1 Beijing’s moves to control financial risks could end up increasing them
Nearly 1,300 bank branches have closed in China this year
June 7
Data disclosed by the PRC National Financial Regulatory Administration showed that 1,257 banking branches across China exited the market in the first five months of 2024, a year-on-year increase of 30.41 percent. During the same period, 927 banking branches were established, resulting in a net exit of 330 banking branches.
The proportional breakdown of banking branches that exited the market was as follows:
- Rural commercial banks: 527 branches, accounting for 41.93 percent.
- Rural credit cooperatives: 226 branches, accounting for 21.16 percent.
- State-owned banks: 227 branches, accounting for 18.06 percent.
- Joint-stock banks: 94 branches, accounting for 7.48 percent.
- Urban commercial banks: 82 branches, accounting for 6.52 percent.
- Village and township banks: 34 branches, accounting for 2.7 percent.
- Foreign-funded banks: 16 branches, accounting for 1.27 percent.
- Policy banks: 6 branches, accounting for 0.48 percent.
- Rural cooperative banks: 5 branches, accounting for 0.4 percent.
Financial regulation and expansion of anti-corruption efforts
June 4
China Merchants Bank said in a post on its official WeChat account that the bank’s headquarters recently conducted a special study session where it was emphasized that the bank must eliminate “erroneous notions” such as the “exceptional theory,” “elite theory,” “special theory,” and others.
June 7
1. Bloomberg News reported that the PRC National Audit Office sent a team of about a dozen staff each to at least 10 of the top mutual funds in China in the past weeks, citing people who requested anonymity in discussing a private matter.
The people said that the National Audit Office team “screened through documents, focusing on expenses.” Two of the people said that the staff at the mutual funds were asked to give full support to the audit teams. Another person said that the work was part of routine audits and a constitution of the examination of large funds.
Bloomberg reported that Chinese mutual funds have been under pressure for collectively losing 1.9 trillion yuan in the two years up to 2023. Earlier this year, several companies proposed capping staff salaries at around 3 million yuan in response to Xi Jinping’s “common prosperity” initiative.
2. Mainland media reported that there was a rumor circulating in the market that the State-owned Assets Supervision and Administration Commission was about to release a document requiring senior executives of major public fund companies who earn in excess of 3 million yuan a year from 2019 onwards to return a portion of their salaries to their respective companies.
Mainland media claimed that some individuals in the public fund sector told reporters that the rumor was true. The individuals added that senior executives who left their job may also be required to return a portion of their salaries, although the move may not be mandatory (i.e. senior executives who left their job may receive a notification without a clear time frame to return part of their salaries). However, mainland media said that other leading figures in the public fund sector said they have not heard such news.
Mainland media further reported a rumor about the regulatory authorities conducting a comprehensive review of all fund companies, which would mark the official start of the anti-corruption campaign’s targeting of the fund industry. Also, another rumor claimed that Zhang Kun, a prominent fund manager from E Fund Management, (China’s largest asset management company) had allegedly claimed more than half of the company’s annual reimbursement quota. E Fund Management later refuted the rumors as false.
At the time of writing, all mainland media reports on the above issues had been scrubbed from the internet.
3. State-run Shanghai Securities News reported rumors that the Shanghai Stock Exchange will implement tiered fee rates for quantitative trading. As part of the adjustment, the highest rate would increase to 500 percent of the current rates plus an additional cancellation fee.
Shanghai Securities News added that recent rumors claimed that the Shanghai exchange would also focus on traders implementing the following two scenarios when engaging in programmatic trading. First, orders that are immediately canceled within the same second, with the total number of such cancellations exceeding 500 times in a day. Second, cancellations in a day that exceed 50 percent of the total number of orders. The Shanghai exchange will pay special attention to traders who carry out both scenarios and issue a letter of inquiry.
A private equity professional told Shanghai Securities News: “We have clearly felt that recent monitoring of quantitative trading behavior has become increasingly detailed and precise. The stock exchange will send letters to brokers regarding abnormal trading behaviors, including verbal notifications, notification letters, and warning letters. These letters specify which products violated trading regulations, the type of violations involved, and require the manager to provide an explanation or correction. Currently, trading behaviors that exceed limit violations, are suspected of price manipulation (such as placing orders at the daily limit price, orders with a price deviation greater than 2 percent, etc.), involve large concentrated transactions, or net selling are all being closely monitored and warned against.”
June 9
The Central Commission for Discipline Inspection announced on its website that Xu Zuo (age 58), the vice general manager of China CITIC Group and a member of its Party Committee, was currently under investigation for “suspected serious violations of discipline and the law.”
