Thought for the month: Connecting the regulatory dots in China - J.P. Morgan Asset Management

Thought for the month: Connecting the regulatory dots in China

While the changes are widely regarded as both necessary and important for the long term stability and safety of the Chinese financial system, the unprecedented breadth and depth of these new regulations has already had major repercussions. Banking activities and financial markets have witnessed substantial dislocations, while the secondary impact on monetary policy and economic growth are now becoming apparent.

In brief, the new AMP rules1 ban implicit guaranteed returns, reduce leveraging, layering and pooling and require investment in (lower yielding) standard asset classes. New products launched after the introduction of the new regulations on the 27th of April 2018 must comply with them, while existing products have a transition period until end of 2020. Meanwhile, the new liquidity rules2 introduced in May encourage stronger bank liquidity profiles by penalizing the use of short term wholesale funding and holdings of undesirable assets. Finally, the new MMF liquidity rules3 limit T+0 redemptions to ten thousand Renminbi per investor per day, effective on 1 July 2018.

Lower returns and the removal of principal guarantees have greatly reduced the desirability of wealth management and trust products. The latest aggregate financing data shows a substantial decline in shadow banking activities with trust loans, entrusted loans and banker’s acceptances all sharply lower. This lack of new AMPs will have considerable implications for commercial banks’ fee revenues and profitability. Especially as competition for time deposits intensifies and issuance of certificates of deposit increases to fund the return of shadow banking debts onto bank balance sheets.

This has triggered several actions by the People’s Bank of China (PBoC) to help alleviate short term commercial bank stresses. Use of quasi-monetary policy tools remain close to record highs, in addition the central bank cut the reserve requirement rate in April to help banks repay PBoC loans and it widened the range of lower grade assets it will accept as collateral, making it easier for commercial banks to borrow from the PBoC.

The impact of the regulatory policy tightening is also evident in the latest Chinese economic data with fixed asset investments and industrial production noticeably weaker. In a divergence from its previous policy, the PBoC did not raise its open market operation interest rates following the June Fed rate hike.

Meanwhile, the new CSRC regulatory cap on T+0 redemptions will also have little direct impact, especially as investors with larger balances can still make unlimited T+1 redemptions. But it should help reduce liquidity risks and clarify that MMF should be regarded as saving products rather than instant access cash accounts.

Fortunately, for corporate treasures who only use time deposits and money market funds, the new AMP rules are unlikely to have any significant impact. Money market funds are already among the most heavily regulated instruments in China and will continue to offer attractive yields and operational convenience. Meanwhile, time deposit yields could move higher as commercial banks compete for stable funding. However, corporate treasurers using wealth management and trust products will need to revisit their investment strategies in order to invest in suitable products under the new regulatory regime.

Nevertheless, while several short term challenges have quickly become apparent, the substantial long term benefits of more standardized, unified and stringent regulations will emerge as the financial industry transitions to a healthier and more stable foundation for future growth.

The article was first published by Treasury Today in July 2018.

1Issued by the Financial Stability and Development Committee (FSDC)
2Issued by the China Banking and Insurance Regulatory Commission (CBIRC)
3Issued by the China Securities Regulatory Commission (CSRC)

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