Defaults in China’s $1.8 trillion trust industry are triggering protests and spurring calls from legal experts for clearer rules on sales of investment products.
Li Taishan, a customer of China Construction Bank Corp., said a saleswoman from the lender in the northern province of Shanxi convinced him to invest 3 million yuan ($484,000) in a trust product with a 10 percent indicated return by calling it risk-free. Two buyers of another failed plan, marketed by Industrial & Commercial Bank of China Ltd. and partially bailed out in January, said salesmen told them it was totally safe, even though documents state there is the chance of losses.
China is cracking down on its shadow-banking industry, where finance companies lend with less transparency, as inefficient allocation of capital slows the world’s second-largest economy and threatens social unrest. Ni Shoubin, deputy head of the law school at Shanghai University of International Business & Economics, said China needs a better trust law, while lawyers in Hong Kong say that city’s tighter regulations could provide a model.
“We should have a law for the trust industry that specifies rules on sales, due diligence and risk management,” said Ni. “Some bankers told clients it’s a product sold by both the bank and the trust company, which gives investors an impression that they are investing in deposits. Trust companies don’t fulfill the responsibility of monitoring and controlling risks in the investments they have made.”
ICBC and CCB have stopped distributing trust products as the risk of defaults mount, Securities Daily reported on March 21, citing bank employees it didn’t identify.
Beijing-based press officers at ICBC and CCB said they couldn’t immediately comment on the report. CCB declined to comment on trust rules while two calls to ICBC weren’t answered. There was no reply to faxed questions to both banks after six working days. The China Banking Regulatory Commission didn’t reply to e-mailed questions or telephone calls.
Trust companies in China have acted as intermediaries to arrange funding by wealthy investors for industries that banks have spurned, including coal, solar energy and property. Documents for the two products marketed by ICBC and CCB show they had indicated annual returns of about 10 percent, triple the official deposit rate of 3 percent. They both had a minimum investment of 3 million yuan.
CBRC rules announced in 2007 and revised in 2009 insist trusts should provide detailed information about products and must not make any misleading statements that may influence investors’ own evaluation of risk. The rules also bar them from guaranteeing principal or a minimum return or exaggerating past performance.
The regulator can order a trust product to be terminated if a sale violates its rules. It can require the trust to return all invested principal plus interest to investors and pay a fine of as much as 500,000 yuan.
The 3 billion yuan Credit Equals Gold No. 1 product, distributed by ICBC, was created by China Credit Trust Co. to fund a coal miner in Shanxi that later collapsed. A copy of the contract signed by holders reviewed by Bloomberg does warn about risks and says that there is no guarantee of profits and the chance of losses.
“It’s a problem with sales and marketing of these products,” Liu Mingkang, former head of the CBRC and previously Chairman of Bank of China Ltd., said in a Jan. 22 interview in Davos when asked about Credit Equals Gold. “They should have made clear the return rate is not guaranteed and what kind of risks are involved.”
As many as 30 investors in a product called Songhuajiang River No. 77, which was created by Jilin Province Trust Co. and backed by a loan to private coal company Shanxi Liansheng Energy Co., gathered in front of the Beijing headquarters of CCB today. Investors didn’t receive payments when some tranches matured, according a Shanghai Securities News report in February.
“We didn’t know it’s a trust,” said a 52-year-old woman surnamed Wang from Shandong province. “They told us it’s risk-free. I just wanted to earn the high interest.”
China’s less-regulated shadow banking sector has ballooned to $7.7 trillion, according to JPMorgan Chase & Co., involving the nation’s biggest banks, state-owned firms, local governments and millions of households. The yuan slumped 2.3 percent this year as surging borrowing costs slow the economy. The yield on the benchmark 10-year sovereign bond jumped 93 basis points in the past year to 4.51 percent. That for similar-maturity AA-corporate debt reached 8.23 percent.
Regulators in Hong Kong have overhauled point-of-sale procedures since the 2008 failure of so-called minibonds connected to Lehman Brothers Holdings Inc. sparked street protests in the city. Singapore also tightened rules.
