China's New Rules Spark Private Equity Collapse
WHY YOU SHOULD CARE
Crackdown on financial risk stifles fundraising as fraud cases proliferate in China.
By Gabriel Wildau and Yizhen Jia
Chinese alternative asset managers have become the latest casualty of the country’s crackdown on debt and financial risk, with a record number of private equity and hedge funds dissolving in recent months as new regulations limit their fundraising.
In the first six months of this year, the Asset Management Association of China (Amac) — a government-controlled industry body — “lost contact” with 163 private fund institutions, more than 70 percent of the total for which contact was lost for 2017. The “lost contact” designation refers to private funds that have failed to renew their registration status with the association every three months as required. While some have simply wound down, others have failed to meet promised investor payouts or even disappeared with investors’ money.
Of these 163 private funds, more than 70 percent are private equity or venture capital funds, according to an analysis of Amac data by National Business Daily, a Shanghai-based newspaper. The others are mostly hedge funds that invest in publicly traded securities.
The new asset management rules delivered a strong blow to the industry.
Wang Bo, private equity fund research director, Noah Holdings
The government launched a “regulatory windstorm” last year to control excessive debt growth. Rules specifically targeting asset managers have limited the ability of banks to partner with nonbank financial institutions to manage clients’ money.
“The new asset management rules delivered a strong blow to the industry,” says Wang Bo, director of private equity fund research at Noah Holdings, a wealth management service provider based in Shanghai. “They can no longer raise funds. This started in late 2016, and it has got steadily worse.”
Though assets under management at private funds have continued to rise, the pace of increase has slowed. Problems in China’s peer-to-peer lending sector — where scores of platforms collapsed in recent weeks — have also spilled over into private funds. Several of the “lost contact” funds belong to broader groups that also operated one of the dozens of peer-to-peer platforms under police investigation.
Some of the “lost contact” funds have also allegedly engaged in fraud directly. Late last month, protesters converged on a branch of Bank of Shanghai to demand repayment from four different private fund institutions owned by Fuxing Group, a conglomerate with businesses ranging from property to asset management to rare earths. Fuxing’s controlling shareholder has fled, according to a statement by Amac, which said it “attached high importance” to the case. Unverified reports indicated that the amount of the investment was as much as RMB 25 billion ($3.7 billion). Fuxing could not be reached for comment. Protesters claimed that Bank of Shanghai had sold them the products; the bank responded that it had not sold these fund products but had only served as custodian.
Unlike alternative asset managers in the West, which market themselves directly to institutional investors and wealthy individuals, Chinese private funds rely heavily on banks to sell their products. In previous cases, rogue bank employees sold products without authorization. Last year, the banking regulator began requiring financial institutions to make video and audio recordings of all product sales.
New regulations targeting excessive complexity in the design of wealth management products have also fallen heavily on private funds. The rules forbid opaque, derivative-like “nesting” structures in which the product sold to investors is composed of other products, with underlying assets buried beneath layers of complexity.
“The prohibition on multilayer nesting had a direct impact on private funds, especially those that relied on fund mandates from banks,” says Xu Li, private equity analyst at Licai, a wealth management consultancy in Beijing.
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