TMI | ISSUE 261 27

executive interview

A New Era forChina Investors

T he final version of the new rules for China’s CNY 100trn asset managementindustry has now been published by the Chinese financial regulators. In this Executive Interview, Aidan Shevlin, Head of Asia Pacific Liquidity

Fund Management, J.P. Morgan Asset Management, explains the implications of thenew rules for the industry, and for corporate treasurers, whilst outlining practicalsteps for rethinking liquidity management practices in the country.

What are the new assetmanagement industry rules?When do they come into force inChina, and what will their broadimpact be?

Officially known as the ‘Guiding Opinionson Regulating the Asset ManagementBusiness of Financial Institutions’, the newregulations represent a comprehensiverestructuring of China’s asset managementindustry. Introduced by the new FinancialStability and Development Committee

By Eleanor Hill, Editor

Aidan Shevlin, Head ofAsia Pacific Liquidity FundManagement, J.P. MorganAsset Management

28 TMI | ISSUE 261

Why were new regulationsneeded for the shadow bankingsector and what were theChinese authorities looking toachieve?A confluence of factors has led to theintroduction of these new rules – butclamping down on China’s shadowbanking industry has been one of the majordrivers. Shadow banking in China is a by-product of past financial regulations andinterest rate liberalisation, as borrowersand lenders sought to circumvent rules toachieve access to capital at more market-driven interest rates.

It is not hard to see why shadowbanking became so popular: investorsbenefited from very attractive and stableyields with principal guarantees, whilefinancial intermediaries like commercialbanks were able to take assets off-balancesheet and generate profitable fee income;and finally these products offeredfinancing to issuers who were perhapsunable to access other sources of funding.Between March 2015 and September 2017the amount of shadow banking productsoutstanding doubled from CNY54.2trn toCNY107.6trn1. At their peak in Q4-2015wealth management products – the largestindividual asset class, representing aquarter of assets - grew by 56%y/y2.

But in some ways, these benefits weretoo good to be true. There was a distinctlack of transparency around the underlyingassets in many shadow banking products,and in recent years some of these opaqueassets turned out to be very poor quality.In addition, the use of leverage andlayering created a complex web thattouched almost every part of China’sfinancial industry. While certain banksperformed bail-outs where necessary, thisonly fuelled further investor interest, sincethey assumed that their WMPs were ‘safe’ –triggering concerns about moral hazard.

By the end of 2017, the shadow bankingsector had ballooned to US$12.3trn,representing approximately 93% of China’sGDP and approximately 63% of all bankloans3. The Chinese authorities realised thisbehemoth need to be contained while alsoeliminating misconceptions about principalguarantees and establishing stronger linksbetween risk and return. To this end, the

(FSDC), the rules are designed to reducefinancial risks, simplify products andincrease investor protection.

The new rules came into force on 27April 2018. As of now, all newly createdAsset Management Products (AMPs)must comply with the rules; while existingAMPs have until the end of 2020 to befully compliant.

These regulations signify a major changein how financial institutions will operate. Asa result, there will be important implicationsfor banks and fund managers, as well asknock-on effects to investors, issuers andmarkets. Corporate treasurers maytherefore have cause to rethink theirliquidity management structures in China,as well as reassessing the counterparty riskof their banking partners in this space.

China’s AMP rules: need to know

At a glance, what are the new AMP rules looking to achieve? In brief, the new rules are designed to: limit shadow banking activities; ban expectedreturn and principal guarantees; harmonise regulatory standards; and reduce regulatoryarbitrage.

What constitutes an ‘Asset Management Product’ according to the rules?Historically, shadow banking was the broad term for all non-time deposit products issuedand managed by commercial banks and financial institutions, including wealthmanagement products (WMP), trust products (TP), asset management plans and so on.The new regulations specifically define Asset Management Products (AMPs) as anumbrella term for all these instruments (with a few exceptions such as private funds andpension products).

Under the new rules, all public AMPs must be managed on a mark-to-market net assetvalue (NAV) basis (there are some exceptions for amortised NAVs) without offeringexpected returns or implicit guarantees. AMPs will have strict rules on leverage, layeringand risk reserves; in addition they must be managed by a segregated asset managementbusiness and have a separate custodian.

How does the regulator define standard assets and non-standard assets?The new rules stipulate that publicly-offered AMPs, which make up the majority ofexisting products, can only invest in standard assets (SAs). Typical standard assets aretradable fixed income instruments or equity shares. Non-standard assets (NSAs) areessentially all other assets. 

According to the new rules, qualified investors can still buy privately offered AMPs thatinvest in NSAs, but there are strict rules regarding the type of investors, pricing of theNSAs and type of investments that private AMPs can put money into. As such, it is worthseeking specialist advice on this topic where appropriate.

These regulationssignify a majorchange in how

financialinstitutions will

operate.

TMI | ISSUE 261 29

executive interview

happen. To put an end to this, a new superfinancial regulator has been created: theFinancial Stability and DevelopmentCommittee (FSDC). In tandem, the CIRCand CBRC have recently merged to form theChina Banking and Insurance RegulatoryCommission (CBIRC), while the PBoC andCSRC remain unchanged.

