1. Why are the Guidelines formulated?
In recent years, financial institutions' asset management business (hereinafter referred to as the asset management business) has developed rapidly in China, and the assets under management continued to expand. At the end of 2016, the balance of banks' in-balance-sheet and off-balance-sheet wealth management products reached RMB 5.9 trillion and RMB 23.1 trillion respectively; the balance of money trust managed by trust companies was RMB 17.5 trillion; AUM of mutual funds, privately offered funds, asset management schemes managed by security firms, and asset management schemes managed by fund companies and their subsidiaries were RMB 9.2 trillion, RMB 10.2 trillion, RMB 17.6 trillion, RMB 16.9 trillion respectively; and the balance of the insurance-managed asset management schemes was RMB 1.7 trillion.
Asset management business has played an active role in meeting people's needs in wealth management, optimizing social financing structure, and supporting the real economy. However, due to inconsistencies between different regulatory requirements on the same kind of asset management business, many problems emerged such as the development of unregulated business, regulatory arbitrage, multi-layered investment, implicit repayment guarantee, and evasion of financial regulation and macro-management. Under the leadership of the CPC Central Committee and the State Council, the PBC, together with China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC), China Insurance Regulatory Commission (CIRC) and State Administration of Foreign Exchange (SAFE), have formulated the Guidelines to fill the regulatory gaps and improve regulatory efficiency, focusing on key problems and taking into consideration the industry practices and regulatory practices. By unifying the regulatory requirements on the same kind of asset management products, the Guidelines aims to promote sound development of the asset management business, effectively prevent and control financial risks, and better serve the real economy.
2. What guidelines and principles does the Guidelines follow?
The general guidelines of the Guidelines are to unify the regulatory requirements on the same type of asset management products, to provide consistent rules on the same kind of asset management business, to ensure fair market access and regulation, to minimize regulatory arbitrage, and to create a favorable institutional environment for the sound development of asset management business.
The Guidelines follows several basic principles. First, hold the bottom-line of strict risk control, dissolve the existing risks, and rigorously prevent new risks. Second, adhere to the principle of serving the real economy, fully tap asset management business to serve investment and financing needs of the real economy, enhance regulation to prevent capital moving within the financial system and products being too complex which may cause cross-industry, cross-market, and cross-region risk transmission. Third, adhere to the regulatory philosophy of integrating macro-prudential management with micro-prudential regulation and institutional regulation with functional regulation to cover asset management businesses conducted by all kinds of financial institutions, and take effective regulatory measures to protect the rights and interests of financial consumers. Fourth, adhere to the problem-solving principle, focus on the problems of product nesting, leverage opacity, regulatory arbitrage and implicit repayment guarantee, and stipulate unified regulatory requirements. Meanwhile, with respect to financial innovation, the Guidelines follow the approach of weighing the pros and cons, managing and avoiding the negative impacts, while leaving the door open for future development. Fifth, take a proactive, steady and prudent approach in implementation, combine risk management with orderly and standardized regulation, take full account of the market's ability to adapt, set a reasonable phase-in period, actively communicate with the market and effectively guide market expectation.
3. Which entities are subject to the Guidelines? Specifically, what institutions and products are included?
The Guidelines applies to asset management business of financial institutions. Trusted by investors, banks, trust companies, security firms, fund management companies, future companies and insurance asset management institutions manage client wealth on their behalf. Financial institutions have fiduciary duty and charge management fees, while the clients shall take investment risks and receive returns. There are many kinds of asset management products, such as non principal-protected wealth management products issued by banks, money trust schemes, and asset management schemes managed by security firms and their subsidiaries, fund management companies and their subsidiaries, futures companies and their subsidiaries, and insurance asset management institutions. The Guidelines is not applicable to the asset-backed securities business conducted in accordance with rules set by financial regulatory authorities.
To address illegal and unregulated asset management business operated by non-financial institutions, based on the philosophy that "financial business shall not be operated unless approved, and financial business must be subject to financial regulation", the Guidelines has specified that non-financial institutions shall not issue or sell asset management products unless otherwise provided for by the state.
