2017.11.27 XIE, Qing (Natasha)、Brigitte(Bing)Lu
The People’s Bank of China (“PBOC”), as the “Super Regulator” of the Chinese financial industry, is now putting its regulatory ideas into practice. Last Friday (November 17, 2017), the PBOC, together with the China Banking Regulatory Commission (“CBRC”), China Securities Regulatory Commission (“CSRC”), China Insurance Regulatory Commission (“CIRC”) and State Administration of Foreign Exchange (“SAFE”), issued the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (Consultation Paper) (“Opinions”). On the same day, the PBOC also released a Media Q&A on its website (“Media Q&A”). The Opinions are along the same lines as other output already provided by the PBOC during this year, that is, to unify regulatory standards for the asset management industry within a macro prudential administration framework.
The Opinions address two key themes, “preventing financial risks” and “serving the real economy”, and focus on preventing any event of “Grey Rhinos” and “Black Swans”. The width of the scope of the Opinions and the increase in the number of issues addressed therein are both unprecedented. With the macro prudential administration taking on the function of managing and guiding market expectations, the Opinions’ overriding intention is to provide signals to the market in a timely fashion. It is apparent that the actions proposed in the Opinions cannot be all immediately brought into force and the implementation of certain provisions will require further, more specific details. Ultimately, the Opinions should be considered as representing a starting point, with the financial regulator’s longer-term mission being to constantly monitor, assess and adjust the asset management industry from macro, counter-cyclical and cross-market perspectives.
In order to help understand the landmark significance of the Opinions, it is useful to review JunHe’s Client Briefing dated February 23, 2017 with respect to the draft opinions (“February Draft”). An excerpt of the February Client Briefing is as follows:
“The contents of the Opinions generally include: (i) formulating a unified standard for qualified investors, (ii) categorizing the asset management products in accordance with the fundraising methods, (iii) providing the duties of prudent operation and due diligence of asset management institutions, (iv) in order to prevent the risk of shadow banking, imposing qualification requirements on asset management products to invest in non-standardized assets, (v) in order to prevent systematic risk, imposing requirements on asset management institutions as to the risk isolation, independent custody, capital requirement and risk reserve allocation, restricting the leverage multiples and prohibiting multiple layers of “nesting”, (vi) requiring Asset Management Institutions to report information data to the PBOC for risk monitoring efficiency.
With respect to the Yi Hang San Hui, the PBOC will take responsibility for the macro prudential regulation and formulating the regulatory standards of the asset management businesses jointly with the CBRC, CSRC and CIRC, whilst the CBRC, CSRC and CIRC will take charge of market access and daily supervision of the asset management businesses as well as the investor protection. The Opinions are meant to formulate unified asset management business regulatory standards, with two major goals: one is to put the micro regulation under the frame of macro prudential regulation, while the other goal is to use the “regulation by functions” to cover the deficiency of “regulation by institutional types” so as to prevent regulatory arbitrage. The Opinions intend to “fix the situation” without adjusting the current financial regulatory functions, i.e., to unify the regulatory standards and rules. The so called “standards and rules” not only include extracting the business rules that have commonality for the asset management products of the same type, but also include formulating some targeted specific regulatory requirements so as to prevent certain kind of risks.
… We believe promulgation of the Opinions will have profound implications. We can anticipate in the short term that the respective regulations governing the asset management business of each financial regulatory department will be faced with large-scale revamping to conform to the Opinions. In the long run, the PBOC, on the basis of commanding the information data of the asset management products, may further elaborate or adjust these kinds of “standards and rules” in accordance with the requirements of macro prudential regulation.
When we compare the February Draft with the recently issued draft, it is apparent that the general analysis we offered at that time and cited above still applies to the recently issued draft. Below we have identified and organized the key terms of the Opinions. While many of them are complex and specific, at this point we provide a brief overview of the terms. We will continue to track the official opinions and attitudes relevant to the Opinions and anticipate sharing further details with you at a later date.
