Rebuilding the faith

With China’s real estate industry in crisis, Michael Zhang, executive director of Jinmao Capital’s risk & compliance department, explores the risks faced by asset managers with their investment strategies for the sector, and offers advice on mitigating these risks

China’s asset management industry has developed at a blistering pace in the past decade. By 2021, the asset management market had reached RMB133.7 trillion (USD19.7 trillion) and is still growing rapidly. In the early days of the industry, investors generally believed in and demanded guaranteed principal and guaranteed minimum returns, and subsequently flocked to financing entities with renowned reputations.

However, with China’s industrial transformation, in particular the downward spiral of the real estate industry, the backbone of the economy, and the constant occurrence of risk events, investors have been left at a loss and asset management institutions have exhausted themselves disposing of risky projects.

Collapse of faith in guaranteed principal and guaranteed returns.For some time, in the asset management industry, investors took guaranteed principal and guaranteed minimum returns as a given, going as far as regarding asset management products as another form of bank deposit, and held up the undertakings given by financial institutions to make up any difference as a talisman, totally ignoring the quality of the assets underlying the products.

In 2014, China Credit Trust’s RMB3 billion Chengzhijinkai No. 1 product ran into a payment crisis. Although this ultimately passed, investors’ faith in guaranteed principal and guaranteed returns quietly began to show cracks.

Subsequently, the courts ruled in numerous disputes over entrusted wealth management contracts that minimum guarantee clauses in entrusted wealth management were invalid, thereby striking a heavy blow to the “faith in guaranteed principal and guaranteed returns”.

In 2018, the New Asset Management Regulations expressly prohibited guaranteed principal and guaranteed return undertakings in the asset management business. In 2019, via the Minutes of the Ninth National Work Conference on Civil and Commercial Adjudication by Courts, the Supreme People’s Court unified the adjudication thinking of judges nationwide and reiterated that the guaranteed minimum or guaranteed principal and guaranteed minimum return clauses of financial institutions were invalid.

Since then, “faith in guaranteed principal and guaranteed returns”, which relies on the entity credit of financial institutions, completely collapsed, leaving investors flailing helplessly, perplexed and wondering whether there could be an alternative for the guaranteed return model.

DISSIPATION OF ‘ENTITY HALOS’

“Halo entities”, companies with public visibility or backed by local governments that are considered to have better credit, may have quickly entered investors’ white lists based on the above-mentioned circumstances. Investors rushed to tack the label “halo entity” on listed companies, Fortune 500 companies, well-known university enterprise co-operations, regional city investment companies, etc., giving them positive credit ratings and offering them higher financing limits.

When liquidity is abundant and the economy is growing rapidly, a “halo entity” could, even if the odd project here and there showed a loss, still protect investors by moving things around. However, once there is a liquidity crunch, economic growth slows and industrial prosperity slides, everything is carried along, and promises of guaranteed principal and guaranteed returns bounce like a rubber cheque, leaving investors high and dry. Based on publicly available information, the author has collated a timeline of the financial crises of distressed entities set out on “real estate industry” and “non-real estate industry”.