In recent years, China's non-bank peer deposits have surged significantly, primarily driven by the redirection of personal demand deposits towards money market funds and cash management financial productsThis shift not only supports the rapid growth of cash assets but reflects a changing landscape in investment behavior within the nationPersonal savers are increasingly looking for better returns, leading them to seek alternative avenues for their fundsIn doing so, they have inadvertently affected the dynamics at play in China's financial ecosystem.

The backdrop of this transformation has been exacerbated by the recent release of two significant documents from a market-oriented interest rate pricing self-regulatory mechanism

These documents have implications for the expected returns and asset allocation of cash management products and money market fundsUnder the new regulations, the interest rates applicable to non-bank peer demand deposits are now included in self-regulatory management, presenting a paradigm shift in how these assets are priced.

Liao Zhimin, the chief analyst for fixed income at Huayuan Securities, has pointed out that the alterations stemming from these new regulations will likely result in a substantial decline in the yields of cash productsThe decline could be as notable as 30 basis points in pre-fee revenue yields for money market fundsIndustry insiders have indicated to media sources that while these regulations may disrupt the yield from cash products, they could also complicate the configuration choices for associated products, potentially leading to greater yield fluctuations during the adjustment period and subjecting managers to additional pressures.

Projected 30 Basis Point Yield Drop for Money Market Funds

The substantial scale of investments in peer deposits is a crucial factor contributing to the heightened impact of these new regulations on cash asset management products

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Recent reports from Huayuan Securities indicate that by the end of October, the balance of non-bank peer deposits had reached an astounding 31.2 trillion yuan, with demand deposits alone likely constituting around 15 trillion yuan.

The primary sources of non-bank peer deposits include publicly offered funds (with money market funds being the largest segment), bank wealth management, brokerage asset management schemes, trust schemes, insurance asset management plans, as well as non-bank institution proprietary funds and funds accumulated by financial infrastructure institutions.

Among them, cash management products and money market funds hold a significant amount of non-bank peer depositsAccording to statistics compiled by Guosheng Securities, as of September this year, cash and deposits made up 46.8% of money market fund assets, corresponding to an asset scale of approximately 6.1 trillion yuan

By mid-year, cash and deposits constituted 25.3% of the wealth management assets, translating into 7.7 trillion yuanCollectively, these figures suggest that wealth management and money market fund categories dominate the deposit and cash market with a total of 13.8 trillion yuan, representing nearly half of the bank's peer deposits.

The aforementioned Huayuan Securities report indicates that the two segments combined currently account for roughly 21 trillion yuan in funding, with an estimate that they collectively invest about 9.2 trillion yuan in bank depositsNotably, among this investment, peer demand deposits are estimated at around 3 trillion yuan, while peer time deposits exceed 6 trillion yuan.

Specifically, as of mid-2023, the scale of money market funds stood at around 13.2 trillion yuan, while cash management products amounted to 7.49 trillion yuan

Out of this, money market funds have allocated approximately 5.94 trillion yuan to bank deposits, out of which demand deposits account for 1.48 trillion yuanBy the end of the third quarter, money market funds had increased their investment in bank deposits to 6.64 trillion yuan, representing nearly 50% of money market fund assets, while the proportion of cash management products investing in bank deposits was about 35%.

Liao Zhimin further elaborates that the purchase of both money market funds and cash management products—both classified as cash-type products—has caused personal deposits to be redirectedThe cash products then reinvest at competitive rates back into banks or into certificates of depositThis effectively converts personal deposits into non-bank peer deposits or certificates of deposit.

With non-bank peer demand deposit rates now subjected to self-regulatory management, the new ceiling rate is anticipated to align with the central bank's seven-day reverse repurchase rate, currently at 1.5%. Predictions state that non-bank peer demand deposit rates will decline broadly to 1.5% or lower, consequently dragging down money market asset yields significantly.

In this context, how will the new regulations further affect the yield of cash management asset management products? Liao Zhimin anticipates that the current standards will lead to money market fund pre-fee yields declining by approximately 30 basis points

As of November 23, 2024, the average annualized yield for money market funds stood at 1.44%, indicating that the downward trend in money market fund yields observed in recent years is likely to continue.

