An eventful 2017 saw Chinese regulators begin to rein in a number of problematic behaviors in its financial sector.
From tightening capital outflows to curbing the dealmaking of insurers funded by high-yield wealth management products, Beijing looked to deleverage its financial industry after years of loosely regulated expansion following the last financial crisis.
And all signs point to an even tougher 2018 for China’s financial sector. With a newly unified regulatory and enforcement policy coming into effect this year, Chinese regulators are just getting started in their efforts to deleverage the economy.
In November 2017, Chinese regulators introduced major legislation, the scale of which has been compared to the U.S. Dodd–Frank Act, to unify rules for the asset management industry and curtail shadow banking. The regulations—a culmination of sorts for Chinese communist regime leader Xi Jinping’s campaign to rein in financial risks—will target off-balance sheet businesses of banks, insurers, and asset management entities such as trusts and mutual funds.
One of the biggest challenges Beijing faced was the various discordant regulatory bodies that oversaw China’s sprawling financial sector, leading to companies taking advantage of “regulatory arbitrage” to skirt the scrutiny of regulators.
Beginning mid-2018, regulations over China’s $15 trillion asset management sector will become unified—the new rules were issued jointly by the People’s Bank of China and several other top regulatory bodies overseeing the country’s banking, securities, foreign exchange, and insurance sectors.
Chairman of the China Banking Regulatory Commission (CBRC) Guo Shuqing gave a glimpse of upcoming regulatory plans in a Jan. 19 interview with People’s Daily, the Chinese Communist Party mouthpiece.
“The situation is still complicated and grim,” Guo said in reference to systemic risks to China’s financial system.
Guo didn’t mince words when describing what ails the Chinese financial system: “We need to focus on reducing the debt ratio of enterprises, inhibit the residential sector leverage, strictly regulate financial products, continue to dismantle shadow banking, clean-up regulatory financial holding companies, dispose of high-risk banking institutions in an orderly manner, crack down on various illegal fundraising activities, continue to curb the real estate bubble, and actively cooperate with local governments to rectify implicit debt.”
A slew of small-scale but impactful enforcement actions have materialized over the last few weeks.
Three senior executives of Zhong Heng Tong Machinery Manufacturing Co. were convicted of fraud on Feb. 1, in connection with falsifying company financials prior to two private placement bond issuances worth 100 million yuan ($16 million). The executives were sentenced in the financial capital of Shanghai, in the first ruling of its kind for the city, according to Caixin Global, a mainland business magazine.
On Feb. 2, the CBRC announced fines totaling 52.5 million yuan ($8.33 million) to 19 banks across Shaanxi and Henan provinces in connection with loan fraud, including a Henan branch of major commercial lender Industrial and Commercial Bank of China.
Closely Watching Insurers
A focus area for regulators will be the insurance sector, specifically asset-to-liability matching.
China’s insurance industry has gained immense power and controversy over the last six years, a period of deregulation overseen by its former chief Xiang Junbo, who was placed under investigation for corruption last year.
Chinese insurers had been flush with cash from the issuance of so-called “universal life policies,” a short-term, high-yielding wealth management product marketed to retail investors.
In turn, insurers such as Anbang Insurance Group, Baoneng Group, and Evergrande Life embarked on an asset purchase spree in recent years, buying up real estate, foreign soccer teams, and other companies across the globe.
The typical business model of an insurer is to match expected cash flows of assets (investments held) and liabilities (policies sold). As such, the balance sheets of traditional insurers are relatively conservative, focusing on corporate bonds, government bonds, and other liquid investments. From the regulator’s perspective, the risky assets Chinese insurers accumulated were illiquid and difficult to sell, which could push insurers insolvent in the event of a market downturn and liquidity crunch.
A statement by the China Insurance Regulatory Commission (CIRC) on Dec. 15, 2017, said that the agency will assess asset and liability management going forward as a key method to monitor inflating risks in the industry.
“Strengthening supervision of assets and liabilities management is conducive to promoting the return of the industry to its origin and exerting long-term sound risk management and protection functions,” the CIRC said in a statement.
Asset Managers Pushing Back?
Despite universal agreement among economists and financial experts that shadow banking activities should be more closely regulated in China, certain financial sector players appear to be pushing back against proposed regulation.
Caixin reported that a December 2017 industry document submitted by the China Banking Association, acting on behalf of 10 midsize commercial banks, asked Beijing regulators to water down the new proposals. Such regulations would upset the industry and threaten China’s financial stability, the banks argued.
In other words, economic growth and cash flow solvency depend on the continuation of the status quo.
The industry group quickly denied submitting such a memo, according to its Weibo account. But such a document, if true, would certainly raise eyebrows—it represents an almost unheard-of pushback against central regulators.
Nonetheless, several Chinese banking executives confirmed to Caixin that the document does reflect views from banks.