PFM WFOEs and Super- Guidance: Out in the Cold?

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1 PFM WFOEs and Super- Guidance: Out in the Cold? The lure of China has long captured the imagination of merchants and traders. From Imperial Japan who traded with China for porcelain, sandalwood, tea, and silk to the multitude of European and American traders who sought access to China as both a market for export goods and a source of luxuries which their wealthy denizens increasingly coveted; the Middle Kingdom has demanded the attention of nations for centuries. While tea and silk may not occupy the minds of foreign traders, free and unfettered access to China s markets remains a high priority for many. Not least in the areas of financial services and asset and wealth management.

2 Recent developments The recent Boao forum held in Hainan had several policy announcements and directives aimed at China s financial services space. Several of these announcements are continuations from earlier efforts and some are new efforts to further China s commitment in opening up its asset and wealth management industry. The latest of these drives originated in late 2017 and is referred to as Super-Guidance. The anticipated result of this initiative is greatly expanded access to China s financial service and asset and wealth management space for foreign players over the next few years. These expectations are driven largely by the gradual removal of ownership restrictions placed on foreign entities across securities firms, banks, fund management companies ( FMCs ), and insurers. In addition to the gradual lifting of ownership restrictions, the draft guidelines among other things: Clarify the definition of financial institutions ( FIs ); Explicitly state that FIs are not allowed to use asset management products to invest in commercial banks credit assets or provide channel service in an attempt to bypass the new regulations; Forbid FIs from conducting asset pools to manage funds raised through asset management products; Allow the People s Bank of China ( PBoC ) to control leverage levels for asset management products in order to curb asset bubbles; State that FIs must make provisions and set aside 10% of their management fee income from asset management products as risk reserves; State that FIs providing implicit guarantees on products will be punished; Prohibit non-fis from issuing or selling asset management products. A lot of these directives are targeted at Wealth Management Products ( WMPs ) and the shadow-banking sector in an attempt to deleverage this industry which has contributed considerably to China s debt, which recent estimates put at 270% of GDP. For a thorough analysis of China s WMP and shadow-banking sector, watch out for our upcoming research digest on the topic. While taming China s debt-bomb is a key consideration to Chinese authorities and foreign players eager to access the market, an arguably more important development was the definition of what constitutes an FI. Impact on foreign private fund enterprises Under the changes, Private Fund Manager ( PFM ) Wholly Foreign Owned Enterprises ( WFOEs ) (also known as Investment Management WFOEs ( IM WFOEs )) a form of WFOE opened up to foreign players in early whereby the foreign firm can have a 100% controlled entity in China which is authorised by the Asset Management Association of China ( AMAC ) to offer private funds to qualified investors are no longer considered FIs and accordingly cannot undertake asset management business ( AMB ) or the selling of Asset Management Products ( AMPs ). Please refer to the definitions section on the following page for a more detailed explanation of what constitutes AMB and AMPs. Non-FIs are then excluded from selling AMPs except where otherwise provided for by law. Such an allowance is seen as allowing for PFMs to operate, as otherwise the products they issue, in their RMB 11.1tn market as of 31 December 2017, would be banned. It is generally thought that the recent legislation is aimed at FIs and their subsidiaries which contribute to the shadow-banking sector in China, like the subsidiary companies of FMCs, rather than at PFMs directly. Until a practical interpretation is provided, the full extent of the changes will remain uncertain. A more immediate cause of concern is the additional guidance stating that Chinese insurers and banks are only able to invest money and give mandates to FIs. Being removed from the FI definition, but given legal rights to undertake AMB, means that PFMs will no longer be able to raise money from insurers and banks as institutional investors. Foreign asset managers who have established a PFM WFOE may find their fundraising activities severely hampered by this development and those who have been considering establishing one may have to completely redevelop their strategy. This is not due to the fact that Chinese insurers were leading investors across the PFM space. In 2016, they ranked sixth behind corporates, investment fund programmes and institutional investors, natural persons excluding co-investor, other institutions excluding manager co-investor, and trusts 2 with RMB 311.7bn in PFM investments. By 2017, this amount is estimated to have increased to between RMB bn and RMB bn out of total insurance assets of RMB 14.9 trillion. 1 This refers to when the Fidelity PFM WFOE received its AMAC license, not to the WFOE establishment date 2 Names taken as direct translations from Chinese PwC 2

