"Super guidance" set to change asset management in China

This article was published by Ignites Asia.

China’s long-awaited “super guidance” (大资管新规) for the asset management industry is likely to be released in early March during the National People’s Congress and the Chinese People’s Political Consultative Conference, writes Melody Yang, a Beijing-based partner at Simmons & Simmons.

The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions addresses two key themes, “preventing financial systemic risks” and “serving the real economy”. It attempts to introduce a unified standard applicable across China’s asset management industry.

This guidance was first introduced as a consultation paper to solicit public comments. It is likely that the guidance will be mostly unchanged from the consultation paper or at least the principles will largely stay the same.

Once promulgated, the guidance will have significant repercussions on the behaviours of market players in the asset management industry and shape the form of asset management products.

As one would expect, the guidance has caused heated debate and discussions in the industry.

For example, more than half of China’s Rmb100 trillion (US$16 trillion) in assets under management involve so-called “channel businesses”. The guidance, once promulgated, may overhaul how these firms do business and inevitably shake the way some of the market players make profits in China.

Given that, banks and trust companies in particular are asking for an extended transition period from the current deadline of  30 June 2019, to a much later one.

On the other hand, the guidance is very high level and generic, leaving room for regulators to issue more detailed rules at the implementing level. One could still argue that, given this, the implementing level still leaves room for regulatory arbitrage.

Some experts believe that there could be a much bigger leap forward from the legislators, such as issuing one law – not guidance - to unify standards across all asset management products, including private funds. That is less likely to take place in the near future, given that Chinese economic reforms are usually evolutionary, not revolutionary.

In any case, the issuance of the guidance is a positive for foreign market players who wish to do business in China, as this will enhance a fairer and cleaner competitive environment in China and is beneficial to those asset managers who have sound risk management and portfolio management capabilities.

Some of the key features of the guidance are set out below.

Scope of the guidance

Under the current regime, financial institutions in China, as well as asset management products launched by them, are regulated by three distinct regulatory bodies, namely the China Banking Regulatory Commission, China Securities Regulatory Commission and the China Insurance Regulatory Commission.

The segregation of supervision across these different regulatory bodies has sometimes led to ambiguity and regulatory arbitrage.

The guidance brings consistency by defining an asset management business as a type of financial service where a financial institution is entrusted by the investors to manage capital raised from such investors. Such a financial institution, which is entitled to a fee for provision of asset management services, shall exercise a duty of care and manage the assets for the benefit of those investors. Any investment risks should be borne by the investors.

This definition will apply to all types of asset management products launched by financial institutions.

Channel businesses and guaranteed returns

In China’s asset management industry, channel businesses and guaranteed returns usually go hand in hand.

Channel businesses refer to the offloading of assets by certain financial institutions, such as banks or trust companies. For example, capital is raised by a bank through a wealth management product and treated as the bank’s off-balance-sheet assets but is managed by a third-party entity, such as a trust company.

In most cases, there are multiple layers. For example, once a bank has raised capital from investors, it may package it and transfer this to a trust company by engaging the trust company as an investment advisor. The trust company then transfers the assets to a securities firm for real management. The bank and trust company charge fees for providing such “channels”.

In the model of channel businesses, investors usually do not care much who is managing their assets, as they are often given a guarantee of the returns they will receive, either explicitly or implicitly.

Regulators are concerned about risks accumulating in the financial system, especially at the banking level. If the economy falters and all investors rush to redeem their assets, it may “force” the banks to draw from their on-balance-sheet assets. Such a bank run could entail systemic risks.

The guidance stipulates that no guarantee shall be given to any investor regarding their principal or returns. And where there is a shortfall in funds available when redeeming from a product, institutions are forbidden to make up the deficit by using proprietary funds or any other funds under their management.

Furthermore, the guidance stipulates that asset management products can invest into only one single layer of other asset management products; such underlying asset management products are generally not allowed to invest into other asset management products (other than investing into retail funds).

In practice, asset management products raised by financial institutions serve as an important source of capital invested into private funds. By the operation of the guidance, if any such asset management products are already structured with more than two layers, they may be prohibited from investing into such private fund products.

Private fund managers

The guidance stipulates that a non-financial institution is not allowed to launch asset management products unless otherwise provided for. Once allowed, the non-financial institution should stick to standards as set out in the “relevant” regulations as well as the guidance in terms of issuing or marketing its asset management products.

Under the current rules, a private fund manager is not a financial institution.

Given the above, while the legislative intention is directed at licensed financial institutions and their subsidiaries, rather than at private fund managers, it appears that the same regulatory standard may still apply to private fund managers if other rules applicable to private fund managers are silent on these areas.

Qualified investors

The guidance stipulates a unified standard of qualified investors, which exists in different versions as released by their respective regulators. That said, the guidance sets different standards for qualified investors from those in the private fund regulations. In other words, one investor may qualify to invest in a private fund but not other types of asset management products, and vice versa. It will be interesting to see how this is reconciled in practice.

Restriction on cash pooling

The guidance restricts financial institutions’ ability to carry out or participate in “cash pooling” activities, whereby capital raised from different accounts are blended and managed together, which enables the financial institution to roll over the products constantly.

This restriction aims to enhance transparency and tackle the situations that regulators believe are against the nature of the asset management businesses.