Trust issues arise over trust products
By Paul Mackintosh - 11/03/13
The recent case, much publicised in Chinese media, of the public dispute between Chinese investment company Shenzhen Kailei (Carlyle’s Chinese name) and Tianjin Trust’s Buffett No. 1 Plan, sheds light on a uniquely Chinese development that poses a competitive challenge to private equity firms in the PRC – at least for now. So-called trust products offer an alternative grey-market channel of non-bank financing for PRC companies, projects and local government entities that could crimp general partner (GP) prospects in China – until a likely regulator intervention, or blow up, or both, ends the game.
Trust products, frequently distributed through the sales channels of reputable banks, pool money from high net worth (HNW) and lower-tier investors chasing a higher return, often without full disclosure of their terms, structure, and investment targets. China’s trusts often invest into higher-risk higher-return businesses in a similar, but less carefully structured and policed, manner to private equity funds. The FT quotes typical 7-10% returns with a one-year maturity on trust products, clearly favourable when compared to traditional private equity capital lock-in. And trusts are clearly not about to seek equity or control rights in invested businesses. Bloomberg cited in January a nearly 680% year-on-year rise in PRC trust lending to US$42 billion, while the Financial Times has just release an estimate of total trust product AUM of $1.2 trillion, second only in the PRC to banks’ aggregate AUM.
Commentators have singled out trust products and China’s entire shadow banking sector as a potential source of financial instability, with some local governments in concert with local banks using them as back doors to avoid central government regulatory attention. Trust companies often default, but this does not seem to constrain their growth or popularity. Much like the RMB-denominated “private equity” funds proliferating in China, and often hardly distinguishable from them, the trust products highlight the shortcomings in the PRC’s conservative, gradualist approach to financial sector reform. Oversight and enforcement in this area is hostage to local interests that may favour this asset class exactly because it evades strict central government scrutiny, while central regulators may lack the means, will or political clout to take on these vested interests so long as the quest for social stability keeps its heavy hand on policy-making. An investing public starved of product and hemmed in by RMB restrictions, meanwhile, will grab what opportunities it can, whatever the downstream risk.
The choice of names in this case brought Western attention to a very Chinese problem. And Western private equity firms may still have to wait for a long time before a more transparent and balanced investment market evolves in China. But at this rate some of their competitors may not last – hopefully without causing knock-on damage to broader growth and financial prospects in China.