China is concerned about the dangers of its financial system. The recent takeover of Anbang, a Global Fortune 500 financial services conglomerate, attests the importance of the task the country embarked on.
A central pillar to President Xi Jinping’s latest 5-year plan is to de-risk China’s financial system. Concerns that the country’s big private sector companies, especially those in the financial sector, have been building up their balance sheets’ risk exposure have been circulating for some years now.
President Xi is starting his second mandate as leader of the Communist Party of China, potentially for life with the recent removal of term limitations. He is widely regarded as the most powerful Chinese leader since Chairman Mao and has vowed to put China back at the centre of the world.
While the potential return to one-man-rule by a strongman is controversial, President Xi is concerned about his popularity. With the likelihood that his second term in office is not planned as his last, he arguably has more to lose than if it was to be. He is clearly determined to avoid any possibility of a systemic financial crash hitting the country on his watch – something which would likely lead to social unrest and undermine the iron grip he currently has on his Party.
Troubled insurance company
Anbang Insurance takeover was the culmination of the China Insurance Regulatory Commission (CIRC) 8-month investigation into the conglomerate’s opaque finances. This was triggered several months earlier when the company’s former chairman, Wu Xiaohui, was detained on charges of fundraising fraud and embezzlement.
CIRC concluded that the company’s aggressive move into high risk consumer investment products had violated laws and regulations that “may seriously endanger the solvency of the company”.
The move is not a government bailout and will facilitate the injection of private capital.
The takeover is being considered as a marker being laid down before new CIRC rules on transparent ownership structures come into force on 10 April.
These include a reduction of the current 51% cap on single shareholder ownership of an insurer down to 33%. Ownership stakes must also be acquired by the owner’s own funds and not a proxy such as a holding company or leverage based on expected future returns.
Insurers will also no longer be allowed to ‘repurpose’ funds acquired through the sale of insurance products into investments. Anbang appears to have been considered by Chinese authorities as a prime example of what it sees as risk-taking private companies endangering the country’s financial markets.
Questions were raised over discrepancies between the insurer’s registered capital, 1.97 trillion Yuan ($310bn) in assets, and relatively low ranking in the insurance business.
Financial risks under control
The private insurance industry has become a key area of concern to the Party and independent analysts agree. A Standards & Poor’s (S&P) Global Ratings report outlined how insurers’ increasingly high risk strategies meant they appeared ‘intent on adding to systemic risks’. It adds that ‘officials are seeking more market discipline, in both investment allocation and product offerings’.
The S&P report surmised that “China’s insurance sector is integral to the country’s deleveraging-related reforms. This is because broadly speaking, insurers can either add to the country’s financial risks, or help offset them”.
Chinese authorities, now, appear to be actively stepping in to ensure that the former is not the case. An increasing trend among the country’s insurers has been a move towards high-yield, short term investment-type products.
The kinds of returns being promised by high risk investment products sold by insurers have been higher than anything else on the market. They also often come with short redemption dates of as little as two years and little to no penalties.
However, a large percentage of the capital invested through these products is said to be reinvested by insurers in long term and illiquid assets such as real estate. This creates a liquidity risk in circumstances market conditions turn and large numbers of product holders move to redeem their policies. In that scenario, there would be a significant risk of assets being sufficient liquid to keep the insurers solvent.
With Chinese insurers also heavily invested in the domestic banking and real estate sectors, their financial fragility is considered by authorities as a potential systematic risk.
Anbang had also made a series of high profile investments in foreign assets, including New York’s emblematic Waldorf Astoria hotel. Other big private insurers have also made major international investments and the Chinese government is determined to avoid the reputational blow of having a company default on foreign debt.
Another consideration is the fact that China has huge infrastructure investment plans and heavily-indebted SOEs (state-owned enterprises). While regulations around investments insurance companies can channel funds into are generally tightening, other rules are being liberalised to encourage the underwriting of infrastructure investments and shoring up of SOEs.
For the next year Anbang Group will be managed by officials from CIRC, the central bank and other key government bodies. As well as equity restructuring to meet the new rules, a major assets disposal process is expected to occur with real estate and shares holdings in private listed companies expected to bear the brunt of the sell-off.
It would not be a surprise if reallocation of the cash raised by disposals sees reinvestment weighted towards domestic infrastructure projects and SOEs. The S&P report states that its expectation that state planners will have an increased role in the private insurance industry’s investment allocations strategy also entails risk.
There is general international consensus among analysts that Chinese insurers had started to play a risky game with the aggression of the products they have been marketing and their investment strategies.
Systematic risk to China’s financial sector is not in anyone’s interests and tighter regulation of balance sheet exposure of insurance companies can be welcomed.