Banks prohibited from selling private equity? Will there be a "one-size-fits-all" approach? In-depth analysis is here!

Recently, there have been market rumors that relevant departments will revise the regulations on commercial banks selling private equity funds, specifically stating that commercial banks are not allowed to sell private equity funds on behalf of others or indirectly sell private equity funds through other licensed financial products.

In response to this news, reporters from Securities Times China received affirmative information from some industry insiders that commercial banks may be prohibited from selling private equity products, and the brewing of the above-mentioned new regulations may be related to recent irregular operations of private equity funds leading to risks for investors. However, some commercial bank personnel have indicated that whether the new regulations will be implemented remains to be seen.

Will the Ban on Banks Selling Private Equity Funds be a "One-Size-Fits-All" Approach?

Apart from direct sales channels for private equity, banks, securities firms, and other financial institutions are actively sought-after distribution channels for private equity fund companies.

Several industry insiders told reporters from Securities Times China that there is no authoritative statistics on the current distribution channels for private equity, but based on observable phenomena, the private equity industry is mixed, with a majority of private equity fund managers engaging in direct sales. They rely on word of mouth, and a considerable proportion of investments come from existing clients continuing to invest after the maturity of previous investments, but these types of private equity funds generally have smaller scales. Private equity funds that can be sold through banks, securities firms, and other third-party sales companies are usually more well-known and are important avenues for scaling up.

The private banking departments of banks serve high-net-worth clients, who are the main natural target market for private equity products. Compared to clients of securities firms, bank clients have a more conservative risk appetite, and those selected by banks are usually private equity firms with outstanding historical performance. The selection of private equity firms and products by banks requires a strict evaluation mechanism.

Some industry insiders speculate that private equity products are an important direction for commercial banks to allocate assets for high-net-worth clients, especially private banking clients. Regulation may not completely prohibit commercial banks from selling private equity investment products, or there may be tiered conditions, such as establishing a "white list."

Information obtained by reporters from Securities Times China from another private banking department of a commercial bank indicated: "All sales are prohibited."

Many industry insiders are also actively monitoring whether this news will eventually be implemented. For some commercial banks, especially those with a certain scale of private banking clients, the prohibition of selling private equity products may have a significant impact.

In the current publicly available financial report data of banks, the specific scale of private equity sales is not extensively disclosed, and among all financial products sold by banks, the proportion of banks selling private equity products is not high. However, for the private equity industry, banks are important distribution channels.

Some commercial banks with a certain scale of private banking clients have private equity sales exceeding hundreds of billions. State-owned banks, leading joint-stock banks, and city commercial banks with good retail layouts have a vast amount of high-net-worth client resources. For example, among joint-stock banks, China Merchants Bank and Ping An Bank excel in retail business and are platforms that private equity firms are eager to enter. According to 2023 annual report data, China Merchants Bank's private banking clients exceeded 140,000 households, and Ping An Bank exceeded 90,000 households.

In terms of private equity sales scale, as early as 2008, China Merchants Bank entered the field of private equity sales and was the first bank in China to introduce private equity products. According to the bank's disclosure, the bank's private equity sales scale exceeded 300 billion yuan in 2020, and as of December 2021, China Merchants Bank has served over 370,000 private equity users, of which 82% are high-net-worth clients, with managed private equity scale exceeding 565 billion yuan In addition, according to the data disclosed by the head of the private banking department of Ping An Bank in a media interview, as of around October 2022, the private placement sales volume of Ping An Bank has exceeded 90 billion yuan, with outstanding holdings exceeding 270 billion yuan, of which securities-related private placements account for about 100 billion yuan.

To improve the efficiency of private placement sales and break through the geographical and time limitations of offline counter sales, the two banks mentioned above have also increased their investment in digital operations. For example, the current online transaction ratio of private placement products at China Merchants Bank exceeds 97%, and Ping An Bank has also launched the country's first AI private placement direct platform, realizing 24/7 online autonomous trading of private placement products.

Banks' Sales of Private Placements Actually "Detours"

According to the current regulatory policies on commercial bank sales agency business, commercial banks are not allowed to directly sell private equity fund products. In fact, the private banking departments of commercial banks currently sell private placements to high-net-worth clients, mostly through "sunshine private placements," where the bank acts as a sales channel and invests in private placements through trust plans. In this model, private equity fund companies do not appear in an "actively managed" manner, but rather in the role of "investment advisor."

According to the "Notice on Regulating the Agency Sales Business of Commercial Banks" issued by the former China Banking Regulatory Commission in May 2016, it is stipulated that apart from government bonds and physical precious metals, commercial banks can only sell financial products issued by financial institutions supervised and managed by the former China Banking Regulatory Commission, China Securities Regulatory Commission, and China Insurance Regulatory Commission in accordance with the law.

In other words, the current regulatory policies on commercial bank sales agency business specify the scope of products that commercial banks can sell, which must be issued by licensed financial institutions.

Specific financial licenses include the "Financial License" and "Insurance Company Legal Person License" issued by the China Banking Regulatory Commission or former China Banking Regulatory Commission, the "Insurance Asset Management Company Legal Person License," and the "Securities and Futures Business License" issued by the China Securities Regulatory Commission. In the aforementioned "Notice," to reserve space for future market development, it is stipulated that "except as otherwise provided by the China Banking Regulatory Commission."