The FSDC is tasked with formulatingthe regulatory structure and co-ordinating regulatory workflows. Sincethe new regulations are based on productlines rather than sectors, the hope is thatthese unified regulations will reduceregulatory arbitrage.

Are the final AMP rules tighteror looser than the original draftreleased in November 2017?On balance, they are a little looser. One ofthe most significant changes is the longertransition period of two years (existingAMPs have until 2020 to comply), whichshould minimise the initial impact onbanks, investors and issuers, whilst givingfinancial institutions time to prepare. Thefinal version also included a more flexibleinterpretation of the net asset value(NAV) rules.

Nevertheless, given the government’sfocus on risk reduction, the regulators willlikely be strict on implementation.

Surely these new rules will havea significant impact oncommercial banks? How willthis change their businessmodels?As alluded to, commercial banks havehistorically played a critical role inshadow banking - both as major issuersand investors in asset managementproducts. Under the new rules, however,the requirement to provide NAVs, theexclusion of NSAs from public AMPs andthe removal of guarantees will likely leadto a dramatic reduction in shadowbanking activity.

The initial result for commercial bankswill be a negative impact on fee incomeand profitability; subsequently banks willneed to increase loan loss provisions andpotentially face higher non-performingloans and impairments as they take some

NSAs back onto their balance sheets. It is not all bad news for the banks,

though. On a more positive note, some ofthe funds currently invested in shadowbanking products may well be re-investedin bank time deposits and certificate ofdeposits. In addition, the new rules allowbanks to set up their own assetmanagement subsidiaries to manage theirlegacy WMPs and new AMPs.

What might this mean for thecompetitive landscape? Whichbanks will be the winners? Andwhere will all the money fromAMPs actually end up?Taking everything into account, it seemsthat banks with stronger traditionalloan/deposit franchises and capital baseswill be better positioned to withstand theimpact of the new rules, at least in the shortterm. Looking longer-term, the reduction insystemic risk and the ability for banks to

new rules are a big step in the rightdirection. In fact, the AMP rules are one ofthe most significant changes ever in thehistory of China’s shadow banking industry.

What other drivers led to theissuance of these new rules?Even as economic growth has slowed(from an average of 11%y/y between 2006and 2011 to 6.8% in Q1-20184), debtoutstanding has sky-rocketed. In fact, thecountry’s percentage of debt to GDP hasincreased from 164% in 2007 to 266% at theend of 20175. Although this is stillsignificantly lower than many developedmarkets like the USA (253%) and the UK(280%), it is substantially higher than theaverage for other emerging marketcountries (circa 140%) and has beengrowing rapidly6. Additionally, the numberof credit defaults in China has increased inrecent years, with 72 issuers defaultingyear-to-date in 2018 compared with noneprior to 2014 and 65 for the whole of 20177.

This is a significant risk and a keyconcern for the government. The majority ofthis growth emanated from the corporateand state-owned enterprise (SOE) sectors –and is widely considered unsustainable,with the potential to trigger a financial crisisif it continued to increase unchecked. Whilethe term SOEs suggests financial strengthand solid government links, it is amisnomer, as China’s SOEs vary widely interms of credit quality and have never beenguaranteed by the central government. Oneof the government’s three main aims for2018 is to reduce financial risk in the market.To that end, they want to focus on thequality of growth rather than the quantity,and therefore want to put a brake on theproliferation of debt; the new AMP rulesrepresent a key step on the path todeleveraging and debt reduction.

These new AMP rules also serve toharmonise the regulatory landscape inChina. Historically there were four financialmarket regulators: the central bank – thePeople’s Bank of China (PBoC); the ChinaBanking Regulatory Commission (CBRC);the China Insurance RegulatoryCommission (CIRC); and the ChinaSecurities Regulatory Commission (CSRC).

Splitting regulatory oversight in this wayled to different focuses in the rules betweensectors and regulatory arbitrage could

In a nutshell

� The new rule is a positive move toreduce shadow banking, reducesystemic risks and avoid regulatoryarbitrage

� However during transitions,commercial banks will suffer fromnegative impacts on fee income andprofitability, credit conditions arelikely to tighten, leading to greateruncertainty and volatility

� Investors will need to rethink theirinvestment and liquidity to searchfor yields, encouraging financialinnovation

30 TMI | ISSUE 261

executive interview

establish asset management businessesshould be supportive for the industry. 

Within these new subsidiaries, banks willneed to get creative to attract new assets –launching a range of more transparent, andclearly delineated investments to appeal todifferent investors with varying risk andreturn requirements. But the good news isthat encouraging banks to diversify theirbusiness models and embrace innovation,whilst spurring competition, should be along-term positive for the banking industry.

How will fund managers inChina be affected by the newrules? Is the future bright?By and large, the new rules are positive forthe onshore asset management industry,which already has a strong track record ofoffering a wide range of funds with gooddisclosure, clear pricing and independentcustodians. What’s more, with mutual fundsonly representing 10%8 of the entire assetmanagement industry in China today, thereappears to be substantial room to growfurther. This is especially true since thereduced availability of WMPs and TPsshould spur growth of existing funds andinnovation of new funds.

