China’s bond market regulator closed off a loophole that allowed banks that sell high-yielding wealth management products (WMPs) to evade regulatory requirements by moving money between the WMP accounts they manage and their own prop accounts

China issues new rules targeting wealth management fund pools: sources

2:30am EDT

By Yong Xu and Pete Sweeney

SHANGHAI (Reuters) – China’s bond market regulator closed off a loophole on Friday that allowed banks that sell high-yielding wealth management products (WMPs) to evade regulatory requirements by moving money between the WMP accounts they manage and their own proprietary accounts, bond traders at four Chinese banks told Reuters. The four traders, who spoke on condition of anonymity because they are not authorized to speak to media, told Reuters the China Government Securities Depository Trust & Clearing Co Ltd (CDC) and the Shanghai Clearing House had jointly notified commercial banks they could no longer trade bonds between their own proprietary accounts and the WMPs they manage for clients. The rules will go into effect Friday afternoon, the sources said. “Yesterday we could do it, today everybody has to undo it; it’s new regulation after new regulation,” said one of the traders.The CDC did not answer calls from Reuters requesting comment.

The traders said the new rule would prevent a common practice in which banks shift bonds back and forth between their own balance sheets and the WMP accounts they manage for clients, allowing them to deliver promised payouts to WMP investors, even if the underlying bonds have not yet matured or have declined in value.

Such transactions have also enabled banks to temporarily shift WMP funds back onto bank balance sheets at quarter-end, as a way to window dress their financial statements by boosting the customer deposits they report.

In other cases, a bank may use its own account to purchase a bond in the primary market before it has completed fundraising for a WMP, then sell the bonds on to the WMP account later. That allows the banks to deliver higher yields to their WMP investors, since yields are typically higher in the primary market.

The China Banking Regulatory Commission (CBRC) announced a crackdown on fund pooling in January, and has been implementing new rules ever since.

Industry observers are concerned that the practice is akin to a Ponzi scheme because of the way such pools allow inflows from the sale of new products to deliver the promised returns on previously issued products.

The complex and interlocking nature of such pools, supporting a wide variety of different WMPs with different maturity periods, also exposes banks to significant liquidity risk, analysts have warned.

The rise of WMPs has been fuelled by Chinese depositors’ hunger for yields above the central bank’s benchmark deposit rate, currently set at 3.0 percent for one year, and economists say Beijing has tolerated the explosive growth in the sector because WMPS can deliver higher yields to ordinary investors, serving as a backdoor way to liberalize interest rates and increase the propensity to consume.

Banks have been quick to issue WMPs to attract customers, and also sell third-party WMPs through their retail channels.

However, the collapse of several WMPs amidst fraud allegations, and the generally opaque nature of the products has attracted concern. State media has taken to warning investors that such products are not tacitly guaranteed by the government, but China has yet to experience a corporate bond default.

Standard & Poors estimated that WMPs offered by Chinese banks grew 56 percent in 2012 to 7.12 trillion yuan ($1.16 trillion), equivalent to 7.6 percent of the system’s total deposits at the end of the year.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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