3 Chart 1 Investor split of PFM products % 32.92% 30% 26.78% 25% 20% 15% 10% 13.95% 10.48% 6.89% 5% 0% Corporates Investment Natural Other Trusts Insurers Government Manager Banks NSSF Foreign fund person guided co-investor investment programmes excluding funds and employee institutional investors co-investor institutions excluding manager co-investor 3.95% 1.70% 1.41% 0.80% 0.58% 0.35% 0.19% % % % Employee co-investor Charity/ donation funds Company annuity Pension fund Source: AMAC, PwC Rather, it is due to the fact that insurers have long been given more lenient investment allocation guidelines than their peers in China s financial industry as outlined in Chart 2 below: Chart 2 Insurer investment allocation limits 100% 100% 100% 90% 80% 70% 60% 50% 40% 30% 20% 30% 30% 25% 20% 15% 10% 0% Deposits Fixed Income Equities Real Estate Other Financial Assets Overseas Investment Source: CSRC, PwC In addition to these less-restrictive investment allocation thresholds, insurers had been rapidly increasing their holdings of non-cash investments compared to bank deposits as shown in Chart 3 on the following page. PwC 3

4 Chart 3 Changes in insurance asset allocation USD (Tr) Source: PwC Bank Deposits Bonds Equities and Securities Funds Other investments Comparing insurers investments in PFMs in 2016, which as previously stated amounted to RMB bn, with their total AUM at the time, shows insurers were only investing 3.27% of their AUM into PFMs. Given that insurers could invest up to 25% in other financial assets despite such an amount being highly unlikely losing this vast pot of potential institutional money in an age when asset allocations towards PFM-like products is increasingly likely to be detrimental to PFM WFOEs. Banks accounted for less than 1% of PFM investment in 2016, amounting to RMB 63.13bn, and, as they have their lucrative Banks WMPs ( BWMPs ) to invest in either directly or through channel business, this amount is unlikely to have increased much in PwC 4

5 Impact of deleveraging on PFMs In addition to losing funding from insurers and banks, PFM WFOEs stand to lose investment from WMPs due to efforts in cracking down on leverage in China s shadowbanking system. Under the new guidelines and the targeting of China s shadow-banking industry - estimated to be 16% of the global total of USD 45tr as of in an attempt to deleverage China s economy, banks are likely to have increased levels of funds that would otherwise be rolled into WMPs and BWMPs. Such funds need a new destination and PFM products could have been a good investment. However, as banks will be prohibited from investing in non-fis, any portion of these monies will not be directed towards PFMs. At the end of 2017, there was RMB 29.54tr in outstanding BWMPs and RMB tr had been issued over the year. Of the RMB 29.54tr, RMB 11.69tr was held in HNWI products, Private Banking WMPs, and Institutional Exclusive WMPs. While determining the amount of funds from these products invested in PFMs would require examining each product individually and there was a total of 93,500 BWMPs outstanding at the end of 2017 it is assumed that some of the AUM of these BWMPs was directed towards PFMs and that PFMs stand to lose a substantial amount due to deleveraging efforts. Chart 4 BWMPs USD (Tr) Source: PwC Personal Products Private Banking WMPs Insitutional Exclusive WMPs Interbank WMPs HNWI Products For trust products, the second-highest contributors to China s shadow-banking sector after BWMPs, at the end of 2017 they had RMB 21.91tr in outstanding AUM with RMB 4.39tr invested in funds and FIs. Again, tracking the specific asset allocation towards PFMs would be an exhaustive logistical task but it stands to reason that some of this AUM would be allocated to them given the nature of trust products and their target audience of HNWIs. PwC 5

6 Chart 5 Trust products USD (Tr) Source: PwC Primary Industries Real Estate Securities (Equities) Securities (Funds) Securities (Bonds) Financial Institutions Commercial Entities Other The third-largest pillar contributing to shadow-banking products is brokerage asset manager products. Like trust products, these are exclusively available to HNWIs and can be tailored to an investors specific requirements. At the end of 2017, these products amounted to RMB 16.88tn in AUM, though it is uncertain how much of this could potentially be invested in PFM products. Chart 6 Brokerage AM products 3.0 USD (Tr) Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Source: PwC Collective Plan Directional Asset Management Plan Special Asset Managfement Plan Direct Investment in Subsidiary While many WMPs are targeted exclusively at HNWIs who may be considered qualified investors, and thus invest directly in PFM products rather than indirectly through other investment products, the inter-connected nature of WMPs means that there is the potential for significant investments to have been made in PFM products through WMPs. Efforts by authorities to reduce the scale of WMPs across China s economy could end up having direct and indirect impacts on PFM products. An alternative would be that HNWIs have a reduced pool of WMPs to buy or the new restrictions on WMPs make them unattractive to wealthy investors who can afford PFM products and they direct their asset allocation towards PFM products instead of WMPs. PwC 6

