Foreigners in the firing line as Chinese regulators take aim
- • The fund management industry could be next in the regulators’ cross-hairs
• Liability could ensnare companies exposed via subsidiaries and joint ventures
• Market and political risks are the same for China’s investing public
By Pauline Loong
China’s aggressive enforcement of its anti-monopoly law in recent months is not some flash-in-the-pan crackdown. The move has all the hallmarks of a wider campaign aimed at establishing the credibility of the Xi Jinping administration’s pledge that the law applies to all — the politically powerful as well as the low-level Party cadre – or "tigers and flies" as China's rulers term them.
The anti-corruption drive has already bagged large numbers of Chinese tigers and flies. Attention is now shifting to foreign entities that break the rules.
Tigers and flies alike under are pressure in Chinese regulators' latest crackdown
Photo: Lintao Zhang \ Getty Images News
International media spotlight has so far focused on the antitrust investigations, which have exploded this summer. More than 30 foreign firms have come under official scrutiny including big names such as Microsoft and Qualcomm. Fines in some cases can go as high as US$1 billion. Adding to corporate anxiety are the dramatic tactics employed by Chinese investigators such as simultaneous multi-city dawn raids on the offices of targeted companies.
But the worst may not be over.
Next in line for regulatory attention could well be players in the trust and fund management industry – particularly those involved in selling high-risk structured funds and investment products to retail investors. A company does not even have to be active in the market. Exposure through a troubled subsidiary or a joint venture could be enough to drag the foreign parent or partner through an investigative nightmare as regulators seek to determine liabilities.
The dreaded D-word amid grassroots anger
The risk of defaults inevitably rises as the economy slows – especially as many of China’s current retail offerings are little more than vehicles to raise funds to lend on to third parties. But while banks can quietly write off non-performing loans, failed investment products can only end in high-profile defaults.
Public perception has always been that the state does – and should – stand behind retail investment products. Despite government attempts to distance itself from private sector offerings, a failed investment typically brings out large angry crowds demanding that the authorities take responsibility for their losses.
Market and political risks are one and the same for investors in a society where government power is seen as near absolute. The Huaxia Bank protests that made global headlines last year hinged on public perceptions that the bank which distributed the failed investment product should be forced by the government to make good on the default.
Grassroots anger is Beijing’s worst fear.
Families searching for higher returns than bank deposits have been pouring their savings into structured products. Household exposure is significant. Investment in wealth management products stood at renminbi12.8 trillion (US$2.1tr) at the end of May, according to central bank data. To put this into context, China’s broadest measure of new credit known as aggregate financing came to Rmb 10.5 tr in the first six months of the year.
The near-collapse in February of the Rmb3bn (US$480bn) product that essentially provided financing for a coal mining venture came even closer to home on the issue of liability. The product was issued by a trust company but sold through the private banking arm of ICBC, China’s biggest bank and state lender and not a mixed-ownership lender as in the case of Huaxia. Investors demanded that ICBC be held liable. In the end, somebody blinked. Default was averted when an unidentified white knight turned up at the last minute with enough spare cash to finance a bailout.
Liability firewalls, dawn raids and the writing on the wall
Defaults in China go beyond financial market stability. A vice-governor of the central bank made it clear in June that regulation of the wealth management product market is “not only a financial issue, but also a major economic and social issue.” He added that more will be done to regulate the market, to control risks, and to ensure “the value of people's financial assets preserved and increased”.
The regulators already have policy approval for action. The State Council issued a directive – Document #107 – to central and local government agencies at the end of last year to pull free-wheeling trust companies back into line. These companies are to be stopped from engaging in "credit-type" business and restricted to asset management which is their purpose.
The writing is on the wall. It is only a matter of time before regulators become involved in disputes over payout in the event of product default and be forced to determine liabilities. They do not have to wait until trouble hits. The government has already stepped up the policing of fund management companies and banks involved in the sale of fund management products with firewall rules announced six weeks ago.
The next hot topic in legal consultations could well be liability firewalling – adding to the current rage in dispensing advice on what to do in the event of dawn raids on the company and how to be seen as having a co-operative attitude.
A Shanghai-based consultant is urging clients to review their risks as there is “an often-substantial mismatch” between many foreign owners' evaluation of the risks being taken and the actual potential for liability on the ground. Foreign businesses in China are in for a long hot summer.
-- Edited by Clare MacCarthy
Pauline Loong is managing director of Asia-analytica Research
Important notice: Nothing in this report is intended to be, or should be construed as, an offer to buy or sell, or invitation to subscribe for any securities or as advice relating to legal, technical or investment matters. This report has been prepared on the basis of information that is believed to be correct and from sources believed to be reliable. Asia-analytica makes no express or implied warranty as to the accuracy or completeness of any such information and makes no undertaking to update any such information. Opinions expressed are subject to change without notice.