trillion) of wealth management products issued by banks, 17.5 trillion yuan of trust products, as well as asset management plans sold by insurers, fund managers and brokerages, according to the regulators' statement. Institutions will be required to set aside risk provisions equivalent to 10% of the management fees, they said.
The rules cover all kinds of asset management products under the administration of different regulators, a sign of improved coordination after the establishment of a national financial stability and development committee, said Li Wei, a senior economist at Standard Chartered Bank in Shanghai.
"The key message is to fend off risks by breaking guaranteed payment with clear requirements and definition," he said.
Among the other rules proposed:
- Closed-end asset management products should have a maturity longer than 90 days and products with longer durations will enjoy lower management fees;
- The leverage — total assets divided by net assets — for publicly raised funds and private funds is capped at 140% and 200%, respectively;
- Asset managements products can only invest in one layer of other investment products; and
- Financial institutions aren't allowed to be channels for each other's asset management products in order to evade regulatory curbs on investment scope and leverage limit.
The value of asset management products has surged in recent years as households and companies sought higher returns than bank deposits can offer. On the other side, banks have created off-balance sheet vehicles to provide such offerings, then channeled funds to riskier borrowers who pay higher interest rates. Most recently, financial institutions have invested in each other's products, leading to a potential chain reaction in the event of a default.
An industry managing assets worth more than China's $11 trillion gross domestic product has thus blossomed, underpinned by assumptions on all sides that the government would prevent failures should investments sour. Changing that mindset is seen as key to reining in financial risks and curbing excessive credit growth.
"Over the past few years while the financial risks are rising, the overall regulations were actually behind the curve," Zhou Hao, an economist at Commerzbank in Singapore, wrote in a note. "This is a critical turning point of the financial regulations."