Downfall of a regulator

The Communist Party’s Central Commission for Discipline Inspection did not provide any details of its probe. Nevertheless, news that Xiang is under scrutiny is not a great surprise. Rumours about the former Agricultural Bank of China chairman have been circulating for several years. In November last year, US financial regulators fined the New York branch of ABC $215mln for repeatedly violating antimoney-laundering rules. The branch manager at the time of the offenses had been Xiang’s secretary in the chairman’s office.

Also, in 2014 The New York Times reported that while heading the China Insurance Regulatory Commission, Xiang had approached Jamie Dimon to request the JP Morgan chief executive hire the daughter of a close friend. After Chinese premier Li Keqiang made a speech last month denouncing “individual regulators... who have embezzled money and colluded with financial crocodiles” Xiang’s days were numbered.

Whatever his precise wrongdoings, Xiang’s fall is likely to put a check on the aggressive expansion of China’s domestic insurers. At the CIRC, Xiang presided over deregulation which ignited rapid growth in the sector. Notably, in 2015 the CIRC scrapped the maximum guaranteed return of 2.5% on investment products sold by insurers, a move which led to an explosion in sales of investments more similar to wealth management products than traditional insurance.

From around RMB30 bln in 2013-2014, monthly sales rose to RMB200 bln in the early months of 2016, accounting for half of life insurers’ total revenues (see chart). Among the most aggressive in selling investment products have been private insurers such as Anbang and Foresea Life. In 2016, Anbang generated revenues of more than RMB200 bln from investment products, more than any other insurer, capturing 20% of the total market. At the peak of the boom in the first quarter of last year, investment product sales accounted for 75% of total revenues for Foresea Life, 80% for Anbang, and over 95% for Evergrande Life. In contrast, large state-owned insurers such as China Life and New China Life remain dependent on traditional insurance sales, with investment products contributing less than 20% of their revenues.

As insurers ramped up their liabilities with the sale of guaranteed-return products, they naturally had to search for higher returns on their assets. Their solution was to start making aggressive acquisitions, both domestically and abroad. Infamously, private insurers including Foresea Life and Evergrande Life bought heavily into the domesticallylisted shares of property developer China Vanke. Their purchases helped propel a quadrupling of Vanke’s stock price in two years, turning the chairman of Foresea Life into one of the wealthiest people in China.

These goings-on raised financial stability concerns among China’s other regulators.

The chairman of the China Securities Regulatory Commission, Liu Shiyu, condemned the private insurers as “giant crocodiles” and accused them of manipulating the stock market. At the same time, overseas forays, such as Anbang’s multi-billion dollar acquisitions of foreign hotels and insurers, have attracted the scrutiny of the State Administration of Foreign Exchange, which has tightened regulations over overseas acquisitions in order to curb capital outflows.

As China’s leadership has stressed stability over expansion in recent months, the CIRC has come under pressure to tighten its supervision of insurers. At least two of Anbang’s proposed deals have been rejected. The CIRC has announced that a number of private life insurers, including Evergrande Life and Foresea Life, violated its regulations. And the chairman of Foresea Life has been banned from the industry for ten years, a big victory for CSRC chairman Liu, who succeeded in imposing his will on the rival insurance regulator.

The fall of Xiang underlines this change of regulatory direction. Not only will aggressive acquisitions by Chinese insurers be brought to a halt, but it is likely that Beijing will seize the opportunity to centralise financial regulation. It has long been a problem of China’s regulatory framework that the different regulators have been incentivised to concentrate only on their own narrow bureaucratic interests. The result has been widespread and repeated regulatory arbitrage. The explosive growth of insurance investment products is merely the latest example in a succession of regulatory lacunae which at times have threatened to destabilise China’s financial system.

Beijing did set up a financial regulatory coordination mechanism following the stock market crash in 2015. But it is only in the last couple of months that coordination among the different regulatory bodies has begun to take effect as the People’s Bank of China and the CSRC have apparently emerged from an inter-regulator power struggle with the upper hand. With financial stability now established as the clear priority, further initiatives to reduce regulatory arbitrage and strengthen China’s system of financial supervision are on the cards.