China will launch a pilot program next week aimed at shattering a widespread assumption among Chinese investors that products, even high-yield ones, provide guaranteed returnswhen offered by state-owned banks

Wealth management products’ yield ‘not guaranteed’

Updated: 2013-10-11 10:27

( Agencies)China will launch a pilot program next week aimed at shattering a widespread assumption among Chinese investors that products, even high-yield ones, provide guaranteed returnswhen offered by state-owned banks, sources said.

For years, many Chinese treated their investments in so-called wealth management products,many of which offered enticing returns, as tantamount to a deposit with a guaranteed yield,even if that was not the case.

Policymakers have warned that such a high level of moral hazard has been built into the wealthmanagement industry that if a product failed to payout as promised, banks would faceenormous pressure to compensate investors, even if they were not legally required to do so.

Investors protested outside a branch of Hua Xia Bank late last year when a product it haddistributed failed to pay out on maturity.

“The key change is to remove an implicit guarantee of principle and yield, in the form of’expected return,’ by wealth management products,” David Cui, equity strategist with Bank ofAmerica-Merrill Lynch in Hong Kong, said in a client note.

“Currently, most wealth management product buyers view their investments as deposits while,legally speaking, they bear most of the downside if investments go bad.”

Wealth management products have soared in popularity in recent years as an alternative toinvestment in real estate, volatile stock markets and State-set deposit rates. Most are short-term savings vehicles often created by third parties but issued through banks.

The rising popularity of the opaque products have sparked concerns of a credit binge directingmoney into increasingly speculative investments, which analysts say could pose a risk to thefinancial system.

Because many of the products were sold through State banks, investors assumed that meantthey were backed by the government and so were 100 percent safe, even if the product’sdocuments spelled out that principal and returns were not guaranteed, bankers said.

Under the pilot project, the China Banking Regulatory Commission (CBRC) will allow 11 banksto sell asset management plans directly to customers, two bankers with direct knowledge of theprogram said.

The approved banks include Industrial and Commercial Bank of China and ChinaConstruction Bank, China’s two largest banks by assets, as well as Bank of Communications,the fifth largest.

“There is no firm legal basis for banks to do direct financing, or at least it’s very weak. So theyhave to start with a pilot program and move gradually,” said a banker involved in the pilot.

Tiny quotas under pilot program

The project will not allow banks to assign an expected return to a product, common in wealthmanagement investments, and one reason they were seen as guaranteed.

Unlike wealth management products, they will also be forced to regularly publish a net assetvalue to reinforce the idea that returns are based on the performance of the asset, not thecreditworthiness of the bank.

Detailed rules have not been released, but bankers said they expected them to require banksto clearly identify the underlying assets of a product.

The rise of the wealth management industry has led to increasingly complex investments. Inmany products, the underlying asset was often an opaque trust fund or brokerage product,providing little clarity on the identity of the ultimate borrower.

The assets in a wealth management product were also often a package of loans from the bankselling the product to investors. It would collect a portion of the interest income from the loans,blurring the lines between on-and off-balance sheet assets.

Banks also often provided guarantees – sometimes informally – to their trust and brokeragepartners, promising to compensate the third party for losses or to repurchase credit assets at afuture date.

Indeed, the nasty cash crunch that roiled China’s interbank lending market in late June, wasdue in part to banks’ need for cash to fund payouts on maturing wealth management productsthat were supposedly off-balance-sheet.

CBRC Chairman Shang Fulin said recently that China’s wealth management industry needed tomove towards a pure asset-management model in which the bank connects borrowers withinvestors – collecting a management fee in the process – but plays no role in guaranteeingreturns or sharing income from the assets they manage.

Under the pilot program, banks will be required to strictly segregate on- and off-balance sheetfunds.

While regulators want a business model akin to mutual funds to become the norm for banks’wealth management business, the initial size of the new pilot is tiny.

Most of the 11 lenders will receive initial quotas between 500 million and 1 billion yuan ($82million to $163 million), though a few may get larger quotas, the bankers said. That comparesto 9.08 trillion yuan in bank wealth management products outstanding at the end of June,CBRC figures show.

The other banks included in the pilot project are: China Merchants Bank, Minsheng Bank,Everbright Bank, CITIC Bank, Ping An Bank, Shanghai Pudong Development Bank, IndustrialBank, and China Bohai Bank.

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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