Regulatory Thinking and Arrangements Under the New Asset Management Rules | A New Era for Asset Management

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Issue 2

Following the comprehensive review and interpretation of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (hereinafter referred to as the "Guiding Opinions" or "new asset management rules") in Issue 1, this issue focuses more on the underlying regulatory philosophy and objectives, analyzes the impact of the new rules on asset management business and future development opportunities, and offers recommendations on response strategies and business transformation directions for various market participants.

Asset management business is off-balance-sheet activity for financial institutions. The Guiding Opinions introduce further regulations covering the funding side, business models, and asset side of financial institutions' asset management operations. On the funding side, the rules prohibit on-balance-sheet asset management business and guaranteed principal or returns; they unify leverage ratio requirements for asset management products, applying uniform liability caps to similar products. On the business model side, the rules require eliminating multi-layer nesting and channel business; breaking rigid redemption to return asset management to its essence; and prohibiting fund pool operations while regulating maturity mismatches. On the asset side, non-standard assets represent one of the core focuses of off-balance-sheet regulation, with the Guiding Opinions restricting their development from both demand and supply perspectives.

Compared to the draft for comment, the formal Guiding Opinions contain five major changes: 1) clearer and stricter definition of non-standard assets; 2) differentiated net value management requirements rather than a one-size-fits-all approach; 3) additional requirements for qualified investor thresholds; 4) relaxed restrictions on tranching of closed-end private products; and 5) extended transition period.

Regulatory Intensity and Resolve Exceed Previous Standards

The new asset management rules should not be seen as a sudden development, but rather as a continuation and implementation of the spirit of the 19th Party Congress and the National Financial Work Conference. With numerous policies introduced recently, the new rules represent one of several regulatory documents launched after the conference, while also signaling that more detailed implementing rules will follow.

On the surface, the new rules regulate financial business, but nearly every provision targets the massive off-balance-sheet activities, gray-area operations, arbitrage businesses, and various unregulated institutions that proliferated during the period of accelerated financial innovation.

In essence, this is supply-side reform and capacity reduction for the financial industry: reducing off-balance-sheet capacity, eliminating channel bubbles, cutting institutional numbers, and removing arbitrage profits. The goal is to eliminate substandard capacity in the asset management industry and improve overall operational efficiency and market competitiveness.

The core principles of the formal new rules remain unchanged, still aimed at maximizing the elimination of regulatory arbitrage space, maintaining strict risk control as the bottom line, and optimizing the social financing structure to serve the real economy. The Guiding Opinions establish unified regulatory standards for asset management product types and consistent rules for similar asset management businesses, reflecting regulators' thinking on guiding the industry back to its essence, deleveraging, and preventing systemic risk.

However, on specific requirements, the new rules place greater emphasis on prudent and steady policy implementation, giving more consideration to the capacity of financial institutions and capital markets to absorb changes. The strictness is somewhat moderated compared to the draft for comment, reducing relative impact on stock and bond markets.

This Guiding Opinions was drafted under the leadership of the People's Bank of China, discussed by the Financial Stability and Development Committee, and reviewed and approved by the Central Committee for Comprehensively Deepening Reform. The high-level intensity and resolve of this regulation exceed previous standards. According to research by CEBM Group①, the focus of financial regulation is unlikely to substantially loosen, and implementation of the new rules will not be subject to discounting.

① "Impact of New Asset Management Rules on Monetary Policy"

Authors: Zhengsheng Zhong, Huiquan Li

1 Financial Regulation Will Remain a Work Priority for the Next Three Years

First, based on recent meeting outcomes, financial regulation will continue as a work priority, likely for the next three years.

In July 2017, the National Financial Work Conference established the State Council Financial Stability and Development Committee, superordinate to the "one bank and three commissions," aimed at strengthening regulatory coordination and filling regulatory gaps, and introduced concepts of consolidated regulation, functional regulation, and conduct regulation. In October 2017, the 19th Party Congress proposed the "three critical battles" of "preventing and defusing major risks, targeted poverty alleviation, and pollution control," and clarified the "dual-pillar regulatory framework of monetary policy and macro-prudential policy." In December 2017, the Political Bureau meeting reiterated the "three critical battles," with the Central Economic Work Conference specifically setting the timeframe as "the next three years."

During the comment period for the new asset management rules, regulators maintained communication with financial institutions while emphasizing the need to "maintain resolve" in regulation. Since late December 2017, numerous regulatory documents have been issued intensively. Particularly notable was the January "eight irregularities" document, requiring retrospective accountability for financial irregularities since May 2017, with the severity of "old-new cutoff" arrangements exceeding market expectations. This situation did not occur during the intensive regulatory issuance of April 2017, reflecting increasingly strict regulatory attitudes.

2 A Favorable Window for Financial Regulation

Second, the current period represents a favorable window for financial regulation; any regulatory backtracking would be counterproductive. Driven by global economic warming and corporate profit recovery, the Chinese economy currently demonstrates considerable "resilience." Any loosening of financial regulation could lead to repeated financial leverage accumulation, concentrating financial risks in more aggressive institutions.

