China Tightens Rules for Trust Companies

China Tightens Rules for Trust Companies

China’s authorities are making a concerted effort to regulate the activities of the country’s trust companies. Trust companies are non-bank lenders that raise funds by selling high-yielding investments known as wealth management products (WMPs). They then use the proceeds to fund loans to risky borrowers to whom banks are reluctant to lend.

But it is believed that this practice, otherwise known as “shadow banking”, could lead to liquidity problems which could in turn threaten a risk to the financial system.

Trust companies have been operating so-called “fund pools”, a term which refers to pools of cash and credit assets from various different WMPs that banks and their trust company partners maintain. These enable them to fund cash payouts on maturing products with the proceeds from new WMP sales.

But China’s regulators are worried that this could turn into a “Ponzi scheme”. This is named after Charles Ponzi, an American businessman who became infamous for operating a fraudulent investment operation in 1920. The operator, be it an individual or an organization, pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by the operator.

Operators of Ponzi schemes usually entice new investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the high returns requires an ever-increasing flow of money from new investors to sustain the scheme.

The scheme is unsustainable in the long run. It collapses either when the promoter vanishes with all the proceeds; investment in the scheme slows down and there are insufficient funds to make the payouts; or if external factors lead to investors withdrawing their funds.

The China Banking Regulatory Commission (CBRC) wants trusts to strictly match each WMP with a specific set of underlying assets, rather than pooling cash and assets from different products together into common pools.

But trusts are under pressure to use fund pools because doing so allows them to offer more attractive yields on the WMPs they sell. Such products typically carry a maturity of a year or less, even as the assets underlying such products are often longer-term loans that cannot be easily sold when the WMP matures and cash is due to investors.

The stakes are high. Assets under management at Chinese trust firms rose to 10.9 trillion yuan ($1.8 trillion) at the end of last year, meaning that trusts surpassed insurance companies to become the largest sector of China’s financial system after the commercial banks.

But several high-profile defaults on trust products earlier this year based on loans to struggling coal producers raised concern over systemic risks. China has heeded the warning, and trusts will have to reduce lending when their capital levels fall due to losses. The regulator also pledged to tighten the approval process for trusts to expand into new business lines.

Most Recent News

UK Will Open New Business Immigration Routes

UK Will Open New Business Immigration Routes

UK Closes Immigration Route to Investors

UK Closes Immigration Route to Investors