At the end of last year, China’s regulatory authorities unveiled plans to overhaul the regulation of the asset management industry, which included scrapping the implicit guarantees embedded in wealth management products and capping investments in such products to one-fifth of a fund’s total net asset value (NAV).
This was only the latest nail in the coffin of China’s vast and murky shadow banking industry, which Beijing had vowed to clamp down on earlier in the year, ahead of the Communist Party’s five-yearly national congress. The suppression of leveraged and profitable guaranteed products meant the private banking sector had a large profit hole to fill and companies lost a key source of funding.
To fill the void, banks and companies turned to structured deposits. China’s market for structured products increased dramatically in the first six months of this year, from 6 trillion yuan of notional value to 9.2 trillion yuan ($0.8 billion to $1.35 trillion), according to data from the People’s Bank of China.
China Minsheng Bank (CMBC) benefitted from the switch as it drew on its substantial experience as one of the top privately-owned structured products houses in the country to give its clients what they need most: good returns in the case of private banking clients and continued access to funding in the case of corporations.
The dramatic increase in structured deposits is a direct result of the new asset management restrictions, which were finalised in April, says Chongfeng Ran, head of structuring with the finance department of CMBC.
For CMBC, structured product assets have doubled in the six months to June. This came as traditional wealth management assets have been dropping across the industry. Some banks are using structured products to fill the gap left by the decline in off-balance sheet wealth management products, Ran says.
“Switching wealth management products to a NAV basis means they are going to have to sit with the profit-and-loss account of the customer, rather than the bank, and so banks cannot issue the same principal-protected products they were able to in the past,” says Ran. “This is why we firmly believe that structured products will become the defining product of the market.”
One-fifth of CMBC’s structured products are sold to retail clients who are looking for an additional yield pick-up and the remainder goes to corporate clients, many of whom are looking to raise funds. While retail clients tend to favour products linked to the equities market – typically well-known local Chinese indices or overseas benchmarks such as Hang Seng’s HSCEI index – corporate clients prefer structured products linked to the bond markets because they tend to have lower volatility.
Although both client types have a strong preference for more vanilla structured products –easy to understand and with an attractive yield pick-up – this has not prevented CMBC from innovating and trying to push the boundaries of what is comfortable for its clients to invest in.
“In terms of AUM, we are already one of the top commercial banks in China for structured banks and this is why we need to search some new eye-catching products to make sure our products remain attractive for our clients,” says Ran.
One of the particular innovations that CMBC has brought to market this year is the development of a series of multi-asset products linked to the bank’s own flagship index, the Minsheng Bank Smart Transglobal Asset Rotation Index.
Although CMBC started developing this index back in 2014, it is only this year that its value has been realised for the firm, as it begins to be integrated into the structured product space. The index links to fixed-income and equity futures contracts in four developed countries: the US, UK, Japan and Germany.
It then uses a momentum strategy to underweight or overweight assets based on the past six months of performance in order to reduce the volatility of the benchmark. For example, the top-four underlying indices that have performed best over the previous two months will be given a 70% weighting in CMBC’s proprietary benchmark, while the worst performers will be given a 30% weighting. This rebalancing takes place on a daily basis.
In a lot of structured banks a lot of risk management guys are pretty conservative, but at CMBC we are fairly open-minded and willing to try new things, especially when it comes to structured products. We receive a lot of support internally and this is why we can offer such products
Chongfeng Ran, CMBC
“At the moment most clients are using simple vanilla structured products and the problem with these is that they are almost like a passive product,” says Ran. “Once the client buys the product they have no control. They have nothing to do except wait until the product has matured. We wanted to make some changes. We wanted to use an innovative cross-asset strategy to make sure the return for the client doesn’t only depend on the performance of a single asset class.”
Over the past four years, the index has seen an annualised return of 5.8%. The three structured products linked to the index, which CMBC launched in June and July, saw inflows of nearly 200 million yuan ($28 million) within a couple of months, with the bank anticipating a lot more interest from clients going forwards.
“These products are attractive to our clients since they guarantee a minimum return no less than [the] original deposit with unlimited upside return potential and, more importantly, gives clients an easier and cheaper way to gain access to global investment under the capital controls in China, helping them to build a globally diversified portfolio,” says Ran.
It was not the structuring of the product that proved challenging. Bringing any new innovation to the Chinese market means making people aware of its value. CMBC initially begun selling this product to retail clients, but believes it could have wider appeal.
“Traditional wealth management products that offer a principal guarantee have been on the market for at least 10 years, and it is really hard to change the situation in just one or two months. It takes some time to educate clients and we are doing a lot of outreach,” says Ran. “We are selling this to the retail clients at the moment, but we really want the corporates on board.”
Shaping the market
In September, CMBC organised the first seminar specifically to pitch this kind of solution to companies. The next stage is to combine the beta approach that has been currently adopted with an alpha component, which could help to improve the stability of the index and reduce the possibility of drawdowns, particularly when there is a systemic risk event in the markets.
This is not the only way in which CMBC has been helping to shape the market. In 2017, the Chinese bank spotted a growing interest in clients to invest in offshore Tier 1 capital offered by domestic banks (Chinese banks have been turning to the offshore market for capital-raising purposes due to rising onshore funding costs). However, there was traditionally no benchmark for investing in such assets, so CMBC decided to publish one: the China Commercial Bank Overseas AT1 Wealth Index. The index was made more investible by giving larger banks, which tend to issue more AT1 capital, a higher weighting and thereby improving their overhaul liquidity.
All of these strategies are underpinned by a sound risk management department, which allows the flexibility to take risk, within certain parameters, while keeping a keen eye on the bank’s capital ratio.
“In a lot of structured banks a lot of risk management guys are pretty conservative, but at CMBC we are fairly open-minded and willing to try new things, especially when it comes to structured products. We receive a lot of support internally and this is why we can offer such products,” says Ran.
This does not mean CMBC is cavalier with risk – far from it. The bank says it makes sure it always adheres to the strictest standards of risk management. In 2017, it saw its capital ratio increase, from 1.71% to 11.85%, while still being able to innovate in the market.