China’s wealth management products cast off their shadows
Post-regulatory overhaul, China’s bank wealth management sector still has a lot more to do
China’s bank wealth management products or WMPs have long been the country’s largest pool of managed assets, but they have been overtaken by public mutual funds in the wake of a sweeping regulatory revamp five years ago.
The move was aimed at reducing the risk of the products, which are primarily purchased by retail investors seeking guaranteed high returns or preservation of principal. But the de-risking reduced the returns, making the products less attractive to these investors.
WMPs have since entered a new phase of development as the growth slowed. Public mutual fund assets currently stand at over 27 trillion RMB (US$3.7 trillion), while the WMP sector had around 25 trillion RMB of total assets as of June 2023, a modest 15% increase over the past five years.
According to a report from the China Banking Wealth Management Registration and Depository Centre, WMP products generated 331 billion RMB of income for investors over the first six months of this year, or an average return of 3.39%. Furthermore, nearly 128 trillion RMB of investment funds were raised with the issuance of 15,200 new products.
The number of investors has surpassed 100 million, up 7% from six months ago. Individual investors accounted for almost all of the investor base, with institutions making up just over 1%.
Most notably, over 95% of the WMPs in operation with a combined market value of more than 24 trillion RMB are now providing net asset valuations. This was a key goal of the regulatory overhaul five years ago. By contrast, net asset value-based products in 2019, the first year after the new regulations were introduced, were only worth a total 10.13 trillion RMB, accounting for 43% of the sector.
Shady past
This progress is very encouraging since the WMP sector in China had long been closely associated with shadow banking.
Before the regulatory overhaul, banks utilised the products for “regulatory arbitrage” to engage in off-balance sheet activities. Non-banking entities such as trust companies also used the products to evade regulations.
Banks issued WMPs and invested the funds raised, either internally or through a “channel” firm in order to keep the products off their balance sheets, thus circumventing regulatory requirements. In most cases involving a channel firm, the banks still retained control over investment decisions while the channel firm acted as a passive administrator.
The products usually had fairly short maturities and differed from conventional mutual funds by offering fixed returns. They also stood out from bank deposits because the returns were well above regulated deposit rates.
The comprehensive new rules to rein in the sector prohibits WMPs from offering any explicit or implicit principal or interest guarantees. Products have to be valued on a net asset value basis, a requirement that was delayed to 2021 after the rules were introduced in 2018 because products invested in local government and property debts were not able to provide disclosure on real-time prices.
Banks also have to obtain new licences to set up independent subsidiaries for wealth management with separate management structure, books and accounts. Foreign joint venture partnership is also permitted.
As of June this year, 30 bank wealth management companies have been established, including five joint ventures with foreign partners. They collectively held an 81.5% market share, a big jump from only 25.8% in 2020, and operated over 16,000 products with a total market value of 26.6 trillion RMB.
The latest foreign entrant was BNP Paribas Asset Management, which formed a joint venture with the Agricultural Bank of China, joining Amundi, BlackRock, Goldman Sachs and Schroders to tap into the growing sector.
Last year “saw the completion of the sector’s transition to the new regulatory regime, with bank wealth management companies now becoming the sector’s main force”, Liu Feng, secretary general of the China Banking Association, said at an annual asset management conference in Shanghai in August. “This marks the beginning of a new phase of high quality development for the sector,” he added.
Challenges
Despite this, the sector faces several challenges. Last year was the first time WMPs were required to report mark-to-market profits and losses for improved transparency. Many retail investors are still grappling with the implications of net asset valuation and have yet to abandon the notion of these products being “risk-free” with principal guarantees and fixed returns above bank deposits.
Many WMPs are invested in bonds, money market funds and other fixed income instruments. When bond prices surged in the third quarter of 2022, the marked-to-market prices of many products dropped below face value, triggering panic redemptions. As a result, the sector’s total assets declined by over 1.2 trillion RMB last year from 2021. According to Chinese financial data provider Wind, over 20% of the products fell below face value.
The sector’s total assets plummeted by another 2 trillion RMB in the first half of 2023, and several product launches were withdrawn because they could not raise enough money to meet the minimum scale for investing. But market pressure appeared to ease in the third quarter and investors are returning cautiously.
Investors also found it difficult to understand the benchmarks used for projected returns of the products, and the implications of performance relative to these benchmarks for their investments. There were numerous complaints about some sales agents setting up arbitrary performance benchmarks to mislead investors, or making unrealistic promises of potential returns.
This prompted the China Banking and Insurance Regulatory Commission to issue interim measures two years ago, requiring sales agents to clearly explain reasons for their performance benchmarks and the calculation methods, and prohibiting exaggerated projected returns.
Returns generated by these products have been declining over the past four years due to the product de-risking. Investments are shifted to less risky assets that can be marked to market to enhance transparency instead of providing credits to companies paying high interest for potentially illegitimate use.
Average returns of WMPs have dropped steadily, and have more than halved from 4.44% in 2019 to 2.09% in 2022. While the average return for the first half of this year rebounded to 3.39%, investors are questioning whether they would be better off investing in fixed income mutual funds with stronger brand names and track records.
Investor confidence has also been hit by developments at debt-ridden property developer China Evergrande Group’s wealth management arm, Evergrande Financial Management. Two years ago, Evergrande Financial failed to make overdue payments on 40 billion RMB of investment products, sparking protests and prompting the company to offer reduced amounts of cash or discounted real estate as alternatives.
In September this year, Chinese police detained some of Evergrande Financial’s staff for investigation, indicating that the parent group’s credit crisis may be entering a criminal phase. The wealth management firm, together with Evergrande’s insurance arm, are widely seen as fundraising channels for the parent company.
Such issues are concerning for investors, who worry whether WMPs have truly severed ties with their shady past and if there are any other hidden risks out there. There is room for greater transparency on the products’ underlying assets and risk exposure.
Economic contribution
Despite the challenges, WMPs are making significant contributions to China’s economic and social developments. According to the China Banking Wealth Management Registration and Depository Centre, these products invested a total 19 trillion RMB in bonds, non-standard debt assets, unlisted equities and trust loans in the first half of 2023, directed towards small and medium size enterprises as well as opportunities related to green financing, Belt-and-Road infrastructure projects, poverty alleviation, and development of underdeveloped areas.
The sector has also issued 67 new environmental, social and governance-related products, raising more than 26 billion RMB. Total outstanding ESG assets in the sector through the first half of 2023 was 158 billion RMB, surging more than 51% from the same period of 2022.
The sector received regulatory approval in January to offer personal pension wealth management products to investors. As of June, 12 banks have begun promoting such products and gained over 110,000 investor accounts. And four wealth management companies have launched 18 personal pension WMPs, accumulating close to 800 million RMB in investments.
As China advances on its journey towards high-quality economic and social development, the bank wealth management sector has the potential to play a vital role in directing resources towards national development priorities, and supporting green industries in the zero carbon transition. However, the sector still has a lot more to do on investor education, professionalism and governance, product innovation and transparency to ensure its long-term success.
*This article was published in Asia asset Management’s November 2023 magazine titled “Casting off shadows”.
