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Wealth Management in China: Growth Prospects and Risk Controls

Yannis Sardis, 17 June 2021

In an environment of historically low interest rates, cross-asset over-valuations and an abundance of new investment products and client services, financial institutions of all sizes seek to establish, expand, or strengthen their footprint in markets that can yield the greatest opportunity of client acquisition, across the spectrum of investable assets, from the mass affluent to the high-net-worth clientele.

Greater China and Wealth Management

Considering that sheer asset size and demand for investment solutions matter in such a selection process, the Greater China region (including the Mainland, Hong Kong, Macau and Taiwan) seems to be the natural focus for most financial groups that wish to capitalise on the gradual opening of its vast financial industry. Recent approvals from Chinese regulators allow foreign financial institutions to set up joint ventures with local financial groups, a fact that allows both parts of the partnership to accelerate their expansion in the world’s 2nd largest economy.

The economic development that the country has been going through has resulted in the accumulation of wealth by individuals, who rapidly enter the wealth management industry, to preserve their earned capital and develop investment strategies that will ensure its incremental growth. To meet such demand, local and foreign wealth and asset managers are expanding their palette of investment funds, across liquid and illiquid strategies, and ranging from traditional assets to private equity and venture capital choices.

Regulatory Oversight: Tightened Controls

China’s wealth management sector has historically been associated with the provision of higher risk products, often with lower liquidity. To protect individual investors, Chinese authorities have started imposing stricter sets of rules that aim to prevent the sale of products that may be unsuitable to certain client profiles, and overall increase the quality of corporate governance within wealth management organisations. The new rules aim to strengthen the risk management practices of local wealth managers, including those related to client background profiling and investment suitability checks.

Although the private banking units of top Chinese commercial banks currently dominate the local market, smaller and medium local wealth management operations are strategically positioned for servicing and advising wealthy clients who are created at a fast pace (and considering that the gradual crackdown on shadow banking forces such investors to seek mainstream solutions).

Risk Management Technology

In every effort of introducing diligence and transparency in the financial markets, technology plays a critical role, especially if one wishes to adopt accurate and scalable solutions.

For most of the investable assets in China that are allocated to non-deposit products, wealth managers will seek solutions that will allow them to not only assess their performance characteristics but most importantly to measure the risk that they are assuming to execute their strategies and achieve their targeted returns. The asset allocation shift that the new regulations will instigate in wealth management, will need to be facilitated by smart and focused risk analytics that will contribute to the managers’ efforts to view the output of their portfolio management systems through a risk-adjusted prism of light.

Wealth Management: How to Differ (or ‘The Avoidance of Capital Dislocation’)

The essence of most risk controls introduced by authorities worldwide, is to lead investors to assess their wealth’s vulnerability to future price fluctuations, by stress-testing the loss-tolerance of their multi-asset portfolios for unexpected changes in stock price volatility and FX, interest rate curve and credit rating shifts, and cross-asset correlations.

The necessity of a holistic approach to risk assessment, especially in markets of China’s size and complexity, is amplified by the growing number of investment vehicles, fund types and alternative asset pools such as derivatives, private equity, private debt, real estate, and tailored structured products.

The ability to implement a multi-faceted portfolio risk analysis can alert the diligent investor and money manager to undertake a frequent evaluation of a portfolio’s risk exposure to normal or Black Swan market conditions, by producing:

  • A risk decomposition analysis for a list of categorizations such as asset class, sector, risk country, reference currency, credit rating and underlying security holdings, thus effectively identifying unwanted asset concentrations
  • A stress-testing simulation framework, for assessing a portfolio’s tolerance to adverse market actions, via past historical crises and customized disaster scenarios, so that investors can estimate the evolving cross-correlations.

This way, money managers can:

  • Timely risk-control their clients’ global asset allocation
  • Protect their clients’ capital with a daily risk assessment
  • Use one system and one dataset (for pricing and reference data) to manage risk
  • Raise the value of their operation for their client and outpace their competitors.

Risk Management: How to Scale (or ‘How to Create Value Across the Firm’)

Although we cannot predict the size and timing of the next financial crisis, we can mitigate the various portfolio risks via disciplined and systematic risk-adjusted considerations. Our experience shows that such a framework would benefit various teams within a firm in their efforts to assess how such risks can influence their line of business, namely:

  • Portfolio Managers: How extreme market events and volatility spikes can impact the valuation of the firm’s investment strategies
  • Relationship Managers: Give clients a holistic portfolio management outcome, providing risk-adjusted performance and valuation figures
  • Risk Officers: Assess the market risk that a firm is exposed to, through predictive ex-ante risk metrics and stress-testing scenario analytics
  • Compliance Officers: Ensure that the group’s trading activity conforms with its pre-determined investment policies and regulatory requirements
  • Executives: Decompose the firm’s client portfolios or managed funds and gain visibility to the market segments that expose it to the biggest risks.

In Chinese culture, Guardian Lions are a strong Feng Shui protection symbol of family wealth. Investors should think about establishing a set of sound principles for protecting their wealth and secure their succession planning. Managing one’s various risks rather than simply moulding expected returns could be the first step to such an endeavor.

FINVENT Software Solutions is a provider of financial software applications and custom engineering services. The award-winning KlarityRisk platform specializes in investment risk analytics and fixed income performance attribution reporting and it is offered to Private Wealth institutions, Asset Managers, Hedge Fund Managers and Family Offices.

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