China to Roll Out Financial Holding Company Regulations Later This Year

After a delay of 16 years, China is expected to finally roll out regulations for financial holding companies later this year.

The news comes after regulators issued a guidance document in April on strengthening the supervision of non-financial companies that invest in financial organizations.

That document — jointly released by the People's Bank of China (PBOC), the China Banking Insurance Regulatory Commission (CBIRC), and the China Securities Regulatory Commission (CSRC) — builds on a pilot program the central bank set up in December to simulate the supervisory system it hopes to have in place soon, multiple sources told Caixin.

Five companies are involved in the pilot, including central government-owned China Merchants Group, private companies Suning Holdings Group and Ant Financial Services, and two local state-owned enterprises.

The financial companies selected for the program have one thing in common — they are controlled by non-financial companies and are precisely the kind of companies previous attempts at supervision overlooked.

China’s central regulators first attempted to set boundaries and rules for financial holding companies after the international Joint Forum on Financial Conglomerates issued its regulations in 1999 and after Taiwan introduced its Financial Holding Company Act in 2001. In 2002, China’s central bank formed a task force in collaboration with financial conglomerate CITIC Group to study international regulatory practices. The task force eventually produced draft regulations, but its recommendations were put aside for over a decade due to a lack of consensus between government agencies on who should regulate financial holding companies and how they should do so.

Now, 16 years later, China’s financial industry has changed dramatically. Financial institutions like banks and insurance companies are no longer the only players establishing financial subsidiaries. Non-financial businesses -- including central government-owned firms, local state-owned enterprises, and private companies -- have flocked to the financial sector, setting up myriad financial platforms and holding companies either through stock acquisition or newly created entities. Additionally, internet giants like Suning and Ant Financial affiliate  Alibaba -- relatively new businesses -- now control multiple financial institutions, creating new challenges for Chinese regulators that demand urgent solutions.

Why now?

A number of risky financial holding company structures have come to light over the past few years, prompting China’s financial regulators to “quickly reach a consensus that regulatory shortcomings related to financial holding companies must be resolved as soon as possible,” a central bank insider told Caixin.

There are 28 private enterprises in China that have equity holdings in more than five financial institutions, according to data provided by Bai Hexiang, president of the Xi’an branch of the People’s Bank of China. The top three investors in financial institutions, by investment volume, are Tomorrow Holdings, Anbang Insurance Group, and HNA Group.

Tomorrow Holdings, one of the country’s most secretive conglomerates, holds equity in multiple financial institutions, ranging from banking to insurance to securities. Anbang is known to have stakes in 14 domestic financial institutions, including six that it controls, while HNA has shares in 21 domestic financial institutions, including nine in which it holds controlling stakes.

According to existing regulations, a bank shareholder may have either non-controlling stakes in as many as two banks or a controlling stake in one. Shareholders in insurance and securities companies are allowed one noncontrolling stake and one controlling stake —- that is, they are not allowed to control more than one financial firm. Yet, companies like Tomorrow, Anbang, and HNA have been able to make multiple investments and acquisitions in the financial industry due to lax regulation of financial holding companies in China.

This has resulted in significant risk for the Chinese financial system as a whole, experts say. After investing in financial institutions, many non-financial companies ignore corporate governance standards and conduct repeated related-party transactions between subsidiaries to provide funding for the parent company, as was the case with Chengdu Rural Commercial Bank and Anbang. "It is unscrupulous and ugly, and totally without regard for manners," an industry source told Caixin.

A Chengdu Rural Commercial Bank outlet. Photo: VCG

Financial holding companies often carry hidden financial risks, according to Hu Xiaolian, chairman of the China Export-Import Bank. Their leverage ratios tend to be very high, they have little control over their debt, and frequently loose sight of their original non-financial functions, Hu said.

Regulators have also increased their scrutiny of non-financial state-owned and state-backed enterprises attempting to enter the financial industry. Local governments use financial holding platforms like Tianjin TEDA Investment Holding and Guangzhou Yuexiu Financial Holdings to directly control local core financial resources and promote local economic growth. Financial assets are especially attractive in areas where economic development is lagging or where growth has declined significantly in recent years, because financial platforms promise to provide revenue for local governments every year, unlike industrial investments that need lead time to become profitable, according to a report by CITIC Construction.

The rapid emergence of internet finance conglomerates has also alarmed regulators. Suning Financial, a subsidiary of online electronics retailer Suning Holding Group, has become a comprehensive financial services provider, offering wealth management, consumer finance, corporate loans, and insurance to the massive user base of the Suning’s commerce network.