New Asset Management Rules Arrangements

Full implementation of the Guiding Opinions may require a process. On one hand, the new rules are a framework document, and many detailed implementing rules will need additional time. Per the Guiding Opinions requirements, banks need time to establish sound valuation systems, information disclosure, statistical systems, and investor education. On the other hand, considering the difficulty of business adjustment for banks and asset management institutions, and seeking to minimize impact on capital markets, the rules incorporate "old-new cutoff" and transition period arrangements. Similar to previous regulatory policies, this reflects the intent to balance strict regulation with risk prevention.

The Guiding Opinions further clarify requirements during and after the transition period. During the transition period, new products issued by financial institutions must comply with these rules; to continue existing products' investments in unmatured assets and maintain necessary liquidity and market stability, financial institutions may issue legacy products for such purposes, but must strictly control this within the overall scale of existing products and orderly compress and reduce such issuance, preventing cliff effects when the transition period ends. Financial institutions should formulate rectification plans for asset management business during the transition period, specifying timelines, and submit these to relevant financial regulatory authorities for approval and supervision, while also filing with the People's Bank of China.

After the transition period ends, financial institutions' asset management products must fully comply with these rules (except where subsidiary establishment requirements for third-party independent custody cannot yet be met). Financial institutions may no longer issue or maintain asset management products that violate these rules.

Deleveraging Resolve Is Firm, But Implementation Faces Resistance

From the "eight irregularities" to the Guiding Opinions, to recent joint restrictions on OTC options trading by the Securities Association of China and the Asset Management Association of China, regulators' determination to deleverage is evident. The formal Guiding Opinions largely maintain leverage ratio requirements from the draft for comment. Given financial derivatives' inherent leverage characteristics, they will also be impacted in this deleveraging wave.

The Guiding Opinions set liability ratio caps (total assets/net assets) of 140% for open-end public offerings, 200% for closed-end public offerings, 140% for tranched private offerings, and 200% for other private offerings. Public offerings and open-end private offerings are prohibited from tranching shares. For tranchable closed-end private offerings, fixed income products may not exceed a 3:1 tranching ratio (senior/junior), equity products 1:1, and commodity/financial derivative products and mixed products 2:1.

Fixed income products	Not to exceed 3:1
Equity products	Not to exceed 1:1
Commodity/financial derivative products, mixed products	Not to exceed 2:1

Note: Mezzanine tranches count as senior tranches.

Regarding product leverage, since leverage multiples for public and segregated account products of fund companies were already clearly specified before the new rules, this regulation largely continues existing requirements, resulting in relatively limited pressure. Greater risk lies with fixed income structured products; some legacy structured trust products and asset management plans reportedly still have fixed income leverage multiples exceeding 3x, requiring gradual cleanup. Given the moderately extended transition period, product deleveraging should proceed smoothly.

Institutional leverage still faces certain pressure. Current leverage multiples for banks, insurers, securities firms, and trust companies—particularly the ratio of asset management product scale to capital—remain extremely high, facing significant downward pressure. Without effective capital replenishment, financial institutions will need to continue deleveraging.

Despite firm regulatory resolve on deleveraging, detailed implementation faces challenges. On one hand, rapid leverage reduction could cause extreme short-term volatility in financial markets; on the other, breaking wealth management fund pools could create redemption problems for certain products holding longer-term assets. Consequently, since issuance last year, detailed implementing rules have not yet been released. Numerous "detailed rules" and "separate provisions" for the new asset management rules are expected to follow, requiring continued attention.

More Policies Are Coming

The Guiding Opinions establish general principles for the asset management industry; future detailed rules from various financial regulators under this unified framework are just beginning. Research indicates that issues requiring clarification in future detailed rules include: investment restrictions on commercial bank credit asset受益权 (beneficial rights), liquidity risk management regulations, specific rules for net value determination under fair value principles, debt-to-asset ratio warning lines for enterprises purchasing asset management products, asset management product statistical systems, and implementing rules for respective regulatory domains.

Preliminary assessment suggests the "barrage" of regulatory policy is not yet over. However, the probability of additional policies with greater intensity, broader scope, and deeper impact is not high; future financial regulatory policies will likely be localized adjustments, with greater emphasis on execution and implementation of existing policy series.

According to the Notice on Effectively Addressing Regulatory Shortcomings and Enhancing Regulatory Effectiveness (Document No. 7) issued April 12, 2017, to date, 7 regulatory documents have been formally issued, 5 have completed or are undergoing public comment, and 4 remain pending, including the Commercial Bank Wealth Management Business Supervision and Administration Measures and Online Microloan Management Guiding Opinions. In other words, in the coming period, the China Banking and Insurance Regulatory Commission will issue or seek public comment on more than 9 additional regulatory documents. The next focus should be on the CBIRC's new wealth management rules.

Next Issue:

"Impact of New Asset Management Rules on Asset Management Institutions and Response Strategies"

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