China crackdown on fund house subsidiaries set to force closures

China has unveiled plans to tighten supervision of fund house subsidiaries – a sector worth Rmb10 trillion ($1.53 trillion) – that look set to force the closure of many such businesses.

The tougher-than-expected proposals come soon after a suspension of registration of investment firms, as Beijing continues to tighten regulation of the domestic funds industry and so-called shadow banking.

Fund management subsidiaries function as a channel for shadow banking, the private financing sector that has seen rapid growth and subsequently come under increasing scrutiny in recent years.

The China Securities Regulatory Commission (CSRC) has distributed the new draft rules to fund houses, reported the state-run Securities Times yesterday. They concern the establishment of subsidiaries and set more stringent capital requirements.

“The proposed measures target risk management, which is very important for the industry, and will have a huge impact on fund managers’ subsidiary businesses,” said Ivan Shi, research director of Shanghai-based consultancy Z-Ben Advisors.

The fund subsidiary segment saw its total AUM swell 14% to Rmb9.8 trillion in just the first quarter of this year, having already doubled to Rmb8.57 trillion during 2015. It is now larger than China’s mutual funds industry, which had assets of Rmb8.4 trillion as of end-2015.

According to the new proposals, seen by AsianInvestor, fund houses applying to set up subsidiaries must manage at least Rmb20 billion in assets, excluding money-market funds, and have a minimum of Rmb600 million in net assets. 

Of the 105 fund houses in China, only 45 met the Rmb20 billion requirement at the end of March, according to the Asset Management Association of China. 

Moreover, the amount of net registered capital – equal to net assets minus risk assets – must be at least Rmb100 million. There are also other controls, such as on the level of liabilities and risk assets. The only capital requirement for fund subsidiaries currently is that they have registered capital of at least Rmb20 million, Shi told AsianInvestor.

As of end-2015, only 12* of the 79 fund subsidiaries in China held Rmb100 million in registered capital, he added. 

However, the big fund subsidiaries are under pressure too. Under the draft rules, the more assets they will need to hold. For example, as of end March, Ping An-UOB Fund was the biggest fund subsidiary with Rmb840.7 billion in assets followed by the subsidiary of Minsheng Royal Fund Management, with Rmb815.6 billion. These two fund subsidiaries would have to boost their registered capital to about Rmb1.2 billion.

Whether the shareholders will be willing to do that is a question mark, a senior executive at a Chinese fund house told AsianInvestor, on condition of anonymity. Acting as a channel for shadow banking is not a very profitable business, he noted, and fund subsidiaries moved into it with a view to building a scale business, but committing more capital would mean higher costs.

Fund subsidiaries have enjoyed favourable policies in the past – as compared to trusts, brokerages and insurers – in that they do not have capital ratio requirements, with the regulator viewing their business as product innovation.

That made it easy for fund subsidiaries to act as the channel for shadow banking, said the unnamed executive, but now the CSRC has shown its determination to regulate this sector.

The latest proposals are similar to rules issued in 2010 by the China Banking Regulatory Commission to strengthen supervision of trust companies’ capital, also with a view to tighter controls for the shadow banking sector. 

There might be changes of the rules if there are too many objections from fund houses, or the guidelines might be delayed in implementation, if there are any major events such as another stock-market rout, said the fund executive.

The draft rules propose a grace period of until December 31 to allow asset managers’ to make any required changes to subsidiary businesses. Their existing assets will not be included in the calculation of risk capital, but no add-on or renewal of these products will be allowed. They will have to liquidate them when the contracts reach termination.

The CSRC could not be reached for comment by press time.

*The 12 in question are the subsidiaries of Harvest Fund (Rmb300 million), China Life AMP Asset Management (Rmb200 million), China Southern Asset Management (Rmb200 million), Aegon-Industrial Fund (Rmb200 million), First Seafront Fund (Rmb180 million), Minsheng Royal Fund Management (Rmb125 million), E Fund (Rmb120 million), China Post Fund (Rmb120 million), Huatai-PineBridge Investments (Rmb100 million), Bank of Beijing Scotiabank Asset Management (Rmb100 million), Dacheng Fund (Rmb100 million) and China Merchants Fund (Rmb100 million).