China Said to Draft Rules to Rein in Asset Management Risks (2)

(Bloomberg) -- China’s financial regulators are working together to draft sweeping new rules for the country’s rapidly-expanding asset-management products that aim to make it clear there’s no government guarantees on such investments, according to people familiar with the matter.

The draft rules would apply to products issued by banks, insurers, brokerages and other financial institutions, said the people, who asked not to be identified because the discussions are private. The rules would be phased in after existing products mature, and would only apply to new issues, they added.

Households and companies have poured into asset management products, seeking 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 three-quarters of 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.

"Regulators are trying to defuse a bomb," said Xia Le, Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria SA. "Shadow banking is an important source of financing to small and private companies and property developers, and the tightening measures will weigh on economic growth in the short term."

Yields Rise

The cost of one-year interest-rate swaps, a gauge of market expectation of money rates, rose six basis points, the most in three weeks, to 3.40 percent, data compiled by Bloomberg showed. The yield on 10-year government notes due November 2026 climbed three basis points after 4 p.m. to 3.38 percent, versus 3.35 percent on Monday, data showed.

The move will lead to tighter liquidity and higher funding costs for borrowers, analysts said.

President Xi Jinping and his top economic deputies have vowed to make control of financial risks their top priority in 2017. They’re better positioned to do so after fiscal and monetary stimulus successfully put a floor under the government’s growth goal of at least 6.5 percent.

China’s asset-management products totaled about 60 trillion yuan ($8.7 trillion) as of June 30, according to a recent estimate by an official at the China Securities Regulatory Commission. Many of the products aren’t recorded on institutions’ balance sheets. As of end-December, off-balance sheet wealth-management products issued by banks amounted to 26 trillion yuan, according to the central bank.

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The new rules are being drafted by the central bank and the CSRC, together with the regulators for the banking and insurance sectors, the people said.

Under the draft rules, financial institutions would be banned from investing the proceeds of asset-management products in non-standard credit assets, mostly loans, or in beneficiary rights linked to such assets, the people said. Financial institutions would be required to set aside 10 percent of fees from managing clients’ assets as reserves for potential risks.

The draft is still being discussed and is subject to changes, the people said.

The People’s Bank of China, the CSRC and the banking and insurance regulators didn’t immediately respond to requests for comment.

For a look at recent PBOC comments on off-book wealth products, click here

China’s capital markets aren’t as developed as their western peers, meaning the banking system accounts for most financial assets. Besides regular deposits and loans, banks collect money from investors by selling wealth management products. Money is then often channeled to companies or projects that otherwise have little access to formal lending.

Such off-balance sheet financing swelled in the past decade. Warning lights flashed in 2014 when some of those asset management plans were on the verge of default, spurring increased efforts by regulators to get a handle on such practices.

Credit data in January suggested banks were again boosting shadow lending as the broadest measure of new credit surged to a record while new loans trailed estimates.

If adopted, the draft regulations may mark a renewed push to curb such growth. The coordinated move also signals increased cooperation among China’s regulators, following reports that officials have considered a revamp to financial supervision by merging some regulators while offering the central bank more power on economic policy.

Other than banks’ wealth management products, trust firms had 15.3 trillion yuan of products outstanding at the end of June, according to the CSRC official. Mutual funds had issued 16.5 trillion and brokerage firms 14.8 trillion yuan of asset management products.

"Asset management is in every single sector of the financial system," according to Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. "Regulators have realized that they have to cooperate to regulate it. Many loopholes are there exactly because regulators are not coordinating."

(Updates with market moves in sixth paragraph.)

--With assistance from Tian Chen Yinan Zhao Dingmin Zhang and Xiaoqing Pi

To contact Bloomberg News staff for this story: Heng Xie in Beijing at hxie34@bloomberg.net, Jun Luo in Shanghai at jluo6@bloomberg.net.

To contact the editors responsible for this story: Jessica Zhou at jzhou75@bloomberg.net, Malcolm Scott at mscott23@bloomberg.net, Marcus Wright at mwright115@bloomberg.net.

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