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  • Dec 20, 2014
  • Updated: 12:16pm
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Chinese mutual funds caught up in shadow banking fallout

PUBLISHED : Monday, 25 August, 2014, 3:34am
UPDATED : Monday, 25 August, 2014, 3:43am

The mainland's shadow banking woes have spread to the mutual fund sector, fuelling fears that defaults and frauds could spread in waves despite Beijing's efforts to deleverage an economy facing the risk of a hard landing.

Two recent scandals were fresh signs that nearly 1.5 trillion yuan (HK$1.89 trillion) of capital raised by the subsidiaries of mutual fund houses is exposed to risks due to the absence of an efficient monitoring system.

Earlier this month, Shanghai Goldstate Brilliance Asset Management, an alternative investment arm of Value Partners Goldstate, announced a 600 million yuan real estate fund would not be able to pay interest to investors, indicating the product would fail amid a weakened property market.

At the same time, Wanjia Win-Win, a subsidiary of Wanjia Asset Management, said it had uncovered fraudulent actions by a partner, Shenzhen Jingtai Fund Management, in the operations of a real estate fund started in June.

Win-Win accused Jingtai of violating the product's agreed investment strategy and misusing 800 million yuan in cash for other projects.

A source close to executives of the two funds said part of the misused 800 million yuan was transferred to the project that Goldstate invested in, in an attempt to disguise problems, a move he described as robbing Peter to pay Paul.

"Shadow banking woes have turned out to be more serious than people ever thought," said the source, who asked not to be identified. "The two scandals won't be isolated cases."

Gopher Asset Management, an investment adviser to the Win-Win real estate fund, said police were conducting a criminal investigation into Jingtai's actions.

In 2012, Beijing encouraged mutual fund managers, which had previously focused on equity investments, to diversify their revenue sources, allowing them to establish subsidiaries to deal with alternative investments.

But the alternative investment units raised funds to bolster the growth of the shadow banking system, which China Securities Regulatory Commission chairman Xiao Gang has labelled a Ponzi scheme.

Commercial lenders on the mainland have issued trillions of yuan of wealth management products to net fresh funds from depositors before relending them to borrowers, many of them property developers.

The practice has seen banks become middle-men in the raising of funds for borrowers, rather than financial institutions dealing directly with deposit and lending business.

Those unable to secure banking loans have resorted to the shadow banking system to obtain funds, offering investors higher returns than those offered by bank deposits.

"The scandals brought the CSRC in because it was forced to step up the policing of fund management companies," said Howhow Zhang, the research head of fund consultancy Z-Ben Advisors. "Tackling the shadow banking problem within the mutual fund houses' subsidiaries should also be put on the regulator's agenda."

About 70 alternative investment companies have been set up by mainland mutual fund houses, with total assets under management of about 1.5 trillion yuan.

Premier Li Keqiang, battered by concerns that the mainland economy could be facing a hard landing, has tried to rein in the shadow banking system by tightening monetary policies.

Those efforts contributed to a cash crunch in the financial system, with interbank interest rates surging to record highs in the middle of last year.

"Look at the massive cash piled in the shadow bank system, and you will find that the mainland is not short of money, but that it lacks an effective system to reasonably allocate the financial resources," said Gu Weiyong, the chief investment officer at Shanghai Ucon Investment Management.

"The authorities are facing an uphill task of fine-tuning the country's financial system. To be honest, financial risks are far from being controlled."


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‘... the mainland is not short of money, but that it lacks an effective system to reasonably allocate the financial resources, ...’
The above is the case because the invisible hand isn’t there, or is handicapped.
China’s interest rate liberalization doesn’t only mean setting the correct banking deposit and lending rates.
It should also mean, more importantly, developing the free-market-determined yield curve to help allocate the scarce capital in the country to the most-valued uses.
Without the correct guidance of the free-market price signals, the scarce resources in the country, like capital, labour, and land, cannot be efficiently allocated (in plain language, the country cannot become rich).
Without a deep and well-developed treasury market, the come-and-go of the foreign hot monies will continue to affect the stability of the domestic capital market and the yuan cannot effectively be developed into one of the world's global reserve currencies in the future.
Also, the country's corporate bond market needs to be further developed to serve the needs of the country's enterprises.
A Super Regulator in the State Department can be set up to overhaul the supervision of the share and bond markets.
According to a Chinese economist, China’s central government can issue short-term treasuries which are to be bought by the banks.
(Chinese readers: ****finance.sina.com.cn/china/20140823/230220100855.shtml)
The banks are allowed to use one-half of their required reserves in the central bank (10%) to buy and own the treasuries, which can then be transacted freely in the secondary market.
The treasury rate can be lower than those offered by the shadow banking market and the treasuries will still be competitive, since they are backed up by the full faith and credit of the central government, which has the right to collect taxes from her citizens.
With the borrowed money the central government can use it in any way she sees fit.
The SMMiEs in the country can be exempted from paying any tax to the government for the next 12 months, say.
By issuing more and more longer-term notes and bonds in the future, the government can gradually lower both the profit and income tax rates in the country.
The PBOC can then engage in open market operations (OMOs) to influence the benchmark interest rate so determined in the short-term treasury market.
The ‘Chibor’ will be similar to Britain’s Libor and America’s Federal Funds Rate (FFR), and hopefully the longer-term interest rates in the market, like those of the central government's notes and bonds and the local governments' municipal bonds, will then be effectively guided by it.


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