Don’t Say You Weren’t Warned About China’s WMPs: QuickTake Q&A

Alarm bells are ringing as Chinese citizens pour their savings into wealth-management products, a market that has tripled to $3.8 trillion in just three years. Like mortgage-backed securities were in the U.S., these products are building blocks of a shadow-banking system that exists largely off banks’ balance sheets. In China, a history of bailouts has persuaded many investors that WMPs are implicitly guaranteed by the issuing bank or the state. The People’s Bank of China has taken note, as have other regulators.

1. Why are WMPs so hot with investors?

Issued by banks, WMPs have emerged as a key tool for lenders to attract funds. Investors are lured by yields of 3 to 5 percent, compared with 1.5 percent for one-year bank deposits. The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep the WMPs off their balance sheets provided the products are not principal-guaranteed, which most are not. They can also hand over the products to non-banks to manage in return for a predetermined interest rate.

2. What are the risks for the financial system?

Banks may face a liquidity crunch if investors turn cold on the products, which mostly have terms of six months or less. Lenders use WMPs in some of the financial engineering that helps them to sidestep lending restrictions and capital requirements. WMPs are increasingly investing in each other, meaning one soured product could infect others. And by ceding control of the products to brokerages and fund management firms, those institutions have created new layers of products investing in bonds and loans to risky investors.

3. So what are the authorities doing?

Financial regulators have bandied together to draft rules for WMPs and other asset management products that aim to make it clear that there is no implicit government guarantee on any product. Under the proposed regulations, financial institutions would be banned from investing the proceeds of asset-management products in non-standard credit assets , mostly loans. And the institutions would have to set aside 10 percent of fees from managing asset management products to cover potential risks.

4. How much money is involved?

The outstanding value of off-balance sheet WMPs rose 30 percent in 2016 to exceed 26 trillion yuan, according to the central bank -- that’s equivalent to 38 percent of China’s gross domestic product. Much of the growth came in open WMPs, which are extra appealing to investors because they can be redeemed at any time, Bank of America Corp. reported. Mid-tier banks such as China Merchants Bank and China Everbright Bank are especially dependent on the products for funding.

5. What steps have already been taken?

The PBOC from January required banks to account for off-balance sheet WMPs in assessing their risks and overall credit growth. The China Banking Regulatory Commission drafted rules on WMPs in July, seeking to limit the involvement of smaller banks and ensure that lenders have adequate capital for potential losses. Those rules are yet to take effect. Besides public warnings on WMP risks from the likes of Xiao Gang -- the former head of the securities regulator -- the authorities have had a series of clampdowns. In 2013, the banking regulator capped WMPs’ investments in those “non-standard” credit assets. In later steps, officials said WMPs sold to retail investors couldn’t invest in equities or in nonperforming loans. The PBOC also told lenders it would limit their outsourcing of the management of WMPs.

6. What do experts and markets say?

Bank of America Corp. strategists warned that “a liquidity crunch in China’s shadow banking sector over the next year or two is a genuine risk.” Banking analyst Charlene Chu says WMPs are defying market gravity. Still, for all the risks, WMPs so far remain profitable for investors and the institutions who manage them.

7. Is there anything else to worry about?

The latest attempt to regulate WMPs extends to other asset management products, covering an industry worth $8.7 trillion. Trust firms had 15.3 trillion yuan of products outstanding at the end of June, according to the securities regulator. Specialized asset management products, issued mostly to institutional investors by China’s mutual fund companies, were worth 16.5 trillion yuan, and brokerage firms had issued 14.8 trillion yuan. In other words, WMPs are just part of a mushrooming shadow-banking system that increased risk in the financial system.

The Reference Shelf

— With assistance by Laurence Arnold, and Jun Luo

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