Complex structures used to sidestep lending restrictions
As a flood of unregulated cash swirls through the Chinese economy, the government has been taking aim at the trust companies because of unrestrained lending practices that are worrying regulators.
The trusts, at the heart of the shadow banking industry, are being pressured to step up compliance and background checks, and become more transparent.
But the fast-growing 20 trillion yuan ( trillion) industry, whose lending operations are cloaked behind opaque structures, will be tough to rein in, according to employees at some trusts.
Shanghai Trust was fined 200,000 yuan for selling a product that violated leverage rules, according to a regulator's notice in January. Regulators provided no further details about the case. Under these rules, property developers are only allowed to borrow up to three times their existing net assets.
According to two people with direct knowledge of the case, an unknown sum was loaned by China Construction Bank (CCB) through Shanghai Trust to Cinda Asset Management Co. Cinda then invested the cash.
One of the sources said Cinda used the cash to acquire land, a sector rife with speculation that regulators have singled out as a "risky" destination for trust company loans. The source provided no further details.
Shanghai Trust, Cinda, CCB and the China Banking Regulatory Commission (CBRC) declined to comment for this story.
One of the biggest challenges facing regulators is that many trusts employ an array of structures and funnel money through webs of beneficiaries, which makes untangling transactions extremely difficult.
Nine people working at trusts, including the two with knowledge of the Shanghai Trust case, said such complex structures are often deliberately used to sidestep lending restrictions on banks and borrowers.
The practices of trusts, and the speed at which the industry is growing, have made them a target for the government as it tries to keep a lid on risky lending, cool overheated markets and control corporate debt.
In April, Deng Zhiyi, head of the CBRC's trust department, warned of "severe risks" from funds flowing into the real estate, coal and steel sectors through trusts.
The industry is now roughly one-tenth the size of China's commercial banking sector.
While the companies are overseen by the CBRC, they are not held to the same standards as banks. For example, they do not have to meet the same capital adequacy standards.
However, the regulator set out in detail in April certain structures that the trusts should not use, such as money-pooling schemes and structuring products to avoid restrictions on leverage.
That was "a signal for financial institutions that from a legal and enforcement perspective, we are entering a stricter period," said Armstrong Chen, financial compliance partner at law firm King & Wood Mallesons.
Trust firms will also have to start registering the details of their products, identifying the ultimate borrower of funds, this year, said Chen, who is in regular contact with the regulators.
Chen said the requirement would improve transparency, but people at trust firms said it will still be difficult to detect the use of the under-the-table agreements typical of the industry.
Some of the trusts are already responding to the government pressure.
Anxin Trust is increasing the number of onsite visits by staff and has doubled its compliance team, said a person with direct knowledge of the company's activities. The trust is also looking at less risky deals - in healthcare, for example, rather than the more volatile property sector.
A spokesman for Anxin said managing risk is a priority for the trust.
Despite these changes, the government's job managing the trusts keeps growing.
"The demand for trust loans is increasing," an internal report at a large trust firm in May said. "In the past, State-owned enterprises would not consider such loans, but are now considering them," said the report, adding that the trend started in March.