HONG KONG. 26 March 2020. Pengyuan International has today published a commentary on the state of the wealth management market in China.
Here are the key takeaways from the report.
We anticipate that the Chinese regulators will take an accommodative approach in pushing through reforms in the wealth management product (WMP) market in the remainder of 2020. This will give the joint-stock banks (JSBs) a much-needed buffer amid a difficult environment, in our view. The new regulations – originally targeted for full implementation by the end of the year – call for fundamental changes in the way WMPs are designed, sold and priced. While the banks have made significant progress in improving their market structures since 2018, a few hurdles remain.
The JSBs are major distributors of WMPs. We believe it would be unlikely for most of them to meet the initial regulatory deadline, especially as COVID-19 continues to wreak havoc across the economy. The JSBs manage over 40% of assets under management (AuM) in the WMP market, which are equivalent to 25-45% of their deposit base. Full implementation in 2020 will affect them in three ways. First, commission income may come under substantial pressure. Under the new regulations, products are required to be priced on a net asset value (NAV) basis and do not offer an explicit expected return. This makes WMPs much less attractive to the average retail investor. Second, the banks may not have adequate management resources to comply with the new sales, investment and reporting requirements. Finally, existing assets that do not meet the new framework may have to be brought back onto their balance sheets, affecting the banks’ deposit reserves, asset provisions and, ultimately, capital positions.
Key remaining challenges include conversion to NAV pricing and treatment of illiquid non-standard credit assets. As of now, only about 35% of WMPs are NAV-based. The banks have made tangible progress towards migrating to NAV product designs, but investor pushback and the lack of secondary market pricing for many asset classes continue to make full conversion difficult. We believe it may be another 1-2 years before NAV-based products account for the majority of sales. Furthermore, non-standard credit assets – which account for around 17% of AuM – present challenges in asset-liability management. Although many of these assets are in run-off and may not be wrapped into new product structures as they mature, their remaining duration is still significantly longer than the WMPs’ investment horizons.
On a more positive note, industry practices and infrastructure have come a long way since the early days of WMP. A total of 16 banks have obtained licenses to set up wealth management subsidiaries, covering a large subset of the industry. Coupled with a more established trustee structure, these dedicated WMP business units offer a significantly higher degree of ring-fencing from the banks’ assets and deposits. Capital or return guarantees on WMPs are now prohibited, with existing products being run-off or converted into on-balance sheet structured or plain-vanilla deposits. Interbank WMPs that are sold among banks represent less than 5% of outstanding AuM, compared to 25% at the peak in 2016. All these factors have contributed to a more prudent operating environment, in our opinion.
Looking ahead, we expect the regulators to relax the 2020 year-end hard deadline, while requiring banks to develop implementation plans for 2021-2022. We regard the potential delay in full implementation to be temporary, as a measure to soften the impact of COVID-19 on the sector, particularly the JSBs. We believe WMP regulations are an integral part of the policymakers’ financial reform package and will remain a long-term priority.
Stanley Tsai, CFA
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+852 3615 8278
Date of relevant rating committee: 19 March 2020.
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