11 May, 2018
On April 27, 2018, the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (“Opinions” or “Final Rules”), which have attracted wide attention, were jointly issued by the People’s Bank of China (“PBOC”), China Banking and Insurance Regulatory Commission (“CBIRC”), China Securities Regulatory Commission (“CSRC”) and State Administration of Foreign Exchange (“SAFE”). Compared to the consultation paper issued on November 17, 2017 (“Consultation Paper”), the most remarkable modification made by the Final Rules is to extend the transition period to the end of 2020. There are also notable adjustments related to investment in non-standard credit assets, net value based management and others, all of which reflects the aim to be more flexible and practicable, echoing the market participants’ appeals. Below we have summarized the key provisions of the Opinions.
Asset Management Business. The Opinions define asset management business as any type of financial service where an asset manager, after accepting an entrustment of property by investors, manages the property entrusted for investment. Asset management business can be conducted by financial institutions (“Financial Institutions”), including banks, trust companies, securities companies, mutual fund management companies, futures brokers, insurance companies and financial asset investment companies. Since the asset management business belongs to a Financial Institution’s off-balance sheet business, no guarantee can be given to investors for principals or returns; and where there is a shortfall in funds available for redemption, a Financial Institution is forbidden to use proprietary funds or other funds under its management to make up the deficiency. We note that the Final Rules add the “financial asset investment companies” into the scope of Financial Institutions, and we are looking forward to seeing how such “financial asset investment companies” will be introduced. It also specifies that the asset-backed securitization business operated according to the rules of financial regulatory departments or the pension funds issued according to the rules of human resources and social security departments will not be governed by the Opinions.
Private Fund Managers (“PFMs”). The Opinions point out that the asset management business, as one type of financial business, requires special licenses for operation, and shall be included under financial regulation and supervision. Except as otherwise provided by laws, non-Financial Institutions are not allowed to issue or distribute asset management products (“AMPs”). The PBOC Media Q&A clarifies that those exceptions mainly refer to the issuance and distribution of private funds. It indicates that the PFMs registered with the Asset Management Association of China shall be excluded outside the scope of Financial Institutions under the Opinions. However, despite that they are not defined as Financial Institutions for this purpose, the PFMs shall be allowed to issue and distribute private funds according to relevant provisions. As further pointed out by the Opinions, private funds shall be subject to the special laws or administrative regulations concerning private funds, and the Opinions will apply only if no express provisions are provided thereunder.
Currently, a large number of department rules and normative documents apply to the PFMs, however, department rules or normative documents are neither law nor regulation. Since the above exclusion only applies to private fund laws and regulations, a PFM could not apply this exclusion to express provisions under relevant department rules or normative documents which are without any basis in law or regulation. Therefore, we suggest the regulatory departments to clarify how the Opinions should apply to PFMs in each specific circumstance. At the current stage, we cannot exclude the possibility of “regulation by following the stricter rules”, that is, PFMs should be aware that the stricter requirements might be imposed by the regulatory departments where provisions overlap or conflict.
Classification of AMPs. The Opinions classify the AMPs in two ways. One is based upon the fundraising method, 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 type 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. 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 requirements 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.
According to the Opinions, the proportion of a fixed-income-type product in investing in credit assets (such as deposits, bonds) shall not be lower than 80%; the proportion of an equity-type product in investing in stocks and equities of non-listed enterprises shall not be lower than 80%; the proportion of a commodity and financial-derivative-type product in investing in commodity and financial derivatives shall not be lower than 80%; and for a mixed-type product, if investing in a credit asset, equity asset or commodity and financial derivative asset, the investment proportions in such asset shall not reach any of the aforesaid criteria. One additional article has been inserted in the Final Rules that, should a limit fail to be satisfied due to any reason not attributable to the Financial Institution itself, the Financial Institution shall make adjustment to satisfy such limit within 15 trading days from the date that the relevant asset restricted for trading becomes available for sale, transfer or trading.
The Opinions set forth the thresholds to become a qualified investor:
(i)For a natural person: having investment experience of at least two years, and having satisfied any of the following conditions: (i) the net value of the financial assets of his/her family shall not be lower than RMB 3,000,000, (ii) the financial assets of his/her family shall not be lower than RMB 5,000,000, or (iii) his/her annual average income for the previous three years shall not be lower than RMB 400,000;
(ii)For a legal person: its net assets 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 products. A new requirement has been added in the Final Rules to forbid an investor to use its non-proprietary funds raised through a loan or issuing bonds to invest in an AMP. We expect that each financial regulatory department will correspondingly amend its rules, so as to satisfy the minimum requirements of the Opinions.
