China's Softer Approach to Debt Doesn't Mean Easy Ride for Banks

(Bloomberg) -- China's top regulators are signaling that they're not about to go soft on overseeing the nation's $40 trillion financial industry, even as an economic slowdown gives them reason to relax their campaign against debt.

The Financial Stability and Development Committee, headed by Vice Premier Liu He, emphasized last week that that it will continue to crack down on wrongdoing and illegal financial institutions. That statement is backed up by record fines against market malpractice in recent months and stronger cooperation between law enforcement and financial regulators, pointing to determination to corral the sector's excesses.

While a recent easing of an ongoing anti-leverage campaign may have suggested a more relaxed posture by the government, regulators are showing that their years-long attack on risk taking and threats to the system remains in place. New capital rules governing an asset swap program also surprised investors last week with their toughness.

The financial stability committee, which sits at the apex of China's financial regulation system, is being bolstered by law enforcement, Ministry of Justice and Communist Party officials to strengthen its ability to swiftly crack down on financial industry fraud and criminal behavior by executives and market participants, according to a person familiar with the matter.

“The signal is that there are ongoing policy tweaks, and the pace of debt growth containment is stabilizing, but it won't be an outright easing,” said Liu Peiqian, Asia strategist at Natwest Markets PLC in Singapore. The involvement of different departments at the committee including law enforcement “will help with the cleanup of financial misconduct, which will do good to the economy and risk prevention.”

China Debt Warriors Are Re-Aiming, Not Giving Up, Amid Slowdown

Closer coordination between the committee and other arms of government, including law enforcement, is key to accomplishing its goal, said the person familiar with the changes, who declined to be identified given the sensitivity of the issue.

The PBOC, which acts as a secretariat for the FSDC, didn't respond to a fax seeking comment on the changes.

“Financial risk prevention is going to be long term,” said Li Peijia, analyst at Bank of China's Institute of International Finance in Beijing.

Policy makers have been easing other areas of their deleveraging campaign in a bid to spur lending. In the face of a credit slump and a slowing economy, and against the backdrop of a trade war with the U.S, officials have eased loan quotas, relaxed capital restrictions for some lenders, and issued new rules for the shadow-finance industry that proved less restrictive than many analysts had anticipated.

However a move in the opposite direction is the tightening of rules that govern how much capital asset management companies must hold for debt-to-equity swaps, according to people familiar with the matter. AMCs will be required to use a risk weighting of 250 percent for holdings swapped from debt into equity in publicly traded companies, an increase from the previous 150 percent threshold, said the people, who asked not to be named because they are not authorized to speak publicly.

China Is Said to Tighten Capital Rules on Some Debt Swaps

“The move shows the China Banking and Insurance Regulatory Commission is more prudent in the managing risks of debt swaps,” said Wang Yifeng, a researcher at China Minsheng Banking Corp. in Beijing.

While policy makers have urged banks and asset management companies to use debt-to-equity swaps, as troubled corporations look for ways to reduce their loan obligations, the new capital rules signal that the financial companies will be constrained in assuming their risk.

Authorities have also been mounting an aggressive campaign to stamp out illicit behavior in China's equity market. In March, fines totaling 5.5 billion yuan were issued against a company charged with manipulating stocks, the biggest ever punishment for such an infringement. That was only the latest of several billion-dollar penalties handed down by the China Securities Regulatory Commission, whose chairman said in early 2017 that he would pursue market wrongdoing, whether it was “historical or current.”

“The crackdown against financial crimes and the protection of financial security will be strengthened in the future,” said financial market analyst Li.

To contact Bloomberg News staff for this story: Miao Han in Beijing at mhan22@bloomberg.net;Yinan Zhao in Beijing at yzhao300@bloomberg.net;Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net;Sam Mamudi at smamudi@bloomberg.net

With assistance from Editorial Board