China Signals Coming Crackdown On $3tn Trust Industry

REPORTS THAT THE leading companies in the $3 trillion trust industry are being audited suggest a coming crackdown on a critical part of China’s financial sector: a hybrid of commercial and investment banking, private equity and wealth management.

Bloomberg reports that for the past month, the National Audit Office has been going over the books of at least 20 trust firms, including the top five.

The concern is the risks the sector poses to financial stability. No other set of financial firms invests in such a broad class of assets, from property to stocks, bonds and commodities. They are also a key intermediary in China’s shadow banking system, a conduit for deposits into risky investments via products often designed to dodge capital or investment regulations.

Auditors appear to be focusing on trust firms’ loans to property developers, suggesting renewed concern on the part of authorities that the problems of the beleaguered property sector could spill over into the broader financial system.

So far this year, trust firms defaulted on $8.6 billion of investment products linked to property developers, according to industry data tracker Use Trust — the knock-on effect of developer defaults and frozen construction across the country.

Trust firms, including Minmetals Trust and Zhongrong Trust, have bought stakes in at least ten troubled real estate projects this year, betting that unfinished homes will eventually yield cash to pay off some of the $230 billion in property-backed funds they have sold to investors.

It is unclear how long the audit inspections will last, whether more firms will be reviewed, or what regulatory actions will follow.

Improving trust firms’ transparency and risk management seems the very minimum to expect. However, that in itself will be insufficient without other changes. Municipal finance needs reforming so that local authorities are not so dependent on land deals to raise revenue and mainstream financial institutions need to offer new retail savings and investment products that can be an alternative to those provided by the shadow banking system.

As Beijing has shown with its rectification of the platform tech companies, it is willing to bear the costs of disrupting even a large domestic industry once it believes that the cost of not doing will be even higher.

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