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 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 shall 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 good faith, 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. To deal with one phenomenon of shadow banking where a large number of AMPs invest in non-standard credit assets, the Opinions put forward principled requirements on the investment direction thereof, the core of which is to require the AMPs to comply with the relevant regulatory standards formulated by the financial regulatory departments with regards to quota limits and liquidity administration, and such AMPs shall not directly invest in the credit assets of commercial banks. Each financial regulatory department shall, according to the Opinions, formulate its own specific regulatory standards.
Compared to the Consultation Paper, the Final Rules clarify the characteristics of the standardized credit asset so that the PBOC, jointly with each financial regulatory department, may lay down specific rules concerning standardized credit asset by reference to the Opinions. The characteristics of the standardized credit asset include
(i) being equally divided and tradable,
(ii) having full information disclosure,
(iii) having centralized registration, and independent custody,
(iv) having fair pricing, and robust liquidity mechanisms,
(v) being traded in the relevant exchange markets that are approved by the State Council, such as stock exchanges and interbank market.
Cross-border AMPs and Businesses. It is noteworthy that Article 10 of the Opinions (relating to investment of AMPs) stipulates that the cross-border AMPs and businesses shall be governed by reference to the Opinions. We presume that for a cross-border AMP, it would probably be subject to the requirement of Article 10, that is, being governed differently based on the nature of its underlying asset; if it belongs to the “non-standardized credit asset”, it might be subject to the regulatory standards formulated by the financial regulatory departments with regards to quota limits and liquidity administration. We would suggest the PBOC and the financial regulatory departments to clarify this issue as soon as possible, so that we could further evaluate the implications of the Opinions on the cross-border AMPs and businesses.
Business Isolation and Independent Custody. Any Financial Institution of which the main business does not include the asset management business shall establish a subsidiary with independent legal person status to develop the relevant business. However, those institutions having not yet been equipped with necessary conditions for the time being may establish special departments instead for conducting 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 transition period, any commercial bank holding a securities investment fund custody business license is still allowed to have custody of 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 transition 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 total investment in the same asset issued by one Financial Institution shall not exceed RMB 30 billion, wherever the investment exceeds such limit, an approval from the relevant financial regulatory department will be required.
Portfolio Management. Pursuant to the Opinions,
(i)The market cap of a single security or a single securities investment fund invested by a publicly-raised AMP shall not exceed 10% of the AMP’s net asset;
(ii)The market cap of a single security or a single securities investment fund invested by all publicly-raised AMPs issued by a Financial Institution shall not exceed 30% of the market cap of such security or securities investment fund;
(iii)The number of stocks of a single listed company invested by all publicly-raised open-ended AMPs managed by a Financial Institution shall not exceed 15% of the total tradable stocks of the listed company;
(iv)The number of stocks of a single listed company invested by all AMPs managed by a Financial Institution shall not exceed 30% of the total tradable 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 a limit fail to be satisfied due to any reason not attributed to the Financial Institution itself, the Financial Institution shall make adjustment to satisfy such limit within 10 trading days from the date that the relevant asset restricted for trading becomes available for sale, transfer or trading.
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. Further clarification is needed on whether the regulatory department will, by taking reference to this rule, apply the same reserve requirements to the PFMs.
Rigid Payment. To deal with “rigid payment”, the Opinions require Financial Institutions to implement net value based management on the AMPs and impose penalties on those deemed rigid payments. For net value based management, the Final Rules require the following: (1) the generation of net value must comply with the Accounting Standards for Business Enterprises, (2) the custodian institution is obligated to conduct the accounting and provide the report on a regular basis, (3) an external auditing firm shall confirm the financial statement, and (4) the relevant Financial Institution being audited shall disclose the auditing result and report it to the financial regulatory department. Financial Institutions are encouraged to adopt market value based calculation. While some qualified institutions may adopt amortized cost based calculation, if the amortized cost based calculation cannot truly reflect net value of the financial asset, the custodian institution shall urge such Financial Institution to adjust the accounting and valuation methods.