4. What are the classification criteria of the asset management products and what is the purpose of classification? What are the major differences in regulatory requirements on different types of products?
The basis of unifying regulatory requirements lies in clear classification of the asset management business. The asset management products are classified from two perspectives in the Guidelines. First, asset management products are divided into publicly-offered and privately-offered products based on fund raising approach. Publicly-offered products are issued to the public and have strong risk-spillover effect. Compared with privately-offered products, the regulatory requirements on publicly-offered products are much stricter in terms of investment scope, leverage, and information disclosure. The raised money shall be invested in low-risk, high-liquidity credit assets and listed equities, and must not be invested in unlisted equities unless otherwise provided for by laws and regulations. Currently, most of the publicly-offered products are fixed-income products. Approval of the banking regulatory authorities is needed to issue equity products and other products. As privately-offered products are issued to qualified investors with certain financial assets who are able to identify and take investment risks, less regulatory requirements are imposed in order to provide more room for investors to exercise autonomy of will. The money raised can be invested in credit assets, listed equities, unlisted corporate equities and its beneficial interests. Second, asset management products are divided into four groups based on investment scope, i.e. fixed income products, equity products, commodities and financial derivative products, and hybrid products. The investment risks increases in the order of fixed income products, hybrid products, and equity products. The requirements on leverage by tranches are stricter in that order. Focus of disclosure requirements are different based on the underlying assets.
There are two purposes of classifications from the above two perspectives. First, it aims to strengthen the functional approach of financial regulation in the principle of "substance over form". In practice, institutions conducting asset management business might be subject to different regulatory requirements due to differences in the type of institutions, which lead to regulatory arbitrage. To address this problem, asset management products shall be classified according to business functions to make sure unified regulatory requirements are applied to the same kind of products. The second purpose is investor eligibility, to make sure investors get appropriate products. Publicly-offered products and privately-offered products are targeted at public and qualified investors respectively, which is consistent with investor eligibility management. At the same time, asset management products are classified into different types based on investment scope and thus have different risk profiles. Product types must be declared at issuance to avoid investor-product mismatch and protect the rights and interests of financial consumers.
5. In what aspects do the Guidelines strengthen the qualification requirements and fiduciary duties of financial institutions in asset management business?
Asset management business is the financial service provided by financial institutions to invest on behalf of their clients. In order to protect the clients' legitimate rights and interests, it is required in the Guidelines that financial institutions shall meet certain qualification requirements and fulfill their fiduciary duties. First, to conduct asset management business, financial institutions should have a management system and management policies compatible with the development of asset management business; the financial institution should have good corporate governance, sound risk management, internal control and accountability mechanism. Second, financial institutions shall establish and improve procedures and policies regarding the employees' qualification, training, assessment and evaluation and accountability mechanism, make sure employees engaged in asset management business have the necessary professional knowledge, industry experience and management capabilities, and act in accordance with the code of conduct and ethics. Third, there are provision on punitive actions, including disqualifying the employees of financial institutions who have violated laws, regulations and the requirements in the Guidelines in asset management business.
6. What restrictions and requirements does the Guidelines stipulate on asset management products' investment in non-standardized credit assets and what are the purposes? Will those requirements impact financing to the real economy?
Some asset management products issued by financial institutions are mainly invested in non-standardized credit assets have certain shadow banking features such as credit, maturity and liquidity transformation. Those opaque and illiquid products are designed to circumvent capital and other regulatory requirements. Some of them are even invested in restricted areas, and most of them are not included in the social financing aggregate statistics. Therefore, it is required in the Guidelines that financial institutions shall meet regulatory authorities' requirements on quota, risk reserve and liquidity when investing in non-standardized credit assets. Several targets are considered in making above requirements, i.e. to ensure asset management business will not become credit business in disguise, to reduce shadow banking risks, to streamline financing to the real economy, to reduce financing cost to real economy, and to improve the efficiency and quality of financial services. Meanwhile, in order to enhance the capacity to serve the real economy, we should deepen financial system reform, increase the proportion of direct financing, promote healthy development of the multi-layered capital market, and improve the two-pillar regulatory framework of monetary and macro prudential policies.