***
Xu Zuo held senior management positions at CITIC Dicastal Co. Ltd. in the early part of his career. After CITIC Group was investigated for short selling and profit transfer during the stock market turbulence in China in 2015 (i.e. the “financial coup” against the Xi leadership), Xu, who was then chairman and Party secretary of CITIC Dicastal, was appointed assistant general manager of CITIC Group in October 2016. In June 2019, Xu was promoted to vice general manager.
June 10
State-run media Securities Times reported that the “relevant authorities” would revise regulations concerning commercial banks’ distribution of private equity investment funds. The new regulations would explicitly prohibit commercial banks from distributing private equity investment funds or using other licensed financial products to distribute these funds indirectly.
Securities Times said that private equity funds actively seek to use banks, securities firms, and other financial institutions as distribution channels in addition to using their own direct sales channels. This is because high-net-worth clients served by the private banking divisions of banks are the natural target audience for private equity products. Also, some commercial banks with significant private banking client bases have distributed products on behalf of private equity funds exceeding hundreds of billions of yuan.
Securities Times quoted several industry insiders as noting that private equity funds sold through banks, securities firms, and other third-party sales companies are usually well-known, making these channels crucial for scaling up.
One industry insider speculated that private equity products are an important asset allocation direction for high-net-worth clients of commercial banks, especially private banking clients. Therefore, regulators may not completely prohibit commercial banks from distributing private equity investment products but may impose tiered conditions such as creating “white lists.”
Another insider from the private banking division of a commercial bank told Securities Times that “all distributions will be banned.”
Securities Times cited data disclosed by the Asset Management Association of China as showing that there were 21,032 existing private equity fund managers managing 1,152,794 funds with a total scale of 219.9 trillion yuan as of the end of April 2024.
Fund manager resignations hit 3-year high
Mainland media reported that over 300 financial products had announced changes in fund managers in the past month as of June 5, citing data from Wind. The 163 departing fund managers represented the highest figure for the same period in the past three years, and was an increase of about 20 percent compared to the same period in 2023 and up about 70 percent compared to 2022.
Listed SOEs commit financial fraud
June 5
Mainland media reported that “state-owned enterprise fraud” recently became a trending topic and sparked widespread discussion.
According to iFinD, a financial data terminal from financial data service provider Hithink RoyalFlush, 21 SOEs had been issued administration penalty decisions for illegal and non-compliant activities this year as of June 4, an increase of 13 compared to the same period in 2023. Additionally, 18 listed SOEs received risk warnings (ST).
Mainland media said that the most talked-about SOE fraud case is that of Jinzhou Port Company, which involves financial fraud and the false disclosure of financial reports. From 2018 to 2021, the company was found to have falsely inflated its operating income by more than 8.6 billion yuan.
Our take
1. The various developments above indicate that China’s financial risks have been steadily rising and are gradually emerging.
The uptick in banking branches exiting the market in the first five months of the year aligns with the recent trend of banks seeing reduced profits, increased non-performing assets, and a credit plunge in April. The closure of banking branches appears to be a cost-saving measure and a reflection of reduced credit demand. The net exit of 330 banking branches is also substantially more than the 77 closures in the whole of 2023, and suggests that China’s financial sector troubles are becoming more severe.
Meanwhile, the National Audit Office’s audit of top mutual funds in China, senior executives being made to return part of their salaries, the limiting of quantitative trading frequency, and investigation of financial fraud in SOEs indicate that Xi Jinping is attempting to address the financial risks left behind by his predecessors (which have worsened over time) through “rectification” and anti-corruption measures. The Xi leadership’s move to deal with SOE financial fraud (particularly after Wu Qing was appointed head of the China Securities Regulatory Commission) is noteworthy because the CCP typically conceals its scandals until they become too big to ignore. The various aforementioned developments further suggest that China’s financial risks — which accumulated during the period of Sino-U.S. “engagement” and bubbled to the surface after the Sino-U.S. “trade war” kicked off in 2018 and with the implementation of “zero-COVID” — have now reached a significant level and require Beijing to adopt tough measures to defuse them.
2. The Xi leadership’s use of tough measures to rectify the financial system will more likely exacerbate rather than resolve risks.
For one, the rectification of public fund companies and salary restrictions on senior executives in those funds would likely turn people away from joining the industry, potentially impacting the profitability of those funds via a talent drain. Meanwhile, restricting the sales channels of private equity funds will reduce their scale, negatively impacting small-cap stocks currently being traded. This will result in decreased liquidity and increased price volatility for small-cap stocks as many of these private equity funds profit primarily through the trading of small-cap stocks.
