China’s bank wealth management business comes out of the shadows
Three years after clean-up, China’s bank wealth management business enters new phase
China’s bank wealth management business is entering a new phase of development after a sweeping regulatory overhaul three years ago.
Total outstanding assets of wealth management products (WMPs) was 25.8 trillion RMB (US$4 trillion) as of end-June, up more than 5% from a year ago, according to the China Banking Wealth Management Registration and Depository Centre, a unit of the China Banking and Insurance Regulatory Commission (CBIRC). The number of investors in the products nearly doubled through the six months to surpass 61 million, nearly all of them retail investors. WMPs have generated 413.75 billion RMB in profits for investors in the first half of 2021.
In the first six months of the year alone, 25,500 new WMPs were issued, attracting 62.4 trillion RMB of investments. Over half of them were short-term deposit-like products.
This is significant progress for what was once a shadow-banking sector linked to the sale of high-risk, illiquid products with lax regulatory oversight.
In 2018, the CBIRC issued regulations governing the wealth management business of commercial banks, including product requirements, leverage ceilings, asset value calculation, suitability checks, and disclosures. In addition, all outstanding WMPs had to be converted by end-2020 into products that are valued on the basis of their net assets. The deadline was later extended by a year to end-2021.
To strengthen governance of the sector, a new licence was created for banks to set up an independent subsidiary for wealth management, with its own management structure and separate books and accounts.
Although the sector still requires a lot more strengthening in product offerings, asset valuation, performance benchmarking, risk management and sales representations, it is now poised for healthy growth after the clean-up.
A shadowy past
The dubious practices in China’s WMPs started around 2011 as a result of “regulatory arbitrage” by banks in the form of off-balance sheet activities, or by non-banking entities such as trust companies that were either lightly regulated or not regulated at all.
The products were marketed to both retail and corporate investors, unlike wealth management or private banking products in other countries which are restricted to high-net-worth and qualified investors.
The products differed from conventional mutual funds in that returns were fixed, sometimes with explicit principal or interest guarantees, and they usually had a fairly short maturity. They were also different from bank deposits because the returns were well above regulated deposit rates.
Banks would issue WMPs and invest the funds that were raised either by themselves or through another financial institution, known as a ‘channel’ firm, in order to keep the products off their balance sheets and thus avoid many regulatory requirements. In most cases where a bank used a channel firm, the lender still retained control over investment decisions, with the channel firm acting just as a passive administrator.
WMPs proved very popular because they offered higher yields compared to bank deposits and had explicit or implicit guarantees by the lenders. At the same time, banks were keen to promote these products, not only for their lucrative margins, but also to obtain funding beyond the regulatory loan-to-deposit ratios and other restrictions by keeping them off the balance sheet.
The products typically invested in high-yield, risky assets in industries that were vulnerable and typically would not be able to obtain bank credit, such as the overheated property sector or others that were highly volatile.
As the assets of these WMPs snowballed, they created an enormous threat to the stability of China’s financial system. If banks were to compensate investors in the event of a default, their partners in the WMP issuance were unlikely to be able to share the burden since most channel firms, including trust companies, had relatively low levels of capital and limited fundraising capabilities.
The CBIRC estimated that at their peak in 2017, shadow-banking assets reached 100.4 trillion RMB. WMPs were a major contributor.
Foreign entry
The new licence for bank wealth management subsidiaries is a comprehensive asset management business licence covering public and private offerings and wealth management advisory and consulting services. It has a wider scope of business and investments compared with asset management licences issued by other Chinese regulators but comes with a higher price tag – one billion RMB in registered capital.
The subsidiaries are able to use their banking parents as sales agents, distributing products through their branches and mobile banking platforms.
In January 2020, CBIRC announced that foreign institutions could apply to set up a joint venture wealth management company and be the majority shareholder, or take up shares in an existing wealth management subsidiary of a bank.
By allowing the entry of foreign competition into the sector, the regulator hopes to encourage weaker local players to innovate and improve their services, the same thinking behind market opening initiatives by other Chinese regulators.
This can be an attractive option for foreign players eyeing the fast-growing $15 trillion of household savings in the Chinese banking system.
Several foreign players have taken up the opportunity to become first movers.
Amundi’s majority-owned wealth management company with Bank of China started operating a year ago. As of May this year, it had launched 37 products with combined assets under management of 20.7 billion RMB.
In early May, US asset management giant BlackRock was given approval to be the majority shareholder in a three-way joint venture wealth management company with China Construction Bank and Singapore’s Temasek Holdings.
Two other foreign asset managers, Schroders and Goldman Sachs Asset Management, also received approval in May to take majority stakes in joint venture wealth management companies with Bank of Communications and Industrial and Commercial Bank of China, respectively.
J.P. Morgan Asset management is taking another route. Instead of pursuing majority ownership, it took a 10% stake in China Merchants Bank’s wealth management subsidiary, a heavyweight in the sector.
According to China Banking Wealth Management Registration and Depository Centre’s first-half 2021 report, eight local and foreign wealth management companies have been approved in the first six months of the year, raising the total to 28. Of these, 21 are already in operation.
Outstanding WMPs issued by wealth management companies accounted for 38.8% of the whole sector as of end-June. The rest were issued by commercial banks.
The asset mix of the sector is heavily skewed towards fixed income products targeting the mass market. About 67% of the assets were invested in bonds and interbank notes, 10% in cash and bank deposits, and only 4% in equities in the first half of 2021.
As of June, WMPs valued on net asset basis represented 79% or 20.4 trillion RMB of the sector’s total outstanding assets, 24% higher than a year ago.
Principal-guaranteed WMPs accounted for only 150 billion RMB, less than 1% of the outstanding WMP assets. Three years ago, they accounted for about 30%. According to Chinese media reports, CBIRC met with WMP asset managers recently to ratchet up pressure on the sector to dispose non-standard credit and equity assets before the end-2021 deadline.
Sustainability is also an emerging theme, with 18 environmental, social and governance related WMPs issued in the first six months of the year, raising 10 billion RMB for investing in green bonds and ESG-compliant assets. Total outstanding ESG-related WMPs stood at 40 billion RMB as of June, up 26% from a year ago.
Greater Bay Area
The 25.8 trillion RMB wealth management sector represents the biggest pool of managed assets in China, larger than the 23 trillion RMB mutual fund market. The potential reward can be huge for foreign entrants, even though it requires a joint venture partnership and managing the challenges that come along. The distribution power of the local bank partner can give the business an immediate jump-start, although it would be wise to develop multi-distribution channels for long-term sustainable growth.
The long-awaited Wealth Management Connect scheme for the Greater Bay Area recently announced can be another booster for Chinese WMPs. A combined quota of 300 billion RMB has been set as a start, half going in each direction. Banks and fund managers in Hong Kong are excited about potential southbound flows into Hong Kong products.
There could also be significant northbound flows because of the returns. Conservative short-term deposit-like WMPs in China currently offer annual returns of 2%-3% whereas bank deposits in Hong Kong pay near zero. Products offered by a bank subsidiary that is majority-owned by a branded foreign fund manager can be attractive to both mainland and northbound investors.
Bank wealth management products can be just as effective as public mutual funds for targeting China’s mass market investors. The two sectors are complementary for meeting the needs of different investor profiles and risk appetites. In fact, Blackrock and J.P. Morgan Asset Management have invested in both sectors in their multi-pronged market development strategy. The choice will depend on the foreign firm’s own level of ambition, investment propositions, and long-term commitment.
*This article was published in Asia Asset Management’s October 2021 magazine titled “Comes out of the shadows”.