7. What do the Guidelines propose to prevent liquidity risk of asset management products and to regulate financial institutions' operation in managing the pool of fund?
In their asset management business, some financial institutions manage the pool of raised fund by rolling issuance, collective operation combined with separate pricing of the underlying assets. Under this model, several asset management products have various underlying assets, it is hard to tell which assets will generate the anticipated return of each product, or to assess the risks of each product. Meanwhile, investing in long term credit and equity projects with underpriced and short term fund will magnify liquidity risk of asset management products. It will trigger liquidity shortage once fund raising becomes unsustainable.
The Guidelines ban managing the fund pool in the above-mentioned ways. On the basis of three-independent principle in management, which are independent management, independent booking and independent accounting, financial institutions are required to improve duration management and the minimum maturity of closed end asset management products should be no less than 90 days. The management fees should be set based on maturity, i.e., the longer the maturity, the lower the management fees, to restrict the short termist, to reduce and eliminate the mismatch between assets and liabilities, and to prevent liquidity risks.
In addition, the Guidelines bans the creation of multiple asset management products to finance one single project, which is practiced by some institutions to duck restrictions on investor numbers and other regulatory requirements. At the same time, in order to prevent risks of one asset from spreading to various products, the Guidelines set the limit of RMB 30 billion for investment into a single asset with capital raised by multiple asset management products issued by one institution. Based on the financing need of real economy, a larger volume of investment can be made after financial regulatory authorities' approval.
8. What is the relationship between capital and risk reserve requirements for asset management products and the capital and existing provisioning standard for various institutions? How do they connect?
Asset management business is the off-balance-sheet business of financial institutions, and investors are to bear their own investment risk. However, in order to cope with operational risks or other non-anticipated risks, a risk compensation mechanism is needed, and the necessary risk reserve shall be put in place. At present, different industries have different capital and risk reserve requirements for asset management products. In the banking sector where capital supervision is carried out, operational risk reserve is required at a certain ratio based on the income of asset management business services; for the asset management plans of the securities companies, publicly offered fund, asset management plan for designated customers of fund management company’s subsidiary and certain insurance asset management plans, the risk reserve is based on management fee income but the ratio differs; and the trust companies draw trust compensation reserve at 5% of the after-tax profits. To integrate the existing requirements of risk reserve of various industries, the Guidelines stipulate risk reserve at 10% of management fee income of asset management products, or operational risk reserve and other relevant risk reserves according to relevant provisions. The upper limit of the risk reserve is set at 1% of the product balance. Risk reserve is set aside to make up for the loss in the managed capital or loss incurred by investors which is caused by the conduct of financial institution in violation of laws and regulations, or asset management product agreement, by operational mistake, or technical failure. The method of risk reserve provisioning will be based on the relevant stipulations of Ministry of Finance. What needs to be clarified is that, the requirements on trust companies and other financial institutions to whom risk reserve or operational risk provisioning requirements are not applicable, will be formulated by the regulatory authorities based on the criteria set by the Guidelines. The Guidelines do not require double provisioning in addition to the existing regulatory standards.
9. How to break implicit repayment guarantee of asset management products? What are the reasons for net asset value management?
Implicit repayment guarantee distorts asset management products' nature of managing client money as a fiduciary duty, disrupts market discipline and exacerbates moral hazard. It is a general consensus of the financial industry to break the guarantee. For this purpose, the Guidelines stipulates net asset value management for asset management products in accordance with the fair value principle, to promptly reflect the risk reward balance of the underlying assets so that investors will have a clear understanding of the risks, and to change the practice of financial institutions keeping the excess investment returns, so that investors will receive all the investment returns after deducting the management fee. The reason to make this stipulation is that, to fundamentally break the implicit payment guarantee, investors are to take on risks based on proper understanding of risks and to receive all the investment returns, and net asset value provides an important basis for understanding risks in the product. In practice, as some asset management products adopt the mode of expected rate of return, the risk of underlying assets is not promptly reflected in the value change of products, thus investors are not aware of the risk taking; while financial institutions convert the investment earnings in excess of the expected rate of return into management fees or directly channel them into intermediate business income, instead of giving them to investors, it is difficult to ask investors to bear the investment risks. Therefore, it is necessary to promote the shift from expected return products to net-asset value products, so that the sellers perform fiduciary duty, and the buyers take their own risks, and the asset management business returns to its original purpose.
