China’s insurance industry gears up to outsource fund management
Category: Asia, China
By Hui Ching-hoo
Third party asset delegation issues provide some food for thought
Reforms have been introduced for China’s insurers in a move aimed at the heart of the sector: allowing players more room to invest their resources to raise their long-term returns and to strengthen their viability. In mid-July, the China Insurance Regulatory Commission (CIRC) unveiled the ‘Interim Measures for Investment Management Entrusted by Insurance Funds’ that allows insurance funds to entrust investment management to securities companies and fund managers.
Asia Asset Management in collaboration with BNP Paribas Securities Services hosted a luncheon in Beijing in September, which brought together a number of leading Mainland insurers to discuss the way forward, how the new measures are likely to impact on the sector, and to assess the new opportunities ahead. It was the sixth in a series of Quintessence luncheons that Asia Asset Management has hosted in the past year.
Risks related to asset delegation
Li Quan, chief executive officer of New China Asset Management (NCAM), noted: “From our perspective, investment returns in the past few years have been lower than expected as a result of the downturn in domestic equity markets. The impact on the bottom line for insurers has been significant, putting pressure on them to reverse the slide.
“For example, Mainland insurers currently have total mortgage assets of somewhere between 50 trillion yuan (US$7.9 trillion) and 60 trillion yuan; returns have averaged about 6.5% per annum excluding administrative and management fees. Thus, market watchers have raised questions on whether the investment constraints on insurance companies have limited their performance.”
Mr. Li remarked that insurance companies can do better to boost returns and said they may well benefit from outsourcing their assets to third parties. Returns could also be enhanced through diversification across a wider array of asset classes.
He said: “The insurance industry welcomes the latest measures from the CIRC. From a risk control standpoint, we understand the market watchdog considers risk to be a critical element. However, insurance companies have already borne considerable risks when it comes to investing in equity products. It is very common for A-share equities to shed 50% to 60% within a short period of time. Apart from the investment in derivatives products and overseas markets, we believe the risks associated with asset outsourcing are controllable and acceptable in general.”
Mr. Li added that the new measures are expected to have a significant impact on capital flows in the long run: “We’re very excited about the new regime and from a risk perspective; the measures will certainly go a long way in promoting industry growth and sustainability. This, together with expectations of achieving higher investment returns, will lead us to significantly reposition our asset allocation base. We think it will then allow us to lower the weighting in risky asset classes.”
Picking third party managers
Taikang Asset Management Chief Operations Officer Ni Li opined that insurance companies need to carefully consider the strengths and weaknesses of external managers. “If insurance companies are too hasty ‘testing the water’ without thoroughly assessing what these managers are capable of, it is possible that they may not perform as well as the internal investment teams of insurers. The outsourced managers should complement the internal investment teams. A key rationale for outsourcing is highly hinged on whether the insurance companies are pressured by their clients.”
China Re Asset Management (CRAM) Chief Operating Officer Lv Ri says that the CIRC and the China Securities Regulatory Commission (CSRC) have to consider third party asset delegation from a macro perspective. “The reform is bilateral. For the initial phase, domestic fund managers and securities brokerages are allowed to dabble in insurance asset management. Insurance companies, in return, will have to be permitted to break into the mutual fund business in the longer term. Both of the regulatory bodies are eager to garner larger market shares in the country’s asset management pie; it is therefore critical for them to reach a common consensus over the issue.”
Mr. Lv continued: “China Re Asset Management has undertaken significant research on the new policy. We conclude that the more mature the investment scope is, the more likely the insurance companies are to delegate their assets to third parties. By contrast, if the market is less developed, insurers would prefer to oversee their assets in-house. However, the policy is unlikely to precipitate into competition between the external managers any time soon. Although some fund managers and securities brokerages have the advantage of being the first movers, the majority are still not ready to break into these new areas.”
Mr. Li noted: “From a regulatory standpoint, the market watchdog hopes to implement the new policy as soon as it is feasible, but I agree with Ms. Ni’s perspective that it should not be exercised in a hurry. As insurance firms are at various stages of growth, each should consider its own merits with regard to the new measures.
NCAM, according to Mr. Li, has managed its investment well in spite of the difficult investment environment. “The company does not urgently need to outsource. We will consider appointing external managers only if the market is mature. However, the outsourcing will take place sooner rather than later for insurance companies which have conflicts between their internal investment affiliates and their clients.
“Many third party entities are touting their investment capabilities, but only a handful of them are worth their salt. Our criteria for selecting external managers is based on their product line-up, risk controls and credibility. In comparison, insurance companies’ internal investment entities are more proficient at risk controls. The parent groups have a greater motivation to safeguard the insurance assets. However, we also need to take their investment capabilities into consideration,” he explained.
To be sure, Mr. Li noted that third party fund managers may enjoy certain competitive advantages: “Some asset classes can be accessed by fund managers or securities brokerages but not by insurance companies. If we favour these asset types, we will then definitely allocate to these assets through third party managers.”
