Chinese wealth management products (WMPs) remain popular for better or worse, despite exhibiting high levels of volatility, particularly in the early years of their development. Now that WMPs have been regulated extensively, with the most recent big regulation governing cash wealth management products, these assets have become a regular part of China’s financial system. However, such short-term products often remain off balance sheet and may be based on illiquid underlying assets, creating a potential for maturity mismatches and systemic risk. As a result, these highly demanded products are not risk-free.
WMPs have faced declining values in recent weeks. According to Wind data, about 8 percent of wealth management products sold by banks have experienced market price declines to below their net asset value (NAV). An additional 7 percent were about to fall below their NAV.
Due to these declining values, financial firms have attempted to shore up their values by purchasing some of the assets. Indeed, Everbright Bank recently purchased some of its own WMPs in what has been publicized as a vote of confidence for this asset category. This is by contrast to stock buybacks in the United States – when companies purchase their own shares, they must cancel those shares – or to bank rules in the U.S. that prevent banks from investing in funds that may create a conflict of interest or expose the bank to excessive risks. In China, such actions taken by wealth management issuers are seen as positive signals to markets.
Banks have attributed declining values to market volatility and geopolitical instability. The internet crackdown and fragility in the property market have increased uncertainty, as has the Russia-Ukraine war (Chinese media have refrained from labelling Russia as responsible). The new COVID-19 lockdowns and potential U.S. delisting of Chinese companies haven’t helped.
Due to asset price volatility, some financial companies have chosen to lower servicing fees for their products. Many fees are levied on such products, and financial institutions can compete with one another or customers by altering such fees.
Wealth management products have proven to be a relatively accessible means of obtaining additional interest incomes for Chinese citizens as well as an important source of profit for financial institutions. Households invest in wealth management products because there are few other easy alternatives to bank deposit interest rates, and the numerous media articles promote WMP investment as a key means of building up savings. Their widespread popularity has led to efforts aimed at legitimizing, rather than eradicating, WMPs.
Regulations have helped to reduce risks in the WMP industry to some extent. Many banks have been involved in regulatory arbitrage, providing liquidity through WMPs during period of tight finance. New rules required banks to standardize their wealth management product business and to end implicit guarantees to investors. The most recent regulation, released in June 2021, prevented cash WMPs from investing in stocks, convertible bonds, floating rate bonds that use fixed term deposit rates, or bonds or asset-backed securities with credit ratings of less than AA+.
Wealth management products are prone to runs when their values decline. This is problematic because many WMPs are invested in long-term underlying assets and must roll over their funding very often; a sudden decline in demand for WMPs can quickly dry up liquidity. This has been found to increase bank risk, particularly insolvency risk, portfolio risk, and leverage risk. In addition, off-balance sheet WMPs are not insured, which means that, by contrast to regular bank accounts, investors can lose money when the values of WMPs decline.
In the recent real estate crisis, in which companies like Evergrande faced insurmountable debt woes, private developers relied on WMPs to obtain scarce capital. Money from property sales was used to pay investors – but then property sales declined, creating major challenges to WMP repayment. Evergrande was forced to pay investors in installments, while other developers failed to pay dividends or meet other obligations. The value of WMPs in trouble ballooned to $14.4 billion in 2021, double the amount from 2020.
The total value of WMPs is $4.4 trillion, and these assets are now ubiquitous among investors. Despite extensive regulations, there are still issues in the WMP industry due to investors’ expectations that they will obtain their principal and interest payments, even though some WMPs are invested in risky industries. As a result, we can expect to see payment problems in the future, as regulators walk a fine line between allowing large-scale WMP activity in order to appease popular demand and reining in abuses. Even if abuses are ruled out, a volatile market due to the pandemic and geopolitical tensions may result in greater investor losses. This is something we continue to watch.