Leverage. The Opinions establish different total asset/net asset ratio ceilings for different types of products, and forbid any holders of an AMP to pledge the units for financing purposes. The Opinions prohibit structured publicly-raised product or open-ended privately-raised product.
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 not invest in any other AMP, except for 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”), the outside institution shall be an institution regulated by the financial regulatory department, with professional investment capabilities and qualifications; however, for the investment management of a publicly-raised AMP, the institution entrusted must be a Financial Institution, while for a privately-raised AMP, the institution entrusted can be either a Financial Institution or a PFM;
(iii)If a Financial Institution engages an outside institution as an investment advisor, the outside institution shall be an institution regulated by the financial regulatory department, with professional qualifications.
Under the Item (ii) of Wei Wai, the institution entrusted shall not sub-contract its duty of investment management, nor shall it invest in other AMPs except for publicly-raised securities investment funds.
Based on the foregoing, as for a PFM, in short, it cannot be an entrusted investment management institution of a publicly-raised AMP, but may become an entrusted management institution or investment advisor of a privately-raised AMP. The clarification given by the Final Rules that a PFM may be engaged as an entrusted investment management institution for a privately-raised AMP is one of the significant improvements compared to the Consultation Paper.
Artificial Intelligence Investment Advisor (“AI Advisor”). The Opinions demonstrate the regulator’s mindset as to regulation of AI Advisor, and include: (i) applying AI technology to engage in investment advisory business shall first obtain the qualification, non-Financial Institutions shall not, by virtue of possessing an AI Advisor, operate an asset management business beyond the scope of business or in a disguised form, (ii) Financial Institutions adopting AI technology in an investment advisory business may not exaggerate when promoting the relevant AMPs or mislead investors, (iii) Financial Institutions shall file with the relevant financial regulatory department the primary parameters of such AI model, as well as the main logic of asset allocation, and shall:
(a) separately open AI-managed accounts for investors,
(b) fully remind them of the inherent flaws of AI algorism and risks of use,
(c) specify the transaction procedures,
(d) intensify the trace management, and
(e) strictly monitor the positions, risk limits, types of trading and access to the prices in the relevant account managed by AI,
(iv) Financial Institutions shall work out pre-arranged plans to deal with any market volatility risks that are caused by the pro-cyclicality of investment aggravated due to homogenization of algorithms, and where a sheep-flock effect is caused by any AI algorithm model defects (such as pro-cyclicality of investment, programming error or deficiency in data use) or system failure, which damages the stability of financial markets, the relevant Financial Institution shall take measures of human intervention, and compulsorily adjust or terminate the AI business.
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 looking through 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) (“regulation by functions”) and Item (ii) (“regulation by look-through”) are the CSRC and CBIRC’s responsibilities, while item (iii) (macro-prudential regulation) and item (iv) (statistical measurement) are the PBOC’s core mission. To achieve this, the Opinions further require Financial Institutions and financial regulatory departments to bear a duty of information reporting to the PBOC. Additionally, it also adopts a new requirement for Financial Institutions to record the information concerning any AMPs involving credit asset investment in the financial credit information database.
Penalty for Violations. The penalties provided in the Opinions appear to reflect the PBOC’s intention to exercise the regulatory power as the Super Regulator. First, it requires financial regulatory departments to respectively formulate the penalty provisions, and to ensure the consistency between the standards of penalty. Second, for any asset management business that violates the requirements of macro-prudential administration, the PBOC has the power to impose a penalty thereon. However, given the difficulty in enforcing this article in practice, it remains to be seen how the PBOC will effectively exercise this power.
Transition Period. The Opinions provide a transition period ending on December 31, 2020. Within the transition period, any newly issued product shall conform to the Opinions, with the exception that, for the purpose of maintaining necessary liquidity and market stability, Financial Institutions may continue to issue products linked to the existing products of which the invested asset is not due yet, but the number of such products shall be under control and shrink orderly. Financial Institutions must lay out their rectification plan and schedule for asset management business, and report them to the PBOC and financial regulatory departments. Upon expiry of the transition period, no AMP that fails to conform to the Opinions can be issued or exist, with the only exception where the third party independent custody requirement cannot be satisfied because a subsidiary has not yet been established for conducting the asset management business.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
