China and Taiwan clamp down on risky products

Following an announcement last week that the Taiwan Financial Supervisory Commission (FSC) is tightening structured product sales, the mainland market is abuzz with talk that the China Banking Regulatory Commission (CBRC) intends to clamp down on wealth management products linked to domestic equities and sold through banking channels.

The CBRC is said to be looking to put a stop to banks issuing wealth management products with A-share equities, unlisted shares or underlying funds, with the reason being that banks have exhibited that they are inadequately set up to manage investment risk. Wealth management products with QDII funds as the underlying assets are not expected to be affected at this point.

The banking regulator's latest measure will follow its high-profile criticism of the banking industry's wealth management practices issued in April last year, shortly after a delta-one product linked to a Barings Hong Kong fund and structured by UBS tumbled by half in value and liquidated. The incident caused public embarrassment and mass threats of class action lawsuits against its issuer Minsheng Bank.

The banking wealth management business first went live in China in 2005. Only banks have authority to issue wealth management products -- a regulatory quip of terms which differ from fund or insurance policies sold through banks. These are targeted towards China's newly rich, but largely unsophisticated high-net-worth clients, with minimum sales starting at Rmb50,000 ($7,352).

According to the CBRC's published statistics, in 2008 alone, domestic and foreign banks sold a total of Rmb3.87 trillion ($567.1 billion) worth of renminbi and foreign currency-denominated wealth management products in China. However, at the end of 2008, all outstanding wealth management products were worth a total of Rmb823.3 billion ($120.6 billion).

How-How Zhang, an analyst at Shanghai research house Z-Ben Advisors, notes the CBRC move will be a reconfirmation of its previous stated policies against high-risk products; and should not bode any near-term danger for bank QDII developments.

At the height of the QDII craze in 2007, international fund execs fought to be taken onto banks' wealth management platforms. A single deal with a bank at the time often translated into a multi-million boon for the fund managers. The trend failed to die off after the Minsheng scandal. Zhang says wealth management products with underlying structured products have since overtaken fund-linked products as the bankers' preferred choice.

Since April 2008, banks have been forbidden to pass through QDII products as a mere distributor. Instead, they are required to assume the role as principal and be involved in product design and risk assessment -- making banks the final party responsible for the products -- although offshore fund houses or banks could be taken on as advisors.

In Taiwan, meanwhile, the familiar scene of the one-man day-trip sales exec will thankfully be put to an end with the implementation of a new law that tightens offshore structured product distribution.

Back in 2005 to 2006, when Taiwan was Asia's hottest market for structured product sales, day-trip sales execs were often seen clearing billion dollars worth of deals by rolling their suitcases in and out of the airport on the same day. It was a sellers' market. Product selection committees were largely under-formed. Such a person would only need two friends in any organisation: a senior official who sat on the management committee and a general counsel to make a deal happen.

Commercial banks and insurance companies at the time were often comfortable selling products already existing in the markets, and generally chose issuing investment banks based on factors beyond product risks, namely: quality and speed of execution, precision in settlements, quality in legal documentation, speed in secondary market making and customer communication.

Now the FSC will regulate structured products originating outside of Taiwan in two categories -- wholesale and retail. Now wholesale investors must demonstrate sufficient risk management abilities, product knowledge and a minimum asset size of NT$30 million ($913,169).

The regulator will now apply multiple checkpoints for structured products intended for retail channels, to bring it on a level playing field with fund products.

On top of distributor's internal product selection and compliance mechanisms, structured products must now be vetted by respective industry associations in banking, insurance and fund management before they are distributed to retail customers.

A legally responsible party must be installed onshore to distribute structured products from now on, either in the form of a local subsidiary or a master agent, who would have to put up guarantee deposits with the regulator before initiating sales in Taiwan. As creditors, investors hurt by actions of the issuer will be entitled to compensation from the deposit funds.

Also mindful of the final days of the Lehman Brothers' mini-bond debacle, the FSC is stepping up the availability of liquidity for such products, as subscriptions and redemptions are now required to be published daily, with bidding and asking prices, available units made public to investors. Issuers need to get the central banks' approval before they remit funds into and out of Taiwan.

The FSC will advise little beyond prudence and self-discipline for wholesale investors, hoping industry players will have the ability to self-assess and regulate.