The CCP authorities’ move to limit quantitative trading appears to be aimed at reining in short selling. However, the move could also reduce trading volumes in stock markets, which could make stock prices become more prone to volatility due to a lack of liquidity in the markets.
3. The investigation into CITIC Group’s vice general manager Xu Zuo suggests that Xi Jinping is looking to scrub financial institutions controlled by Party princelings. CITIC Group has long been swayed by members of the CCP’s “red aristocracy,” and a probe of senior executives in the company will send a signal to the princelings who control other financial institutions that they should not continue to engage in financial activities that benefit themselves but heighten the regime’s financial risks.
The probe of CITIC senior executives could also give Xi more political leverage to rein in the Party elites during a crucial period for the regime. However, increased financial regulation and anti-corruption work will inevitably harm the interests of powerful CCP elites and lay the groundwork for increased internal conflict in the upper echelons of the Party.
2 EU, US tariffs threaten to worsen problems facing China’s auto industry
China’s auto industry sees fierce internal competition
June 7
Mainland media reported that car company executives slammed the severe internal competition within the industry at the 2024 China Auto Chongqing Summit.
In a video speech, Geely Holding chairman Li Shufu said that the degree of internal competition in China’s auto industry is the highest in the world, with successive waves of price wars. Li added that endless internal competition and crude, brutal price wars have led to companies cutting corners, producing and selling fake products, and the emergence of “non-compliant, chaotic competition.”
Zeng Qinghong (曾慶洪, not to be confused with the former Politburo Standing Committee member Zeng Qinghong [曾慶紅], chairman of GAC Group, said in a speech that severe internal competition is untenable. Zeng stressed that a company’s goal is to be profitable and should contribute to society through paying taxes and providing employment. Therefore, the auto industry should adopt a broader perspective and long-term strategy rather than engage in endless competition.
June 11
Data released by the China Passenger Car Association (CPCA) shows the penetration rate of new energy vehicles (NEVs) reaching a record high in May 2024 and the sales of traditional fuel vehicles plummeting. The sales of joint venture brands with low NEV penetration rates were the most significantly impacted.
Details include:
- Retail sales of traditional fuel vehicles in China decreased by 23 percent to 910,000 units in May. During the January to May period, retail sales of traditional fuel vehicles decreased by 9 percent to 4.82 million units.
- Retail sales of NEVs in China increased by 38.5 percent to 804,000 units in May. During the January to May period, retail sales of NEVs increased by 17.4 percent to 1.93 million units.
- The domestic retail penetration rate of NEVs in May was 47 percent, up 14 percentage points from 33 percent in the same period last year. The penetration rate for domestic brands was 71.2 percent while the penetration rate for mainstream joint venture brands was 7.5 percent.
- Retail sales of domestic car brands were 980,000 units in May, a year-on-year increase of 12 percent and a month-on-month increase of 12 percent. The domestic retail market share increased by 7.3 percent from a year ago to 57.6 percent.
- Retail sales of mainstream joint venture brands were 490,000 units, a year-on-year decrease of 21 percent and a month-on-month increase of 8 percent.
- The retail market share of German brands decreased by 2 percentage points year-on-year to 18.6 percent.
- The retail market share of Japanese brands decreased by 3.2 percentage points year-on-year to 14.8 percent.
- The retail market share of American brands decreased by 1.4 percentage points year-on-year to 6.7 percent.
Europe plans to impose tariffs on Chinese EVs
June 7 to June 10
Several Western media outlets reported that the European Union is expected to disclose the tariffs it plans to impose on Chinese electric vehicles over excessive subsidies. Analysts expect tariffs to fall between 10 percent to 25 percent.
Reuters reported that every additional 10 percent of tariffs on top of the existing 10 percent levy would cost EU importers of Chinese EVs about $1 billion based on 2023 trade data, and would come as a “blow for a sector struggling with slowing demand and falling prices at home.” The cost will grow in 2024 as Chinese EV manufacturers expand exports to Europe.
June 8
Turkey raised tariffs on all cars imported from China by 40 percent, according to a presidential decision published in the Official Gazette. The minimum tariff imposed will be $7,000. The decision will go into effect after 30 days on July 7.
June 12
The EU imposed an additional tariff of 21 percent on most imports of Chinese vehicles that cooperated with its investigation on top of the existing 10 percent.
Cars from SAIC face a 38.1 percent tariff because it did not participate in the European Union’s investigation. The duty for BYD cars was 17.4 percent and 20 percent for Geely because they were more compliant with the EU probe.