“It ought to be useful for regulators in China to look at what’s happening in other jurisdictions, just as Hong Kong and Singapore have done since the minibonds crisis,” said Andrew Malcolm, a partner in Hong Kong at Linklaters LLP. “The documentation that I’ve seen for some of these onshore products looks very short by comparison. They’re either amazingly good at summarizing or it’s probably more of an overview.”
Hong Kong regulates sales under separate regimes for retail and professional investors. Documents for public offerings are authorized by the Securities & Futures Commission and must include risk summaries and examples of how the product might perform under stress. The regulator introduced a plain-language statement of key facts in 2010.
Sales to high-net worth individuals, who are considered professional investors, must comply with a code of conduct, also overseen by the SFC. Distributors should know their client and make sure that any recommendation is suitable. Some banks have responded to closer oversight by taping interviews with retail customers and regulators are considering stronger protections for wealthy investors considered professionals.
“The Hong Kong regulators are very keen to ensure very full disclosure,” Linklaters’ Malcolm said. “Banks are being very careful. They’re taking a lead from the retail offering requirements as to what investors and what the regulators really expect to see in terms of risk disclosure.”
Li from Shanxi said a saleswoman took him aside and made the limited-period offer while he was doing bank errands at a CCB branch in the city of Jinzhong in December 2011. He bought a tranche of the Songhuajiang River product.
“She said if you want to buy, you must buy soon,” Li said in a March 19 telephone interview from Jinzhong, Shanxi. “She said the product is risk-free. I didn’t know what a trust fund is. I bought the product because I trusted CCB.”
Li, whose contract also outlines risks and who joined the group of investors in Beijing today, said they don’t plan a lawsuit because of doubts over the time and costs involved in taking on a state-owned bank. “We’ve been cheated out of our hard-earned money by CCB,” he said.
A press official at CCB declined to comment over the phone about the investors’ gathering today. Jilin Trust said through its PR company when asked for comment on the same issue that it’s waiting for news concerning restructuring of Shanxi Liansheng.
The trust said in a Feb. 20 statement it was cooperating with CCB and the mining company on making payments related to the trust product. On March 11, it declined to comment on whether it had missed a further installment. The company hasn’t replied to faxed questions sent via a public relations company after seven working days. Two calls to the general line of Shanxi Liansheng went unanswered.
About 20 investors in Credit Equals Gold protested in Shanghai in January. After a restructuring of the plan involving unidentified buyers, they received their principal but not the final interest payment. China Credit Trust’s board secretary declined to comment when reached by phone.
Alex Ke, from the eastern province of Zhejiang, said in a Feb. 21 interview in front of an ICBC branch in Shanghai that when he bought the Credit Equals Gold product in Hangzhou in 2011 the bank’s salesperson “said it’s part of the process to provide you with the documents, but you don’t need to worry about the safety of the product.”
Chang Feng said at the same gathering that a salesman at ICBC’s private bank in Shanghai told him that he needn’t worry about the risk warning in the contract because “after working for ICBC for so many years, he can promise that this product is absolutely safe.” The investors declined to reveal their ages and jobs.
The CBRC rules lack guidelines on how trust companies should act as prudent trustees and sufficient investor protections, according to Ni, the Shanghai-based legal expert.
“The only regulation we have now is the CBRC’s rules,” said Ni. “But since CBRC is only a banking regulator, the rules aren’t as effective as laws.”
China Trustee Association said in a Feb. 13 statement that the industry had 10.9 trillion yuan of assets as of Dec. 31 and their quality is “quite sound.” Since 2012, more than 20 trust products totaling 23.8 billion yuan have run into payment issues, according to a Jan. 27 UBS AG report.
“The shadow banking sector will be more regulated,” said Gene Buttrill, a Hong Kong-based partner at Jones Day, which specializes in commercial law. “Some trust companies are going to survive and have a thriving business because there’s a severe credit shortage, and some are going to shut up shop.”