The Guidelines also contains provisions on determining implicit repayment guarantee by looking at the process of business conduct and its final outcome, including guaranteeing principal and return in violation of the principle of net asset value based on fair value, adopting rolling issuance or other methods to transfer the principal, return and risks of asset management products among the different investors, making repayments with raised fund or entrusting other financial institutions to make repayments, and so on. The Guidelines put forward punitive actions against implicit repayment guarantee, requiring licensed depository financial institutions to make up for the shortfall in the deposit reserve and deposit insurance fund contribution, and imposing fines and other administrative penalties on licensed non-depository financial institutions.
10. How is the leverage level of asset management product managed?
In order to maintain the stable operation of bond, stock and other financial markets, and to contain asset price bubbles, the leverage level of asset management products shall be controlled. The leverage of asset management products are divided into two categories. The first is financial leverage through inter-bank borrowing, pledged repo after product offering; the other is leverage based on the division of prior and inferior tranches. In addition, attention should be given to leverage behavior of holders using their share of asset management products as pledges for financing and buying asset management products with borrowed money.
In terms of financial leverage, the Guidelines set an upper limit of 140% and 200% for the debt ratio (total assets /net assets) of publicly offered products and privately offered products respectively, and an upper limit of 140% for privately offered products with tranches. In order to truly reflect the liability level, the Guidelines emphasizes the looking-through principle in calculating the total assets of single product, i.e. the total assets of underlying investment. To contain asset price bubble from leverage build-up, it requires that holders of asset management products must not use them as pledge for financing, individuals must not use bank loans or other non-proprietary fund to invest in asset management products, and enterprises who has excessive asset-liability ratio must not invest in asset management products.
In terms of tranches, after fully considering the current industry regulatory standards, the Guidelines has provisions on the product types that can be structured into tranches, i.e. neither publicly offered products nor privately offered products with more than 50 percent of fund invested in standard assets shall be structured into tranches. On privately offered products that can be structured into tranches, the Guidelines stipulates that the prior to inferior ratio of fixed income products shall not exceed 3:1, the prior to inferior ratio of equity products shall not exceed 1:1, and the prior to inferior ratio of commodities and financial derivative products as well as mixed product shall not exceed 2:1. To prevent such products from becoming tools of leveraged buyout and tunneling, financial institutions that offer tranches are required to manage such products on their own and must not entrust them to inferior investors, and shall not provide principal and return guaranteed arrangements to prior investors.
11. How to eliminate multi-layered investments and channel business?
Asset management products with multi-layered investments through channel businesses not only increases the complexity of products, making it difficult to look through underlying assets and risks, but also stretches the funding chain, causing money to move around within the financial system and pushing up financing cost. To address the problem, the Guidelines addresses the motives of multi-layered investments and channel business, requiring financial regulatory authorities to give equal market access and equal treatment to all kinds of financial institutions in asset management business. Specifically, a financial regulatory authority must not erect market access barriers based on the type of financial institutions; they must neither restrict investments by financial institutions under its regulation in financial markets regulated by another regulatory authority, nor restrict investments in financial markets under its own regulation by financial institutions regulated by another authority. Second, there are strict provisions on multi-layered investments and channel business, i.e. money raised from an asset management product offering can be invested in another management product, but the invested asset management products are not allowed to invest in other asset management products (except for publicly offered securities investment funds), and financial institutions shall not provide channel services for asset management products of another institution to help it circumvent regulatory requirements in terms of investment scope, leverage limit, and etc.
The Guidelines fully considers the reasonable need of financial institutions with insufficient investment capacity to entrust other institutions to make investment as their agent, and allows financial institutions to use the proceeds of asset management product offering to invest in asset management products issued by other institutions, i.e. entrusting the other institution to make investment with the fund it has raised. However, the principal institution shall not absolve itself of its own responsibility due to such an arrangement, and the agent institution shall be a financial institution with professional investment capacity and qualification that is regulated by a financial regulatory authority; the agent institution shall fulfills its responsibilities in investment management with good faith, and must not entrust another institution for investment nor use the entrusted fund to invest in other asset management products (except for publicly offered securities investment funds).
