Four Things to Know About China’s New Trust Industry Rules
Chinese regulators are taking another step to put the country’s $3.1 trillion trust industry under closer oversight by drafting new rules to govern how trust companies should manage client funds.
The draft regulation, issued by the China Banking and Insurance Regulatory Commission (CBIRC) recently for public comment, is set to clarify requirements on trust products managed by the country’s 68 trust companies and toughen regulation of their load-related investments to contain risks of the once-freewheeling industry.
China’s trust companies managed 21.6 trillion yuan ($3.1 trillion) as of the end of 2019 and invested in a wide range of assets including bonds, stocks, loans to private companies and local government financing vehicles. For years, the trust industry has provided a key alternative funding source for companies that have difficulty obtaining bank credit.
Financial regulators in recent years have tightened scrutiny of trust product investment as part of broader efforts to rein in the rapidly expanding, risky shadow banking sector.
In 2019, nearly one-third of China’s trust companies were punished by regulators for a range of violations, including conducting illicit off-balance-sheet lending and illegal real estate investments. Fines amounting to 22.5 million yuan ($3.2 million) were levied.
Concerns over default of some of the trust products have mounted amid the economic slowdown and the Covid-19 pandemic. By the end of 2019, about 2.67% of trust industry investment, or 577 billion yuan on 1,547 projects, were deemed risky, official data showed.
“The new regulations will lay the foundation for trust companies’ asset management business, which will help the industry to grow in a healthy way,” said an official at the CBIRC’s trust industry department.
According to Everbright Securities, trust products falling under the new regulation amount about 19.5 trillion yuan, or 90% of the total business of trust companies.
Here are four key points to know about the new rules:
What are the purposes of the new draft rules?
The draft regulation will provide clear guidance for the trust industry to comply with China’s overarching 2018 regulatory framework overhauling the entire asset management industry. China issued the rules in April 2018, affecting more than $16 trillion of business by banks, brokerages, trust firms and other financial institutions. More-detailed guidelines have been issued by regulators for specific sectors, but the one for the trust industry has not yet been published.
The draft rules specified requirements on where trust companies can raise funds and how they should invest the money in accordance with the general asset management rules. The draft document also asked trust companies to modify risk controls and internal management systems.
One notable requirement in the draft regulation is that trust products should be open only to a limited number of qualified investors and the total number of investors should not exceed 200 for one product. Such restrictions dismissed previous speculation that trust companies might be allowed to raise funds from the general public.
What are the key changes to be made by the new rules?
The draft regulation will allow trust companies to take on debt as long as they follow strict requirements and meet certain leverage ratios. Trust companies can borrow money only for investments in fixed-income securities, according to the draft rules. Leverage ratios for nonstructured products should stay below 200%, and those for structured products should not exceed 140%.
The new rules will cap trust companies’ total investments in so-called nonstandard credit assets, typically loans, at 50% of the funds they raise from investors. Trust companies should invest no more than 30% of net assets in nonstandard credit assets backed by the same company and affiliates.
Trust companies must also follow requirements on investor suitability, asset management and disclosure, according to the asset management rules.
Nonstandard credit assets with less transparency, weaker liquidity and greater risks have been a major target of trust company investments. The new rules are designed to reduce the companies’ risk exposure to such assets, the CBIRC official said.
What do the changes mean for trust companies?
Many trust companies face pressure to adjust their businesses under the draft rules, several industry sources said. For instance, most trust companies have exceeded the 50% asset cap on nonstandard asset investments, they said.
The CBIRC official said more-detailed guidelines will be issued following the new regulation to guide the revamp. The draft document also pledged to provide a grace period for trust companies to fix their operations and to offer extra time under certain circumstance.
What do the new rules say about trust companies’ risk controls?
The new regulation requires trust companies to set up dynamic mechanisms to monitor risks of each trust product and conduct regular risk assessments and stress tests. It also orders the companies to improve internal management and business compliance, enhance information disclosure and sharing with regulators to keep risks at bay.
Regulators will work closely with trust companies to dismantle risks in the industry at a proper pace and based on companies’ actual condition, the CBIRC official said.
Contact reporter Han Wei (email@example.com) and editor Bob Simison (firstname.lastname@example.org)
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