Chinese Wealth Management (WMP) products remain popular for better or worse, despite high levels of volatility, especially in the early years of their development. Now that WMPs have been extensively regulated, with the most recent major regulation governing cash-based wealth management products, these assets have become an integral part of the Chinese financial system. However, these short-term products often remain off-balance sheet and may be based on illiquid underlying assets, creating the potential for maturity mismatch and systemic risk. Therefore, these highly demanded products are not without risk.
WMPs have faced declining values in recent weeks. According to data from Wind, around 8% of wealth management products sold by banks saw market prices fall below their net asset value (NAV). Another 7% were about to fall below their net asset value.
Due to these falling values, the financial companies tried to shore up their values by buying some of the assets. Indeed, Everbright Bank recently purchased some of its own WMPs in what was billed as a vote of confidence for the asset class. This contrasts with share buybacks in the United States – when companies buy their own shares, they must cancel those shares – or with banking rules in the United States that prevent banks from investing in funds that could create a conflict of interest or expose the bank to excessive risk. In China, such measures taken by wealth management issuers are seen as positive signals for the markets.
Banks attributed the drop in values to market volatility and geopolitical instability. A crackdown on the internet and a fragile real estate market have heightened uncertainty, as has the Russian-Ukrainian war (Chinese media refrained from calling Russia responsible). New COVID-19 lockdowns and the potential delisting of Chinese companies in the United States have not helped.
Due to the volatility of asset prices, some financial companies have chosen to reduce the management fees of their products. Many fees are levied on these products, and financial institutions can compete with each other or customers by changing these fees.
Wealth management products have proven to be a relatively accessible means of obtaining additional interest income for Chinese citizens as well as an important source of profit for financial institutions. Households invest in wealth management products because there are few easy alternatives to interest rates on bank deposits, and the many news articles promote WMP investing as a key way to build savings. Their widespread popularity has led to efforts to legitimize, rather than eradicate, WMPs.
Regulations have helped reduce the risks in the WMP industry to some extent. Many banks have been involved in regulatory arbitrage, providing liquidity through WMP during a time of tight funding. New rules required banks to standardize their wealth management product business and end implicit guarantees to investors. The most recent regulations, issued in June 2021, prohibited cash WMPs from investing in equities, convertible bonds, floating rate notes using fixed term deposit rates, or bonds or asset-backed securities. assets with credit ratings below AA+.
Wealth management products are prone to leaks when their value drops. This is problematic because many WMPs are invested in long-term underlying assets and have to renew their funding very often; a sudden drop in demand for WMP can quickly dry up liquidity. This has been found to increase banking risk, particularly insolvency risk, portfolio risk and leverage risk. Additionally, off-balance sheet WMPs are uninsured, which means that unlike regular bank accounts, investors can lose money when the value of WMPs drops.
During the recent real estate crisis, in which companies like Evergrande faced insurmountable debt problems, private developers relied on WMPs for scarce capital. Money from property sales was used to pay investors – but then property sales dwindled, creating major challenges for WMP repayment. Evergrande was forced to pay investors in installments, while other developers failed to pay dividends or fulfill other obligations. The value of distressed WMPs soared to $14.4 billion in 2021, double the amount in 2020.
The total value of WMPs is $4.4 trillion, and these assets are now ubiquitous among investors. Despite extensive regulation, there are still problems in the WMP industry due to investors’ expectations that they will get their principal and interest payments, even though some WMPs are invested in risky industries. As a result, we can expect to see payment issues in the future as regulators vacillate between allowing large-scale WMP activity to appease popular demand and curb abuse. Even if abuse is ruled out, a volatile market due to the pandemic and geopolitical tensions can lead to greater losses for investors. This is something we continue to monitor.