Will RMB money market funds(MMFs) be impacted by the newrules, then?MMF assets in China continue to trendupwards. While RMB MMFs fall within thescope of the new rules, the CSRC hadalready introduced detailed new MMF rulesin September 2017 – which have already de-risked the MMF sector by improvingliquidity, security and disclosures.

That said, the CSRC may issue furtherclarification for the entire mutual fundindustry following the publication of theAMP rules. But it is unlikely that anysignificant, or even minor, changes willbe made.

All in all, we see the rules being largelypositive for MMFs as these productstypically offer good disclosure, strictregulations and competitive returns –which should appeal to investors focusedon security, liquidity and yield. Moreover,opinion in the market suggests that RMBMMFs will continue to operate at a stable NAV.

In your view, what will theimpact of the AMP rules be onasset classes and market-drivenyields?Assets deemed ‘non-standard’ will likely seesignificantly lower demand, even if returnsincrease. Issuers of these NSAs may struggleto get funding – especially if banks areunwilling to take these debts back onbalance sheet. This could push corporatebond spreads wider and trigger an increasein credit events.

Meanwhile, demand for standard assetswill increase. This is potentially a positive forbond and equity prices, although this will bea longer-term trend.

What does all of this mean forcorporate treasury functions andtheir liquidity managementpractices in China? While the new rules represent a significantchange in the market, corporate treasurers’core investment goals should remain thesame: security; liquidity and yield.

Where treasurers may need to rethinktheir investments is if they currently use anyWMPs or TPs. Under the new rules, thebenefits that some, more adventurous,treasurers have become accustomed to, in particular higher returns and principalguarantees, will no longer be available.This will require treasury professionals toreassess the risks they are comfortable with.

On the other hand, little will change formore conservative corporates, who willlikely continue to invest in time depositsand MMFs. Nevertheless, they should alsobenefit from a greater range of products asthe banks and fund managers innovate inreaction to the new rules. The choice ofinvestments in China may soon rival that ofWestern markets.

Any other useful tips you couldoffer treasurers with liquidity inChina around preparing for thenew rules? All treasurers will need to consider theircredit and bank counterparty risks. Whichbanks are more exposed to the loss of

income from WMPs, for example? Andwhich banks will need to take more of theseloans back on to their balance sheet in thefuture, thereby reducing the quality of thebank itself? These are important points toconsider – sooner rather than later.

Elsewhere, the momentum generated bythe new rules could be harnessed by localcorporates to further embrace global bestpractice in cash and liquidity management.Local methods will no longer stand up toscrutiny. This is a great opportunity tointernationalise.

Finally, how would yousummarise the impact of thenew rules? And what next stepsshould corporate treasurers taketo embrace this change?Overall, the new rules are a positive moveby the regulators. While the rules may welltighten liquidity conditions and sloweconomic growth, they offer major benefitsincluding the ability to reduce systemic riskand moral hazard. Their introductionbrings an end to an era of regulatoryuncertainty in the asset managementsector, while the long grace period shouldallow for a smooth transition.

As well as continuing to focus on theirthree core investment goals, treasurerswould do well to make sure theirinvestment policies are kept up to date andthat they have enough flexibility built-in todeal with the changes that may happen tothe products they use. Another importantnext step is education. Treasurers ought tomake internal stakeholders aware of thechanges, the risks, and why more clarityaround investments will be required goingforward. In short, this is an excitingopportunity for treasurers to questionexisting set-ups and ensure they have aliquidity structure in place that is truly fit-for-purpose. �

Notes1 Source: JPMorgan as at 31st March 20182 Source: Bloomberg Data as at 31st March 20183 Source: UBS report as at 30th April 20184 Source: Bloomberg Data as at 31st May 20185 Source: Bloomberg Data as at 31st Dec 20176 Source: JPMorgan as at 30th Apr 20187 Source: Moody’s Investor Services as at 31st Mar 20188 Source: JPMorgan as at 30th Apr 2018

NOT FOR RETAIL DISTRIBUTION: This communication is for intended recipients only.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment or interest thereto. This document is confidential and intended only for the person or entity to which it has been provided. Reliance upon information in this material is at the sole discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any particular receiver. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are those of as of the date of issuance.

Investment involves risks. Any investment decision should be based solely on the basis of any relevant offering documents such as the prospectus, annual report, semi-annual report, private placement or offering memorandum. For further information, any questions and for copies of the offering material you can contact your usual J.P. Morgan Asset Management representative. Both past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast will come to pass.

J.P. Morgan Asset Management and/or any of its affiliates and employees may hold positions or act as a market maker in the financial instruments of any issuer discussed herein or act as the underwriter, placement agent or lender to such issuer. The investments and strategies discussed herein may not be suitable for all investors and may not be authorized or its offering may be restricted in your jurisdiction, it is the responsibility of every reader to satisfy himself as to the full observance of the laws and regulations of the relevant jurisdictions. Prior to any application investors are advised to take all necessary legal, regulatory and tax advice on the consequences of an investment in the products.

LV–JPM51374 | 08/18 | 0903c02a821a22d8