New plans unveiled by China's regulators send a clear signal about the future direction of China's booming wealth management sector and the government's desire to regulate China's shadow banking market.
China's banking regulator, China Banking Regulatory Commission (CBRC), released its Administrative Measures on the Sales of Wealth Management Product by the Commercial Banks (the Measures) on 9 October 2011, with an effective date of 1 January 2012.
The release of the Measures is not a surprise. In an earlier Client Alert ( A quiet revolution in China's financial markets), we noted that China's regulators had started to acknowledge publicly the importance of non-mainstream finance and, implicitly, the need to introduce new rules to regulate it.
The Measures are consistent with that policy direction. They support the development of wealth management and alternative financing channels, and at the same time crack down on a range of business practices that the government sees as imposing dangers to the financial system. As a package they provide a further demonstration of China's commitment to the development of its financial markets.
The Measures are broad in their scope. They extend to such matters as the classification of products and investors, disclosure requirements, sales and marketing practices, training and compliance programs and documentation requirements. We will look at these in more detail in coming months, but for the moment we provide comments on the key issues.
Classification of products and clients
The authorities are keen to ensure that investors are fully aware of the scale or nature of the risks they take on when investing in wealth management products. One of the ways of doing this will be to require banks to adopt a "suitable products to suitable clients" principle.
Banks will need to classify their wealth products and clients into five risk rated categories respectively, with prohibitions on sales of complex products with higher risk ratings to clients with lower than approved risk ratings.
There is no clear guidance as to how the five categories of products are to be determined, other than that it is "in the sole discretion" of the banks. It is expected that some guidance will emerge over time but, for the moment, banks seem free to be able to use their own risk assessment processes.
Having established the product risk categories, investors will be subject to a minimum purchase amount for the products with different risk ratings:
- RMB 50,000 for buying the products with risk rating of 1 or 2;
- RMB 100,000 for buying the products with risk rating of 3 or 4; and
- RMB 200,000 for buying the products with risk rating of 5.
Banks will be required to conduct a risk assessment for each client (other than institutional clients) by considering various factors such as the client's age, financial status, investment experience and risk appetite. These assessments must be updated annually, or sooner if certain risk events arise.
Having assigned customers a risk rating, the banks may also determine whether they are a "private banking client" or a "high net worth individual" - both of which are the new legal terms expressly recognised under PRC law. The former are clients with total net financial assets of RMB 6 million or more, the latter being clients who satisfy one of the following requirements:
- natural persons who purchase products worth at least RMB 1 million in a single transaction;
- natural persons with personal or combined family net financial assets of more than RMB 1 million; or
- natural persons with annual income of more than RMB 200,000 or combined family annual income of more than RMB 300,000 over the most recent three years.
Importantly and for the first time, the new rules extend to institutional clients. As such, the current legal framework regulating banks' wealth management businesses applies to both private wealth and corporate wealth regimes.
Promotion and sales of products
The Measures also impose a number of stringent restrictions on the ability of banks to promote and sell their wealth management products. In particular they will not be allowed to:
- use wealth products to attract deposits or bundle products in other promotions;
- sell wealth products as deposits by raising interest rates in any disguised forms;
- use price discounts and free gifts to attract sales;
- promise specified investment returns without conditions; and
- use television or radio broadcasting to advertise products.
Although the concepts are reasonably clear, as practical matter it remains to be seen how CBRC implements these rules.
For any client who spends a "substantial amount" in a single transaction or purchases any product with "higher risk rating", unless the parties agree otherwise, the bank will be required to make a final confirmation with the client by telephone before the client makes any payment.
If during the call the client decides not to proceed with the purchase of the relevant product, the bank must terminate any previously signed selling documentation. Unfortunately the Measures do not provide any threshold or guidance as to what constitute a "substantial amount" or "higher risk rating".
Sales staff training and activities
The Measures also focus on the training and actual selling efforts by sales staff.