Asset Management Business. Article 2 of the Opinions defines the asset management business as any asset management businesses conducted by financial institutions, including banks, trust companies, securities companies, mutual fund management companies, futures brokers, insurance companies or their subsidiaries, under the jurisdiction of the CSRC, CBRC and CIRC; and determine its legal substance, namely that the asset management service refers to a type of financial service where an asset manager, by accepting the entrustment of investors, manages the property entrusted for investment. Since the asset management business belongs to the financial institution’s off-balance sheet business, no guarantee shall be given to any investor regarding their principals or returns; and where there is a shortfall in funds available for redemption for a product, institutions are forbidden to make up the deficiency by using proprietary funds or any other funds under their management.
As further pointed out by Article 29 of the Opinions, the asset management business is a type of financial business that shall operate with a special license, and therefore shall fall under the supervision by the financial regulator. Non-financial institutions shall not issue or sell any asset management product (“AMP”), except otherwise provided by the law. The Media Q&A clarifies that the phrase “except otherwise provided by the law” shall mainly refer to private funds. Literally speaking, the Opinions specifically exclude those private fund managers (“PFMs”) registered with the Asset Management Association of China as being outside the scope of a “financial institution”. However, any private fund issued by a PFM as a non-financial institution may still potentially fall within the scope of an AMP regulated by the Opinions. While the legislative intention is directed at licensed financial institutions and their subsidiaries rather than at private fund managers, it appears that the same regulatory standard may still be “followed” by the regulator to avoid any regulatory arbitrage, thus requiring PFMs to be governed with reference to the full text of the Opinions. The practical interpretation of this point, which will impact on more than 20,000 PFMs, has yet to be specified in a detailed ruling from the CSRC, the competent department.
Classification of AMPs. The Opinions classify the AMPs in two ways. One is based upon the fundraising methods, divided into public funds (issued to non-specific public and raising capital publicly) and private funds (issued to qualified investors and raising capital non-publicly). The other is based upon the types of investment target, i.e., the underlying assets, divided into fixed-income-type products, equity-type products, commodity and financial-derivative-type products and mixed-type products. The purposes for such classification are: firstly, from a regulatory perspective, to apply a unified regulatory standard on products of the same type; secondly, from the perspective of protecting the investors’ interest, to establish different sets of management requirement for investor suitability according to different types of product. Having uniform and widely-recognized classification is a precondition of data collection aiming for continuous monitoring and assessment.
Qualified Investors. Article 5 of the Opinions sets forth the thresholds to become a qualified investor:
(i) For a natural person: the financial assets of his/her family shall not be lower than RMB 5,000,000, or his/her annual average income for the previous three years shall not be lower than RMB 400,000; and he/she shall have investment experience of at least two years,
(ii) For a legal person: its net asset at the end of most recent year shall not be less than RMB 10,000,000, and
(iii) Other scenarios regarded as qualified investors by the respective financial regulatory department.
Additionally, the Opinions specify the minimum amounts required for qualified investors to invest in different types of private product. Each financial regulatory department needs to correspondingly amend its rules so as to keep them consistent with the above thresholds for qualified investors and the requirements for the minimum amount to invest in a single product.
Qualification Requirement and Prudential Operation Principles. The Opinions generally provide that financial institutions shall satisfy certain qualification requirements to engage in the asset management business, namely:
(i) The institution shall have a management system and a management policy that is adapted to the asset management business, good corporate governance, robust risk management, internal controls and accountability mechanisms, and
(ii) The business personnel shall have the requisite professional knowledge, industrial experience and management ability, and shall observe the relevant codes of conduct and comply with professional ethical standards.
Furthermore, the Opinions propose that financial institutions shall observe the principles of prudential operation when using the funds entrusted for investment, and set out the specific duties of investment management. It is noteworthy that the Opinions propose that should a financial institution fail to effectively perform its investment management duty in accordance with the principles of diligence and responsibility, it shall bear the liability to compensate any losses so incurred to the investors according to the law. This reflects the overall tone of the Opinions relating to investor protection.
Shadow Banking. The PBOC notes in the Media Q&A that, in practice, some AMPs invest in non-standardized credit assets, and as such are operating in the realm of shadow banking. As a response to the risks of shadow banking, the Opinions require financial institutions, whether directly or indirectly, to avoid using any AMP fund to invest in the credit asset of a commercial bank. Moreover, any AMP that invests in a non-standardized credit asset shall, pursuant to the Opinions, abide by certain regulatory standards (e.g. upper limit, risk reserves and liquidity management) formulated by the financial regulatory department.