Big picture
1. Car companies in China started laying off workers in May. Mainland media reported that Li Auto, GAC Honda, and FAW-Volkswagen have let go of approximately 5,600, 1,700, and 565 employees respectively.
Major companies in the automotive industry have also begun layoffs. According to media reports, some departments of Tesla China have laid off more than 30 percent of their staff; Continental plans to lay off over 7,000 employees by the end of 2025; Bosch will cut 1,200 software jobs; and ZF Group may lay off a quarter of its employees in Germany over the next six years.
2. On May 14, the Biden administration sharply hiked U.S. tariffs on various Chinese imports, including increasing tariffs on Chinese electric vehicles from 25 percent to 100 percent.
Our take
1. Intense internal competition in China’s auto industry will create more problems for the sector and affect local finances.
Mainland media has reported on the various problems that stiff internal competition has created for China’s auto industry in general. Many parts manufacturers are running into trouble and lack funds for research and development, and troubled manufacturers are constantly holding meetings on reducing costs. As part of cost-saving measures, many parts manufacturers have lowered their once high-quality standards by reducing inspections and key processes. Meanwhile, some car companies have repeatedly lowered the usage limit standards for parts to consider a new car qualified as long as it can function normally. The auto industry’s cost-saving measures, however, will likely cause more problems for it further down the road and create new risks (i.e. vehicle malfunctions and damages that lead to injuries and fatalities, high repair costs, increased insurance premiums, etc.).
Intense internal competition will likely translate into steep losses for car companies, and especially NEV companies. This would in turn lead to expanded layoffs and reduce the ability of auto companies to contribute to local finances. According to CPCA data, the auto industry’s average profit margin was just 4.6 percent in April, which is lower than the average profit margin of 5 percent for all industrial enterprises. Also, the financial reports of listed car companies show that only BYD, Tesla, and Li Auto managed to be profitable in 2023. With most NEV companies operating at a loss, their tax contributions would be limited.
The auto industry’s ability to support local finances becomes even more worrisome considering that NEVs are taking over traditional fuel vehicles in sales and are affecting tax contributions. The China Automotive Technology and Research Center found that auto taxes account for about 10 percent of the total national tax revenue, and domestic auto retail sales in 2022 reached 20.543 million units with a total tax revenue (excluding tariffs) approaching 2 trillion yuan. A breakdown of the retail sales showed 14.87 million units (72.4 percent) of traditional fuel vehicles and 5.673 million units (27.6 percent) of NEVs. Also in 2022, the purchase tax exemption of NEVs amounted to 87.9 billion yuan, with an average exemption of 15,500 yuan per vehicle.
The auto tax situation, however, is changing with the spike in NEV penetration rates. The NEV penetration rate was 14.8 percent in 2021, 27.6 percent in 2022, 35.7 percent in 2023, 47 percent in May 2024, and is likely to exceed 50 percent by the year’s end. Assuming a 5 percent growth in China’s domestic auto retail sales in 2024 (about 22.8 million units) and a 50 percent NEV penetration rate, the purchase tax exemption for electric vehicles would be nearly 180 billion yuan. Concurrently, retail sales of traditional fuel vehicles would fall to less than 11.4 million units, or down 23.3 percent from 2022. Local governments will see increased financial pressure if current trends in China’s auto industry persist and expand.
2. The move by the EU and the U.S. to impose stiff tariffs on Chinese EVs will likely further intensify internal competition in China’s auto industry and its associated problems, as well as negatively impact the CCP’s strategy of exporting EVs as part of a broader agenda to help the regime achieve global dominance.
Data from the CPCA in May shows that China’s overall car exports are continuing the strong growth trend from the end of 2023:
- Chinese vehicles exported in May increased by 30 percent year-on-year to 569,000 units, according to customs statistics. Also, the export value from cars increased by 17 percent to $10.5 billion.
- Overall car exports increased by 27 percent during the January to May period to reach 2.45 million units, while the revenue from car exports increased by 20 percent year-on-year to reach $46.4 billion.
- NEVs accounted for 24.8 percent of China’s car exports in May, a decrease of 6.8 percentage points compared to the same period in 2023. With the recovery of exports to markets such as South America, the export of domestic brands increased by 27 percent year-on-year in May to reach 319,000 units.
China’s car exports are likely to be affected when EU and U.S. tariffs on Chinese cars go into effect in the second half of 2024. This will put pressure on the domestic market to digest the excess capacity and sharply ramp up the internal competition in China’s auto industry. This could lead to even more intense price wars and could see some car companies exit the market.