12. What are the measures to strengthen the regulation on asset management business?
Enhancing regulatory coordination and macro prudential management, and conducting functional regulation and business conduct regulation the principle of "substance over form" are the necessary measures to regulate asset management business. First, the PBC has strengthened macro-prudential management, establishing a macro-prudential policy framework for asset management business, to strengthen regulation from a macro, counter-cyclical and cross-market perspective. Second, in its market access and routine regulation over asset management business, the financial regulatory authorities will enhance functional regulation based on the category of products, strengthens business conduct regulation over financial institutions, and strengthen protection of financial consumers. Third, based on the business nature of asset management products, there will be looking-through regulation in indentifying if the ultimate investors are qualified, and if the underlying assets meet investment requirements, and in establishing a comprehensive statistical system to cover all asset management products. Fourth, regulatory coordination will be strengthened. The financial regulatory authorities will formulate detailed supporting rules within the framework of the Guidelines, and ensure that the detailed supporting rules are consistent to avoid new regulatory arbitrage and unfair competition. At the same time, it is necessary to continuously assess the effectiveness of the regulatory standards of asset management business, and to timely adjust in view of the changes in economic and financial reform and development.
13. What are the provisions for the non-financial institutions to comply with to conduct asset management business?
At present, in addition to financial institutions, non-financial institutions such as Internet enterprises, various kinds of investment consulting firms have also been very active in asset management business. Some risks and problems have emerged as a result of lack of market access regulation and continuous regulation. To address the situation, the Guidelines clearly stipulates that as a financial business, the asset management business must be included in the purview of financial regulation. Specifically, a non-financial institution shall not issue or sell asset management products unless otherwise stipulated by the state. "Unless otherwise stipulated by the state" herein mainly refers to the issue and sales of privately offered funds. Where there are other provisions in the case of otherwise stipulated by laws and regulations, financial and non-financial institutions shall comply with the provisions. Otherwise they shall comply with provisions of the Guidelines. Second, when a non-financial institution issues and sells an asset management product in accordance with the laws and regulations, it shall strictly comply with relevant requirements of the Guidelines on investor eligibility, and sell asset management products which are commensurate with their risk identification ability and risk affordability. Third, a non-financial institution or an individual must not sell asset management products on a commission basis without prior approval of financial regulatory authority. The conduct of non-financial institutions in asset management business in violation of the laws and regulations, especially breaking up and selling on the Internet platform any underlying investment with an investment threshold, hiding product risks with credit enhancement, or establishing secondary trading market for the products, and etc., will be addressed according to Implementation Measures for the Special Project on Internet Financial Risks Rectification. The penalty shall be aggravated when a non-financial institution conducts asset management business, promises and honors implicit repayment guarantee.
14. How does the Guidelines set a phase-in period? How will the “cutoff between the new and old” be implemented?
In order to ensure orderly implementation of the Guidelines, a phase-in period is provided. In the principle of ensuring a “cutoff between the old and new”, the outstanding asset management products will continue to exist until the underlying assets mature, i.e. following the principle of "the maturity of assets". During the phase-in period, financial institutions shall not expand the net subscription of asset management products which does not meet the requirements of the Guidelines. That is to say, newly issued products shall comply with requirements of the Guidelines, with the exception of the issuance made to ensure the liquidity of outstanding asset management products and maintain market stability. The phase-in period starts with the implementation of the Guidelines and ends on June 30, 2019. After the transition period ends, asset management products of financial institutions shall be fully regulated in accordance with the Guidelines (except for the case that the requirements of independent custody by the third party cannot be met when a subsidiary has not yet been established), and financial institutions shall not issue or renew the assets management products that violate the provisions in the Guidelines. The above-mentioned stipulations have fully considered the duration, market volume of outstanding asset management products, and taken account of the rational need of issuing new asset management products, in order to support an orderly phase-in of asset management business in accordance with the Guidelines.