Business Isolation and Independent Custody. The Opinions require all financial institutions engaging in the asset management business to establish an independent legal entity or a special business department to separately conduct the asset management business. Unless otherwise provided by the law or administrative regulation, it is mandated that all AMPs issued by a financial institution are required to be held under the custody of a third party. Within the transitional period, any commercial bank holding a securities investment fund custody business license is still allowed to custody AMPs managed by itself, provided that the bank shall open a separate custody account for each product, so as to ensure isolation between the assets. Upon expiry of the transitional period, any commercial bank holding such securities investment fund custody business license shall set up a subsidiary with independent legal person status to conduct the asset management business.
Fund Pooling. The Opinions prohibit any fund pooling activities that involve rolling issuance, commingled operation or separate pricing. The Opinions provide specific guidelines in relation to product duration. The Opinions take a relatively temperate approach to financial institutions that intend to issue multiple AMPs to invest in the same asset, so long as the total investment in the same asset does not exceed RMB 30 billion. In such cases where the investment exceeds such limit, an approval from the relevant financial regulatory department will be required.
Portfolio Management. In the Opinions, the measures that may have a direct impact on the stock market are those that mandate the upper limits of concentration ratio for the underlying assets invested by the AMPs.
Pursuant to the Opinions,
(i) For a publicly-raised AMP, the market cap of a single security or a securities investment fund invested by the AMP shall not exceed 10% of the AMP’s net asset;
(ii) For a financial institution, the market cap of a single security or a securities investment fund invested by all publicly-raised AMPs issued by the institution shall not exceed 30% of the market cap of the security or securities investment fund;
(iii) The market cap of the stocks of a single listed company invested by all publicly-raised open-ended AMPs shall not exceed 15% of the market cap of the total tradeable stocks of the listed company;
(iv) The market cap of the stocks of a single listed company invested by all AMPs shall not exceed 30% of the market cap of the total tradeable stocks of the listed company.
All of the above limits could be exempted if it is stipulated otherwise by the relevant financial regulatory department.
Should such limits fail to be satisfied due to any reason not attributed to the financial institution itself, the institution shall make the necessary adjustments within 10 trading days of the date when the relevant restricted tradable assets became open for sale, transfer or the trading is resumed.
Risk Reserves. All financial institutions are obliged to hold 10% of their management fees collected from each AMP as risk reserves. When the sum of risk reserves reaches 1% of the balance of a certain product, no more accrual will be required for such product. These risk reserves are to be used to make up any losses incurred to the assets of the AMP or the properties of the investors due to any violation of laws and regulations, breach of the AMP agreement, operational error or technical failure caused by the financial institution. It remains to be seen whether the regulatory department will, by taking reference to this rule, apply the same reserve requirements to the PFMs.
Rigid Payment. In the Chinese asset management industry, despite the widespread saying “without banishing the rigid payment practice, the asset management industry cannot truly prosper”, banishing such practice may actually rely on some “technical” means. As the Media Q&A explains, the means adopted by the Opinions include, requiring financial institutions to carry out net asset value (NAV) management for AMPs, requiring NAV to be generated based upon the principle of fair value, and encouraging the so-called “anticipated rate of return model” (i.e. the manager may not necessarily distribute any amount that exceeds the anticipated rate of return to the investors) to be converted into “NAV based model”. The Opinions also detail the penalties applicable to various circumstances of rigid payment. It should be noted that since the Opinions are neither laws nor administrative regulations, the PBOC and other respective financial regulatory department cannot use the Opinions to directly impose any administrative penalties. Therefore, the administrative penalties on non-deposit-type licensed financial institutions will have to await amendment to the current regulations.
