China steps up crackdown on $1tr bank wealth products

China's crackdown on shadow banking is taking aim at more than $1 trillion of opaque investments sold by banks as low risk and high yield, even while funds were channeled to riskier borrowers such as developers.

Banks and wealth mangers can no longer use money invested in so-called cash management products to buy long-term debt or bonds rated below AA+, according to long-awaited rules published on Friday. An estimated 2.5 trillion yuan ($390.5 billion) of the products are currently invested in assets that will soon become non-compliant, and need to be swapped for lower-yielding, high quality investments by the end of next year.

While the regulatory tightening was flagged 17 months back, China's lenders have continued to make riskier investments with some of the hundreds of billions of dollars that have flowed into the products, which offer higher rates than deposits and money market funds.

Those flows should now be tempered as returns decline, shrinking the market by 10% and denting bank revenues, according to CSC Financial Co. analysts. Shares of China's property developers, which count cash management products as a funding source, slumped on the news.

There will be pressure to gradually sell-off debt securities that don't comply with the new rules, China International Capital Corp. analysts led by Huang Wenjing wrote in a report on Tuesday.

That may benefit other assets such as equities as investors chase yields elsewhere, they wrote. More than 16% of the assets in cash management products reviewed by the brokerage are not compliant with changes to maturity and credit rating requirements, according to the report.

Wealth management products -- of which cash products form the biggest chunk -- have drawn increasing scrutiny from regulators concerned about a host of risks from implicit guarantees and leverage, to duration mismatches and a lack of transparency around where the money is invested. Financial regulators unveiled draft rules for cash management products in December 2019.

Shares of CIFI Holdings Group Co Ltd. fell 5.3% and China Evergrande Group dropped 2.5% in Hong Kong on Tuesday, while a Bloomberg gauge tracking Chinese developers posted its biggest daily decline since September 2020. Property developers will have trouble raising funds to repay their debts if they lose the liquidity from cash management products, according to Castor Pang, head of research at Core Pacific Yamaichi.

Many of the assets that underpin the products are likely to be sold off when banks rush to find safer investments demanded by the new rules, Citic Securities Co.'s head of fixed-income research Ming Ming wrote in a June 7 report. About 2.5 trillion yuan of such products is invested in assets that will be non-compliant, according to the Chinese brokerage. Total cash management products grew 76% to 7.34 trillion yuan as of March 31 from the end of 2019.

Such efforts to improve oversight of wealth management products and the removal of guaranteed returns that had drawn in retail investors will boost the likes of Blackrock Inc. and JPMorgan Chase & Co., who are now moving in to capture a slice of China's wealth assets.

Under the new rules, the leverage of each cash management product will be capped at 120%, while investment areas will be limited to short-term bank deposits, bond repurchase agreements and central bank bills, as well as openly-traded bonds and asset-backed securities with a remaining maturity of no more than 397 days.