Sales staff must possess the qualifications, knowledge and skills appropriate for sales promotion and selling activities. This includes having an understanding of relevant laws and regulations and the product's characteristics and the market in which it trades.
Sales activities will be more closely regulated. So, for example, before processing any sales agreements, the sales person must inform the client of the product characteristics and fees, have a good understanding of the client's risk tolerance and investment objectives, and highlight the investment risks to the client.
Although these requirements are not a new focus for CBRC, they heighten the need for banks to implement a robust system of risk assessment and monitoring and to institute appropriate internal training programs, systems and compliance programs. In addition, the compensation and appraisal of sales staff must not be solely based upon their sales performance alone.
Risk and information disclosure
The Measures stipulate that selling documentation must contain specific pages in respect of "risk disclosures" and an "acknowledgement of client's right and interest".
One new requirement that will play a key role in enforcing the risk disclosures is that non-institutional customers are required to physically copy and write the relevant extract from the risk disclosures section in the selling documentation and acknowledge that they have read and understood the risks associated with the investment. The intention is that this process will therefore make the customer focus more carefully on the risks associated with the particular investment. At a practical level, some PRC banks have already adopted this approach. However, we are not sure that this will necessarily be achievable and whether it will really bring out the required level of understanding.
The "Acknowledgement of client's right and interest" is a new documentation requirement which requires the relevant rights and interests of clients to be disclosed in the selling documentation. So, for example, the product sales and risk assessment procedures by the bank, the method and frequency that the bank discloses the relevant information to the client, and its compliance procedures must be specified.
This disclosure requirement should not cause any particular difficulties but there is also a new requirement that confers on the client a right to call for the redemption of the investment if the client does not accept a proposed change by the bank in respect of such matters as the scope of investment, type of product, investment ratio or the fee arrangement. There is no guidance as to how this works in practice, especially if the product is a structured product.
Other requirements extend to such matters as:
- the use of clear and easy to understand language to describe the characteristics and investment risks of the product;
- the requirement for specific warnings about the product's risk and profit return characteristics be explicitly stated in relevant marketing material; and
- the need for bank to make accurate disclosures when the product is terminated, and inform the client promptly of any changes to the proposed investment.
In addition to the risk and information disclosures described above, the Measures generally require relevant documentation to be comprehensive, realistic and objectively reflect the key features and important relevant facts of the product. Any information or description that is false, misleading, exaggerated or one-sided, or contains statements in violation of law is prohibited. The language used must be truthful, accurate and clear, and any unverified data or statistics must not be used.
If the name of any wealth product contains the name of any proposed asset that is to be invested in, the investment value of such asset must be at least 50% of the total value of the wealth product. If the name of any structured product contains the name of a linked asset, the ratio between the value of the wealth product and such linked asset must be specified. In addition, the bank must enter into a separate "wealth management service agreement" when it proposes to sell any specifically designed product to an institutional client or private banking client.
The development of the wealth management sector in China remains a priority for the government, and for that reason the Measures provide a welcome guidance for participants in the market.
The Measures are however significant in their scope and will require close scrutiny. For many organisations, changes and upgrades to their policies and practices will be required.
As China's markets evolve these changes refect an intent by the authorities to adopt world best practice and will undoubtedly play a role in shaping future market practice. Over time we expect that their broad themes will be replicated across a range of the currently less regulated financing channels.
At a higher level the changes also lay the groundwork for the potential liberalisation of interest rates in China, something which is a necessary pre-requisite to the further maturing of the domestic financial markets. The business model of most of China's banks is underpinned by a diet of lending to SOEs as a means of generating their core profits. That business model is likely to remain in place until such time as the government policy of maintaining a fixed margin between deposit and lending rates is relaxed. The new Measures provide some encouragement that that the authorities are encouraging a move to a more fee based business model for financial institutions, which over time, may be helpful in promoting a liberalised interest rate regime.