7 Conclusion Over the last few years, the PFM market in China has progressed from unregulated Sunshine funds, to being regulated by AMAC who made a clear point of culling the number of PFMs, and the segment is now thriving with AUM rivalling China s public fund space. Opportunities for foreign players who establish PFM WFOEs and apply an appropriate strategy remain strong and the potential for these WFOEs with expected future changes remains bright. The guidelines introduced by authorities, while seeking to codify vast swathes of a previously regulatory-segmented market, may change based off the needs of industry, authorities, regulators, and investors alike. Losing the ability to target banks and insurers for institutional funds, particularly when the foreign entity may have had a banking or insurance J.V. in China or strong ties to one, may be a set-back but it would have been a foolish China strategy to rely on them for the success of a PFM WFOE. As the future of both China s asset and wealth management space in general, and PFMs in particular, continues to evolve and grow, new opportunities will continue to be created while others may lose significance. Helping you identify and exploit these opportunities is why we are here as the Asian Funds Research Centre. PwC 7

8 Important definitionss The recent guidance came with several definitions regarding AMB, AMPs, and who qualifies as an investor. AMB is defined as: Any asset management businesses conducted by financial institutions, including banks, trust companies, securities companies, mutual fund management companies, futures brokers, insurance companies or their subsidiaries, under the jurisdiction of the CSRC, CBRC and CIRC; and determine its legal substance, namely that the asset management service refers to a type of financial service where an asset manager, by accepting the entrustment of investors, manages the property entrusted for investment. In addition, AMPs are split into two parts. The first is based on the fundraising methods used public and private and the second is based on the type of investment targets, for example; underlying assets, fixed-income, equity, mixed, etc. The rationale given for this split in classification is twofold; firstly, to apply a uniform regulatory standard on products which fall into the same categories and secondly, to establish adequate protections for investors regarding product suitability. Finally, the thresholds to become a qualified investor have been codified and are as follows: For a natural person: the financial assets of his/ her family shall not be lower than RMB 5,000,000, or his/her annual average income for the previous three years shall not be lower than RMB 400,000; and he/she shall have investment experience of at least two years, For a legal person: its net asset at the end of most recent year shall not be less than RMB 10,000,000, and 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 product. Each financial regulatory department needs to correspondingly amend its rules so as to keep them consistent with the above thresholds for qualified investors and the requirements for the minimum amount to invest in a single product. Previously, minimum product investment thresholds had been imposed by the various regulatory bodies responsible for the issuing FI. This marks a more coherent approach across the great and varied investment products available in China. Large SOEs Bank loans National SOE banks Banking Sector Inter-bank loans Local / Regional / Joint-stock banks Deposits Retail depositors Borrowers Government LGFVs/ Infrastructure projects, local SOES Private firms Bonds, trust loans Trust Companies Channeling Shadowbanking Sector Structured shadowbanking product intermediation Securities firms, bank wealth management arms, FMC subsidiaries Entrusted loans BWMPs Trust products HNWIs Institutional Investors Corporate Investors (GFCs) Investors Bank Intermediation Online Platforms Source: BIS, PwC PwC 8

9 Globally, the shadow-banking sector reached circa USD 45tn at the end of 2016 and China was estimated to account for approximately 16% of the world s shadow-banking assets at this point in time 3. Within China, three main pillars contribute to the shadow-banking landscape, these are: Banks who launch Bank WMPs ( BWMPs ); Brokerage AMs who launch securities products; and Trust companies who launch trust products. In addition to these there are also Fund Management Company subsidiaries and Peer-to-Peer lenders, though their contributions to China s shadow-banking industry and WMPs is much lower compared to the three major players. Traditionally, a range of factors helped the shadowbanking and WMP industry thrive in China. These factors predominantly related to restrictive business practices imposed on China s banks and include the following: Bank lending limits imposed by the People s Bank of China ( PBoC ); A constraining loan to deposit ratio of 75% which was only scrapped in late 2015; State-directed lending to large SOEs, many of which are zombie firms ; and Uncompetitive banking practices which other shadow-banking entities were not subject to. 3 Look out for our next monthly edition of AWM Market Research digest to be released end-june Subscribe to our future research digests at our website here Contact Armin Choksey Partner, Asian Investment Fund Centre & Market Research Centre Leader PwC Singapore T: armin.p.choksey@sg.pwc.com Conal McMahon Senior Manager, Market Research Centre PwC Singapore conal.j.mcmahon@sg.pwc.com 2018 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers and PwC refer to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is a separate legal entity and does not act as an agent of PwCIL or any other member firm.