Leverage. The Opinions establish different total asset/net asset ratio ceilings for different types of product and prohibit any holders of an AMP from pledging the unit it holds for financing purposes. Individuals are not permitted to use any non-proprietary funds (such as a bank loan) to invest in an AMP. Upon an enterprise’s debt-to-asset ratio reaching or exceeding a certain “warning limit”, no investment shall be made in an AMP. Relevant standards for the warning limits will be separately provided by the PBOC together with any other relevant department. Additionally, the Opinions forbid differentiating according to seniority of classes for the following products:
(i) Publicly-raised AMP;
(ii) Privately-raised open-ended AMP;
(iii) Any privately-raised AMP that invests in a single underlying asset (i.e. any such AMP of which the investment portion for one underlying asset exceeds 50%);
(iv) Any privately-raised AMP of which the investment proportion for standardized assets (such as stocks or bonds) exceeds 50%.
Issues of Multilevel “Nesting” and “Wei Wai”. The key contents of the Opinions in relation to such issues are:
(i) An AMP may invest in other AMPs, but any such AMP invested shall no more invest in any other AMP (excluding the publicly-raised securities investment funds);
(ii) If a financial institution engages an outside institution to provide investment management services (in Chinese, such service is called “Wei Wai”), such institution engaged shall be a financial institution regulated by the financial regulatory department, with professional investment qualifications and capabilities;
(iii) If a financial institution engages an outside institution as an investment advisor, such institution engaged shall have professional qualifications and be under the regulation of the financial regulatory department.
Under the circumstance of Wei Wai, the institution engaged shall not sub-contract its duty of investment management, nor shall it invest in other AMPs (excluding the publicly-raised securities investment funds).
The Opinions appear to draw a distinction in the qualifications required for the institution engaged for investment management and that for investment advisory. The former must be a licensed financial institution, whilst the latter only needs to be an institution regulated by a financial regulator. When it comes to Wei Wai, given that banking and insurance financial institutions are already implementing a white list system, and that the private fund industry has been undergoing rapid development in recent years, we suggest the private securities investment fund managers be qualified to join the financial institutions’ white list for investment managers, rather than only be on the white list for investment advisors.
Artificial Intelligence Investment Advisor. It is noteworthy that these latest Opinions have gone beyond the February Draft by adding in provisions regarding investment advice provided using artificial intelligence (AI), such as requiring financial institutions that are using artificial intelligence technology or engaging “robot” investment advisors for asset management activities to provide the key parameters of their AI investment advisory model, the rationale behind asset allocation, and the Opinions further set forth the specific regulatory requirements. It appears that the rapid uptake of robot advisors for investment in the Chinese market is prompting the regulators to consider pre-emptive solutions to prevent any systemic risk arising therefrom.
Regulatory Principles. Four regulatory principles are set forth in the Opinions:
(i)Regulation by institutional types shall be combined with regulation by functions, and AMPs of the same type shall be governed by the same regulatory standards, so as to reduce regulatory arbitrage;
(ii)Regulation by probing the specifics of both the funding side and the asset side, that is, identifying the ultimate investors and the underlying assets of each product (excluding the publicly-raised securities investment funds);
(iii)Under the macro-prudential policy framework, strengthening monitoring, assessment and adjustment for asset management business from macro, counter-cyclical and cross-market perspectives;
(iv)Establishing a comprehensive statistics system and realizing real-time supervision and dynamic supervision.
Item (i) for “regulation by functions” and item (ii) for “regulation by probing” are the responsibilities of the CSRC, CBRC and CIRC, while the macro-prudential regulation of item (iii) and the statistical measurement of item (iv) are the responsibilities of the PBOC. To achieve this, the Opinions further stipulate that all financial institutions and financial regulatory departments should have the duty of information reporting to the PBOC.
Penalty for Violations. The penalty provisions for violations provided in the Opinions appear to reflect the PBOC’s intention to exercise the regulatory power as the Super Regulator. First, it requires each financial regulatory department to formulate the penalty provisions for violations, and to ensure the consistency between the standards of penalty. Second, for any asset management business that violates any requirement of the macro-prudential administration, the PBOC has the power to impose a penalty. However, given the difficulty in the practical enforcement of this clause, it remains to be seen how the PBOC will effectively exercise this power.
Transitional Period. The Opinions provide that the transitional period will last until June 30, 2019. Within the transitional period, any AMP that fails to conform to the Opinions will be prohibited from increasing the size of its net subscription; upon expiry of the transitional period, any AMP violating the Opinions will be fully prohibited or banned from renewal.