Domestic and international regulators alike are struggling with the question of how, and how much, to regulate this new internet finance sector. Zhang Jinfan, a former International Monetary Fund economist and associate professor at the Shenzhen campus of the Chinese University of Hong Kong, told Caixin that regulators should consider whether it’s necessary to implement the same strong standards for internet giants as for other financial holding companies. In Zhang’s opinion, the strengthening of measures against internet finance risks over the past two years has closed up regulatory gaps and so it might not be appropriate at present to constrain ongoing financial innovation by these large-scale internet platforms.

Defining and regulating financial holding companies

One of the most important steps to regulating financial holding companies is to define what these companies are. Sources told Caixin that China may follow the example of the Joint Forum on Financial Conglomerates, which says that as long as a holding group has substantial influence or control over subsidiaries in at least two of the three main financial industries -- banking, securities, and insurance -- they are a financial holding company. In the future, companies that fit this criterion may have to apply to the central bank for a financial holding company license, the sources said.

Other jurisdictions have additional criteria for determining whether a holding company is “financial”. For example, Taiwan requires that the total capital of the holding company’s financial subsidiaries must exceed 25% of the holding company’s total capital, or the holding company’s financial subsidiaries must account for at least half of the seats on the parent’s board of directors.

Recent publications by former PBOC financial stability bureau director Lu Lei and other policymakers suggest another idea regulators may incorporate into the new regulations: Non-financial companies that already have controlling stakes in two or more financial institutions and whose financial industry assets have reached a certain size may be required to establish specialized financial companies to manage the group’s internal financial services to isolate risk and rationalize the group’s overall organizational structure.

Furthermore, the guidance document issued in April by the PBOC, CBIRC and CSRC stipulates that the controlling shareholders of a financial institution must, in principle, meet certain minimum criteria, such as having made a profit for three consecutive years and having net assets no lower than 40% of total assets. The document also established a list of conditions, including unfair competition due to technological advantage and high-leverage investments, which would automatically disqualify companies from becoming controlling shareholders of financial institutions.

A problem created by past policies

In contrast to its stance today, China’s central government previously supported the integration of non-financial central state-owned enterprises with financial companies. At a meeting with the heads of central state-owned enterprises in December 2010, China’s State-owned Assets Supervision and Administration Commission (SASAC) voiced for the first time its clear support for the practice, calling integration a “necessary path for cultivating large, internationally competitive enterprises.”

But according to Wang Jun, a former chief financial expert at the World Bank, financial holding companies controlled by non-financial groups have difficulty finding international success because non-financial companies lack knowledge of how to manage financial risks, creating a high probability of failure.

A number of central government-owned enterprise executives told Caixin that most of them are deviating from their main businesses “just to make money.” In China, they said, a non-financial company involving itself in a financial business does so only because there are high profits in the financial industry. “Making money in finance is enough, who cares about the main business,” an executive at Chinatex Corporation told Caixin.

A SASAC law and regulation bureau official told Caixin that one of the central government's main goals this year is to prevent companies from straying from their main business objectives. As part of this, SASAC no longer advocates the integration of industry and finance. After all, finance is not an area that most central government-owned enterprises are familiar with, the official said.

Unlike in 2002, it is clear that the central bank will be responsible for supervising financial holding companies, with regulation led by its financial stability bureau. The regulatory constraints on financial holding companies will cover capital adequacy ratios, regulation of related-party transactions, improvement of governance structures, limits on leverage, and strengthening the validation of capital contributions.

During the 2002 regulation drafting process, the biggest question was whether regulating financial holding companies would lead to redundant supervision. The financial subsidiaries controlled by CITIC Group and China Everbright Group were already being individually supervised by the China Banking Regulatory Commission, China Insurance Regulatory Commission and China Securities Regulatory Commission.

But events in the past 16 years have shown that the separate supervision of banks, insurance companies and securities firms can easily lead to regulatory arbitrage by companies and a lack of accountability by individual regulators. For example, at the end of 2010, Anbang Insurance Group took a stake in Chengdu Rural Commercial Bank in a transaction that went against multiple banking regulations but was allowed to continue. According to informed sources, the attitude of the China Banking Regulatory Commission at the time was that if the insurance regulators agreed to the move, they too would agree, since Anbang, as an insurer, was under the jurisdiction of the China Insurance Regulatory Commission.

Now, “regulatory authorities have finally realized that financial holding companies do need supervision and are not easily regulated," a person close to the central bank told Caixin.

Contact reporter Teng Jing Xuan (jingxuanteng@caixin.com)