Private fund managers are not considered "financial institutions." "Private fund registration and filing is not an administrative license, and the Association does not conduct substantive pre-examination of the registration and filing information of private funds." The China Fund Industry Association has emphasized on its official website and in public occasions multiple times the nature of private fund managers.

Although private fund managers and the private funds they issue need to be registered and filed with the Association, the information disclosed on the China Fund Industry Association website only serves as a carrier of private fund manager registration information and does not constitute recognition of the investment capabilities and ongoing compliance of private fund managers Under the current regulations, private placement products issued by securities firms, fund companies, fund subsidiaries, and other channels can be sold through banks because they are products issued by licensed financial institutions.

In the rumored revision of the regulations, it is clarified that commercial banks are not allowed to act as agents for the sale of private equity investment funds or indirectly act as agents for the sale of private equity investment funds through other licensed financial products. This is a clear prohibition on the "detour" mentioned above, but whether it will be fully implemented depends on the issuance of regulatory documents.

Urgent Need for Clarification and Strengthening of Private Equity Regulation and Legal Status

Currently, there are over 20,000 domestic private equity institutions in China. According to data disclosed by the China Fund Industry Association, as of the end of April 2024, there were 21,032 surviving private equity fund managers, managing 1,152,794 funds with a total scale of 21.99 trillion yuan. Among them, there are 8,306 private equity securities fund managers and 12,489 private equity, venture capital fund managers.

Despite the large number, the structure is mixed and the quality varies. In recent years, there have been many cases of misuse of registration and filing information of the China Fund Industry Association, illegal self-enhancement, and engaging in non-private equity fund management business. There have even been continuous cases of institutions running away, such as the recent "Ruifengda runs away" incident.

For example, a investigative report by Securities Times in late May revealed the "Investigation of Haiyin Wealth's 70 Billion 'Fund Pool': Puppet Shells, Cross-Nesting, and Empty Bottom Layers". Haiyin Wealth, a top three third-party wealth management company in the industry, sold all its wealth management products in violation of regulations and manipulated dozens of shell companies to build a "nested fund pool" exceeding 700 billion yuan in scale. The investigation further found that a large number of underlying assets were even confirmed to be completely fabricated and most of the raised funds had unknown destinations.

Once commercial banks are involved in such disputes, they will face more challenging brand reputation issues. For example, in recent years, Shanghai Pudong Development Bank has been exposed to multiple violations in selling private equity products; Shanghai Bank has also been involved in private equity fund explosion incidents multiple times, leading to legal disputes with investors.

Wang Huaitao, a lawyer at Shanghai Xingu Law Firm, believes that the revision of the new regulations on bank sales of private equity may be related to disputes between investors and sales banks arising from the closure of some small and medium-sized private equity firms. He stated that if bank employees as sellers violate regulations during the sales process, such as whether the "dual recording" is standardized, they may be sued by investors for violating suitability obligations and held legally responsible. Once a precedent is set, investors suing banks will severely affect the bank's reputation.

In recent years, private equity fund management companies have frequently violated their fiduciary duties and abused entrusted funds, becoming a hidden risk of systemic financial risks.

It is worth noting that in cases of default, explosions, or even runaways by some small and medium-sized private equity institutions, the disputes between investors and institutions are often only civil disputes. Why is it easier for the "buyer to bear the responsibility" in terms of legal costs of default, while it is more difficult for the "seller to fulfill the responsibility"?

There is a dispute over whether current private equity fund management companies belong to financial institutions under criminal law in terms of legal entity status "Private fund management companies can be the subject of the crime of breach of trust in the use of entrusted property." Li Yong, director of the Research Office of the People's Procuratorate of Nanjing, Jiangsu Province, stated in an article in January this year that the fund management activities carried out by private fund management companies have financial attributes, interpreting them as still within the scope of criminal law provisions regarding financial institutions. From the perspective of the general public, both private equity funds and public funds are financial investment products. The assets managed by a single private fund management company often amount to billions, and the scale of a single private fund may also reach billions, making it an important financial tool for capital circulation. Therefore, interpreting private fund management companies as financial institutions is not beyond the objective prediction of the general public.

The crime of breach of trust in the use of entrusted property has been criminalized for more than a decade. Apart from individual cases, this charge has been almost in a "dormant" state in judicial practice, a phenomenon that could have been avoided through proper interpretation. In the current situation, there is an urgent need to "activate" the crime of breach of trust in the use of entrusted property.

A more proactive approach is that, under the idea of "supporting the superior and limiting the inferior," the private equity industry, which currently has 20,000 surviving private fund institutions, is facing strict regulatory rules to achieve automatic clearance. In December 2023, the China Securities Regulatory Commission issued the "Administrative Measures for the Supervision and Management of Private Investment Funds (Draft for Solicitation of Comments)," which clearly stipulates the requirements for the exit and liquidation of private equity funds, increases the cost of illegal activities, etc., marking a significant event in private equity regulation. It can be seen that since 2023, the private equity industry has started a wave of cancellations, with over 2,500 private equity funds deregistered in just the past year, setting a historical record.

Author: Holly, Source: Securities China (ID: quanshangcn), Original Title: "Breaking News! Banks Prohibit the Sale of Private Equity? Will There Be a 'One-Size-Fits-All' Approach? In-Depth Analysis!"