Your loss is your problem, China tells small investors as it tightens money rules

High-risk, high-return, yet state-protected products have warped prices and bred complacency

Retired Shanghai truck driver Shen Xipei shunned risky stocks and low-yielding deposits and instead put his life savings into a wealth management product (WMP) sold - and guaranteed - by a bank.

Soon, however, investors such as Mr Shen may start switching into other assets after Beijing published draft guidelines on Nov 17 to ban financial institutions from guaranteeing investors against losses, tightening supervision of what the central bank says is a US$9 trillion asset management industry.

A move away from bank WMPs by armies of Chinese investors - which some analysts expect - would likely trigger a seismic shift in China's asset management industry, with the new rules apparently favouring transparent mutual fund products.

"I bought the WMP because I trust banks. They don't run away with your money," said 63-year-old Mr Shen.

The product he bought from Industrial Bank promised an annualised return of around 4.15 per cent - far exceeding the 1.5 per cent yield on one-year bank deposits, he said.

"But if they no longer guarantee my principal, I'll definitely put my money elsewhere."

It remains to be seen where, exactly, the flood of cash will slosh, but some analysts expect relatively safe bond funds or more liquid money market funds to benefit. With limited options for onshore investments, people may also park their money in already inflated real estate markets.

"When implicit guarantee fades out . . . demand for off-balance-sheet WMPs may partially switch to similar products such as money market funds or bond funds," said Sophie Jiang, banking analyst at Nomura. "We see stronger competition for deposits as loopholes around WMPs get fixed."

The new rules underscore Beijing's determination to reduce risks and further standardise the country's financial markets.

More investment securities, meanwhile, will be allowed to fail, leading to a better pricing of risk and professionalisation in the asset management industry.

By holding investors responsible for their own losses, the authorities are also trying to change a deeply ingrained culture that made it common for investors to dump money into risky, high-yielding assets and expect state protection. Prices have been warped along the way.

"Breaking the implicit principal guarantee will force a risk repricing in the market," said Hong Hao, head of research at BOCOM International.

"Investors should get used to a new high-return, high-risk regime, instead of the old, risk-free but high-return regime. It won't be easy."

Financial markets have started to react to the flurry of financial reforms announced in recent weeks, with domestic bond yields rising steadily since the end of September, while stocks saw their biggest one-day drop in nearly 18 months on Thursday.

There is no official data on the number of people who have invested in WMPs, but official statistics show that at the end of June, 555 Chinese banks had 85,800 outstanding WMPs. In the first half of 2017, a cumulative 119,200 WMPs had been issued.

WMPs issued by banks and other financial institutions, such as trust companies, have been a central component of China's murky shadow banking sector, which the government has struggled to contain.

As part of efforts to break implicit principal guarantees, the new guidelines require that all asset management products must be based on net asset value to reflect risks on a timely basis - rules that analysts say favour mutual funds.

"For institutions such as trust firms, it would take time to adjust their products in a bid to meet the tall order," said Ivan Shi, head of research at fund consultancy Z-Ben Advisers, predicting greater investment flows into fixed income or money market mutual funds.

Although banks are expected to redesign WMPs and set up asset management units to compete, fund distributor Puyi Wealth Management said there was "a huge question mark" over whether banks could persuade investors not to shift to more mature mutual fund products.

The sweeping new guidelines, covering all financial institutions including banks, brokerages, insurers, fund houses and trust companies, are the latest effort to rein in China's rampantly growing shadow banking sector, notorious for excessive leverage, Byzantine structures and opaqueness.

A transition period will last until June 30, 2019, to give institutions breathing space.

The ban on principal guarantees has been singled out by the state news agency, Xinhua, as the most significant step against "financial chaos". In an editorial, it likened the guarantees to landmines in the financial system.

Other measures announced in the draft regulations include leverage caps, provision requirements and a ban on "capital pools" - a mixed bag of products with different risk levels, maturities and investors.

By the end of June, China's asset management business totalled more than 60 trillion yuan (S$12.2 trillion), according to central bank data, almost as big as the country's annual gross domestic product. Bank WMPs account for nearly half.

It's not just in the asset management industry that regulators are ending implicit state guarantees to investors.

In the bond market, the government is increasingly allowing issuers - both private and state-owned - to default or go bankrupt, seeking to break the link between commercial and sovereign credit.

In a recent case, creditors of state-owned Chongqing Iron & Steel Co agreed to accept a debt-for-equity swap plan to restructure nearly 40 billion yuan in debts.

Beijing has also deepened efforts to bar local governments from making implicit guarantees to investors in infrastructure projects and local government financing vehicles, breaking the traditionally unshakeable faith that such projects will never default.

Chen Jie, of Hi-Jion Law Group, said banks provide implicit guarantees even when there's no legal obligation to do so because of SOEs' ambiguous relationships with the government.

"Retail investors walking into a bank outlet would naturally assume WMPs sold there have state backing. For them, state lenders and the government are one thing," said Mr Chen, who represents investors in WMP disputes.

Reuters

27 November 2017