Mr. Li said that the insurance industry is mindful of the challenges in managing its portfolios. “We have to be realistic about our limitations as the industry does not enjoy a monopoly on investment management talent. Insurers operate very differently from asset managers. We believe insurance firms will be able to retain talent when the market is further liberalised, but NCAM would rather leverage on the capabilities of third party asset managers, particularly firms that are able to demonstrate stellar track records.”
Ms. Ni observed that insurance asset delegation involves many challenges and issues. “Operational risks are among one of the top concerns. Although the outsourced fund managers and securities brokerages are all qualified, the delegation processes may involve many issues such as data mergers, trading platforms, and system coordination that will significantly raise the cost for insurers,” she said.
Mr. Li stated that the issue of investing offshore is a novel one; current holdings by Mainland insurers of foreign currency denominated assets are minuscule. “The mechanisms are not in place yet for insurers to go abroad,” he noted. In addition, he said that global market volatility will deter insurers from venturing offshore. “Against the backdrop of a volatile market environment, it is important for insurance companies to manage market risks and to cover their operating costs. In our case, while we expect to raise our allocations to the various asset classes, fixed income will likely remain to be a major focus going forward.”
According to Ms. Ni: “There were many derivatives and trust products in the early 2000s, such as collateralised debt obligations (CDOs). Many product providers approached us to market the collateralised products at that time. However, the company decided to stay away from the products because it did not fully understand how to gauge its risk exposures. When the credit crunch hit, which drove many CDO holders into insolvency during the global financial crisis, we managed to steer clear. This was the lesson the company learnt before we set up our overseas subsidiary in Hong Kong in 2007.”
She added: “After the formation of our Hong Kong office, we decided to replicate the strength of our domestic business model overseas. Insurance companies are relatively good at managing long-term bond asset allocations and stable strategies. Therefore, we replicated our investment capabilities in fixed income to develop the products in Hong Kong. Aside from that, our overseas office launched an equity fund when global equity markets underwent a significant rebound stemming from the first round of the US quantitative easing (QE) in 2009.”
Diversifying investment scope
Ms. Ni remarked: “From a management board’s perspective, producing sustainable investment returns, managing costs and ensuring a viable product line-up are among the main factors that would improve balance sheets. Governance has to be more comprehensive when market conditions are volatile. Investment decisions should not be affected by pressure from operations. In addition, a company’s investment entity should have good interaction with its management board.”
Secondly, she added: “In terms of asset allocation, insurance companies cannot solely rely on two to three conventional asset types. It is important for them to broaden their investment scope and introduce new products. For example, we have recently focused more on community retirement products. We believe it is one of the most important financial products for asset allocation, which has significantly affected investor’s portfolio composition.”
Ms. Ni went on: “I echo Mr. Li’s view that infrastructure and equities still have plenty of room for further growth. I’ve seen that the market has strong demand for direct investment. The market is expected to have a larger platform for debt financing going forward. Insurance companies are able to build dedicated teams to make long-term investments in these projects if they are awarded the related licenses.”
Separately, BNP Paribas Securities Services Head of Asia Pacific Lawrence Au raised a question on whether insurance companies should increase their exposure to domestic infrastructure projects. Ms. Ni noted that the government’s affordable housing and fixed-priced housing projects released last year did offer good opportunities to insurance companies.
“However,” she said, “the company decided not to participate in the projects because not much research had been undertaken. In addition, the efficiencies and returns from state-owned infrastructure projects are very low.”
Mainland insurers currently sit on more than 6 trillion yuan worth of assets. Mr. Li said third party fund managers and securities brokerages are unlikely to make major inroads in tapping these assets, at least not in the short- to medium-term. “Their focus is on conventional products such as bond funds, equity funds and money market funds – collectively they account for a significant proportion of their business. However, if managers can develop products to cater to the insurance industry, especially for long-term asset allocation, they should be able to tap into the market more effectively in the longer run.”
Criteria for custodian banks
In terms of selecting custodian banks, Ms. Ni noted that the difference between onshore and offshore custodian banks is huge in terms of integrating resources. “We tend to select offshore custodian banks with strong specialty and technical expertise. For example, we assess whether the custodian banks are capable of providing support and assistance to our business or whether they can complement our operation model. We believe the task of custodian banks is not only limited to trade settlement. Rather, we hope that they can play a greater role in terms of leveraging our resources as well as helping in expanding our business into new areas.
When asked whether the offshore custodian banks with local teams in China have the edge to attract Mainland insurance companies, Ms. Ni noted: “If the services are at the same level, the custodian banks with a local presence are certainly preferable because their Chinese teams can provide services to us directly and effectively. Taikang is developing its asset management franchise and we do expect it to take a relatively long period of time. Therefore, custodian fees and capabilities are among the most important factors for us to consider when it comes to selecting custodian banks.”
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