People’s Bank of China (PBoC) issued a ‘Monetary execution report Q2 2017’, which outlines problems in the asset management industry and regulations aimed at solving these issues.

The asset management industry is a market with a value of over 60 tn, of which, bank-issued off-balance-sheet wealth management products (WMP) form the largest segment, says the report.

Problems in this industry include

  • the ‘capital pool’ model which exacerbates liquidity risk
    • under this model, asset management institutions raise low-cost short-term capital and invest in long-term debt or equity asset classes through rolling release, aggregated management and separated pricing
    • difficulty in rolling over asset management products causes strains on liquidity
  • nesting of different asset management products which transmit risk from one industry to another
    • bank-issued wealth management products are limited in availability of debt instruments; trusts, securities, funds and insurance asset management products are used as conduits into equity instruments
    • nesting complicates product structure, making risks harder to detect
  • products that guarantee returns which pose risks to the financial system
    • some asset management products guarantee returns which are funded using their own funds or the capital pool

To tackle these problems, PBoC proposes regulations that will

  • enhance liquidity risk management
    • independent accounting and management for asset management products (as opposed to aggregated management in ‘capital pool’), ensuring matching maturities between the asset and liability sides
    • encouraging financial institutions to set up asset management subsidiaries with independent legal status to carry out asset management business
    • improving the fund custodianship system; isolating risks associated with an asset management product from other products it offers and the institution’s own funds
  • unify standards for products, eliminating room for regulatory arbitrage
    • strengthening function-based and ‘see-through’ regulation
  • eliminate nesting and conduits
    • granting all asset management institutions an equal footing
    • preventing institutions from becoming conduits for others to avoid investment and leverage restrictions
  • redirect the industry back to basics
    • enforcing the concept that investors should bear all risks and returns, and only pay asset managers a management fee
    • restricting asset management companies from guaranteeing returns while encouraging them to better educate their investors