Liao argues that this yield downtrend will significantly diminish the attractiveness of cash products for individual investors, thus alleviating the pressure on personal demand deposit losses in banksHowever, it will simultaneously heighten the pressure related to reducing product fees.

"At present, the overall average management fee for public money market funds stands at around 25.8 basis points, with custody fees at 6.0 basis points and sales service fees amounting to 16.8 basis points, leading to a comprehensive fee ratio of 48.5 basis points

Certain brokerage asset management products charge management fees as high as 90 basis points, deviating from the inclusive finance aim of public productsAfter the pricing norms, money market asset yields are predicted to drop to roughly 1.5%, which will challenge the sustainability of a near 50 basis point comprehensive fee structureTherefore, significant reductions in the comprehensive fee, especially the sales service charge, may be essential," noted Liao.

Peer Deposit Allocation Will Be Passively Reduced

Additionally, the new guidelines standardize the pricing behavior for non-bank peer time deposits withdrawn ahead of maturity, capping their rates of early withdrawal at the excess reserve rate (presently sitting at 0.35%).

This development signals that condition-free early withdrawals of peer time deposits will gradually become passé. According to the definition of illiquid assets, peer time deposits will be regarded as illiquid financial products

For money market funds and cash management products that price their assets at amortized cost, their preference for asset allocation will be impacted.

Liao further notes that this modification is likely to significantly lower the proportion of peer time deposits held by cash-type products, thereby increasing the allocation towards peer demand depositsThis shift will consequently lower the yield levels of cash productsNotably, for money market funds, the previous loophole for arbitraging peer time deposits will effectively be closed, as the investment proportion in peer time deposits is expected to drop below 10%.

Before this development, engaging in banks' deposits that permitted early withdrawal without interest loss was a method to assure liquidity while boosting portfolio yields, positioning itself as a vital strategy for enhancing product competitiveness among money market funds

Analyst Qin Han from Zheshang Securities pointed out that existing regulations stipulated that significant money market funds could not have fixed-term deposit allocations exceed 30%. However, deposits allowing for early withdrawal were not subject to this constraint, and the new regulations are poised to affect money market funds' inclination towards these deposit types.

"Due to the substantial interest penalties imposed on early withdrawal of non-bank peer time deposits, money market funds must ensure that such deposits are not withdrawn ahead of maturityOtherwise, fund managers could be liable to compensate investors for the interest lost," explained LiaoWith the unrestricted early withdrawal of non-bank peer time deposits a relic of the past, cash products will face heightened liquidity risks, which may necessitate an increased investment ratio in non-bank peer demand deposits to guard against liquidity challenges

The upper limit for non-bank peer demand deposit rates aligns with the central bank's seven-day reverse repurchase rate, further exacerbating the decline in money market fund yields.

At present, liquidity-restricted asset management regulations are largely aligned for cash management and money market fund investments, meaning that investments cannot exceed 10% of the product's net asset value.

Each cash management product is allowed to invest in bank term deposits with maturities exceeding ten trading days (including banks with conditional early withdrawal agreements), but the total must not surpass 10% of the product's net asset value.

Qin Han posits that taking into account the implications of the new regulations on cash management products, stakeholders should remain attentive to whether regulators will introduce supplementary measures

Absent such measures, the engagement of cash management products in deposit configuration may undergo substantial adjustments considering the existence of "negative deviation." Liao Zhimin expects that the investment ratio of cash management products in non-bank peer time deposits will significantly fall, redirecting investments towards certificates of deposit, short-term bonds, and non-bank peer demand deposits.

In addition, Guosheng Securities’ fixed income analyst Yang Yewai has noted that compared to previous peer deposit rates of around 1.7% to 1.8% or even higher, if peer demand deposit rates maintain near 1.5% under the new guidelines, the drop in yield could induce a trend of redeeming demand deposits in favor of increased investments in certificates of deposit, short-term debt, and more substantial repurchase transactions.

Liao Zhimin also emphasized that an enhanced investment in certificates of deposit and short-term debt is predicted to significantly elevate the risk of negative deviation within cash products, compelling managers to strengthen their liquidity management capacities.