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.


Michael Zhang
Michael Zhang

“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”.


Refocus on core assets. As the industry declines and conventional risk control measures such as the credit of the financing entity become increasingly weak, investors are compelled to re-examine the long-overlooked quality of the underlying assets.

In an era led by the stock economy, population flows are showing a concentration trend, whereas residents’ incomes are showing a dispersal trend. The values of core assets are increasing even faster, whereas marginal assets are overabundant or even constantly depreciating in value. Under such logic, investing in marginal assets itself is risky, such that the focus should be trained on buying core assets. However, is this the new talisman?

Where a financing entity can enter into substantive consolidation and reorganisation, investment remains risky. Substantive consolidation and reorganisation is a legal concept in bankruptcy proceedings and means that, in a bankruptcy reorganisation procedure, the independent legal personality of affiliates is no longer considered, their assets and liabilities are consolidated, and all the affiliates are treated as a single enterprise and reorganised. Accordingly, once an affiliate of a financing entity (generally its parent company) goes bankrupt and the financing entity is included in the bankruptcy consolidation and reorganisation procedure, such financing entity will be considered bankrupt with its parent.

Accordingly, even if an investor selects a financing entity based on its core assets, the investor remains unable to avert the risk that such entity will be consolidated into a bankruptcy procedure, thereby harming the investor’s investment returns.

Notwithstanding the fact that certain local courts have issued their criteria for the application of substantive consolidation and reorganisation with a view to better clarifying the boundaries of application, bankruptcy cases are intricate and complex, and the interests involved are convoluted and difficult to clarify. The bankruptcy consolidation and reorganisation rules have, in several “star” cases, repeatedly challenged investors’ new investment strategy of switching to core assets.

In December 2019, the Sanya Intermediate Court ruled that affiliate substantive consolidation and reorganisation applied to 12 companies including Sanya Luhuitou, a subsidiary of Zhonghong Real Estate, and to 17 companies including Sanya Hongxi. In February 2021, the Hainan High Court ruled to accept the reorganisation of seven companies including HNA Group, and three listed companies with their subsidiaries affiliated to the HNA Group, and ruled in March to subject 321 companies, including the HNA Group, to substantive consolidation and reorganisation. In April 2021, the Nanjing Intermediate Court ruled to subject 122 companies under Yurun Group to substantive consolidation and reorganisation.

In view of this, it would seem that investment in core assets still cannot address the above-mentioned risks. With this, have the investment logic and risk control criteria, which are based on considering target projects as core, also been subverted?


(1) Undertakings to make up a difference of loans remain legally valid. In 2016, Everbright Jinhui, Storm Investment, Shanghai Qunchang, China Merchants Wealth and Everbright Capital, a wholly-owned subsidiary of Everbright Securities, jointly sponsored the establishment of Shanghai Jinxin Investment Fund to assist Storm in indirectly subscribing for equity in then British sports media company MP & Silva (MPS).

Under the transaction plan, Everbright Capital Corporation issued a “Difference Make-up Letter” to China Merchants Bank to underwrite the proceeds from withdrawal from the fund. Subsequently, MPS went bankrupt, the fund suffered serious losses, withdrawal therefrom became impossible and Everbright Capital failed to perform its above-mentioned obligation to make up the difference, giving rise to litigation.

The court in the case rendered a judgment ordering Everbright Capital to bear an obligation of paying the investment principal and returns (about RMB3.1 billion) to China Merchants Bank. The case in question was included by the Supreme People’s Court as one of the 10 major commercial cases heard by courts nationwide in 2021, having a far-reaching impact.

In this case, Everbright Capital was neither the custodian of the asset management product nor a licensed financial institution. In its capacity as an inferior limited partner (LP), it promised compensation if the investment failed to pay off to the prior LP of the funds managed by its wholly owned subsidiary, Everbright Jinhui, essentially offering such prior LP guaranteed principal and returns.

Notwithstanding the fact that the adjudication thinking in the above-mentioned minutes and relevant judicial decisions reflects that an undertaking of guaranteed principal and guaranteed minimum returns given by the custodian of an asset management product (particularly a financial institution) to the beneficiary is invalid, there is room for fallback undertakings in other situations (such as inferior class investors against priority class investors, third parties not part of the transaction against investors, etc.) to be found legally valid.

(2) Ascertaining the true gearing ratio of the investment target. Investors that are dazzled by a “halo entity” tend to ignore its overall solvency, not seeing the forest for the trees. On the one hand, they only examine the basic financial reports, but ignore the issue of off-balance sheet liabilities. The common off-balance-sheet financing methods of large groups include debt investment carried out in the guise of equity investment, non-consolidated enterprise financing, advances from upstream and downstream enterprises, etc. They can hide off-balance-sheet liabilities through various financial tricks to obtain beautiful financial data. On the other hand, investors only examine the overall debt situation and take short-term solvency lightly.

Large groups will generally be involved in multiple projects simultaneously, and if several projects make losses or experience refinancing problems in the same fiscal period, they will experience a liquidity crunch. At such time, the group itself may not have a high debt ratio but it may already be on a mined road.

Accordingly, even if a “halo entity” has a strong background, and the quality of individual projects it proposes to invest in is excellent, investors nevertheless need to look closely at its overall debt situation and analyse its solvency, although the same can be extremely difficult in practice.

(3) Implementation of “three independents” control and establishment of firewalls to isolate entities. Usually, in a real estate project plan, the real estate group (parent company) is responsible for securing the land, and a subsidiary, as the project company, is responsible for the external financing, with a great deal of transactions and appropriations occurring between the parent and subsidiary. If the parent company experiences a debt problem and the independent legal personality of the subsidiary comes into question, this may lead to the application of substantive consolidation and reorganisation.

Accordingly, it is imperative to achieve risk isolation between the parent company and the financing entity (i.e. the subsidiary), that is to say, the “three independents” control principle needs to be adhered to: (1) independent governance, the parent company not having a veto over the financing entity’s decisions and not giving rise to actual control; (2) independence of employees, the parent company and the financing entity not sharing employees, in particular the senior management and financial personnel of the subsidiary may not serve concurrently with the parent company; and (3) independent finances, the financial seals, permits, licences, financial books and financial systems of the parent company and the financing entity being managed separately and not commingled.

(4) Going with the flow and paying close attention to the policy guidance of the central government to guide the direction of investment decisions. At a meeting held on 29 April 2022, the Political Bureau of the Central Committee of the Communist Party of China asserted that, “we must stick to the positioning that housing is for living in and not for speculation, support local areas in improving their real estate policies in light of their local realities, support rigid and improved housing demand, optimise oversight over proceeds derived from the pre-sale of commercially developed housing and promote the steady and healthy development of the real estate market”.

This signifies that, on the one hand, the positioning of the development of the real estate industry advocated by the central government is that “housing is not for speculation”; on the other hand, the central government is not advocating deterioration of the real estate industry, but supports local governments in implementing policies suitable to their municipalities and the steady and healthy development of the real estate industry. After the authorities stressed “ensuring the delivery of premises, ensuring the people’s livelihood and ensuring stability”, real estate companies began to compete on their “power to deliver”.

Recently, the White List of the First Batch of Stable Delivery Property Enterprises, widely circulating in the industry, lists eight real estate companies considered as those carefully selected by the government, and provides investors positive reference for selecting partners and judging projects.