"China takes control of Sichuan Trust as it ramps up shadow banking clampdown”: S&P

December 29, 2020

HONG KONG -- China's move to take control of Sichuan Trust Co. Ltd. signals a growing assertiveness with the sector, according to global ratings agency Standard and Poor's. Chinese officials said the entity was plagued with governance issues, resulting in a swath of defaulted trust products, but S&P Global Ratings believes the authorities' action on Sichuan Trust demonstrates China's intention to continue its crackdown on trust entities specifically, and China's shadow bank sector generally, in 2021.

The Sichuan bureau of the China Banking and Insurance Regulatory Commission (CBIRC) has announced it will work with the local government to take over management of Sichuan Trust. It said four of the top five shareholders of Sichuan Trust were not co-operating with authorities to resolve risks.

The four major shareholders, Sichuan Hongda (Group) Co. Ltd., Sichuan Hongda Co. Ltd., Sichuan Haoji Food Co. Ltd. and Huiyuan Group Co. Ltd., all belong to the private sector.

China's central bank in its Financial Stability Report 2020 said that the possibility of default (of trusts or their products) could present spill-over risks for related industries and markets, S&P says.

"Sichuan Trust's corporate governance issues and the scale of its financial risk compelled regulators to take control of the entity, in our view," said S&P Global Ratings credit analyst, Annie Ao.

A statement by the Sichuan CBIRC said Sichuan Trust failed to operate prudently, and breached rules on related-party transactions. The major shareholders also failed to co-operate with regulators to manage related-party exposure, it claimed.

S&P says Sichuan Trust faces an estimated Chinese renminbi (RMB) 20 billion to RMB30 billion of losses from its trust products under management, according to press reports. The products were sold to about 8,000 investors, including retail investors, according to the same reports.

"We see a low likelihood the Government will provide direct financial support to investors of defaulted trust products. The government wants to break investor expectations it implicitly guarantees trust investments and wealth management products," said Ao.

S&P reports that the industry has established a fund (capitalised at RMB153.5 billion as of September 30, 2019) to cover trust company defaults in China. However, there is no established practice for how these funds might be used, or on whether any of the money might go to those holding investments managed by Sichuan Trust.

S&P says the default of the trust-of-trust (ToT) products issued by Sichuan Trust was partly due to the weak credit quality of the underlying assets. As of June 30, 2020, Sichuan Trust's outstanding ToT products amounted to about RMB25 billion, with most backed by real estate assets and company shares.

China's trust industry defaults rose in 2020, S&P said. "Soft economic growth resulting from the pandemic likely explains many of the cases. Regulatory action and COVID effects hit some sectors particularly hard, such as real estate and manufacturing, where most of the defaulted trust loans occurred in the year."

S&P said the trust industry had higher exposure to real estate developers, especially the weaker ones, and possibly lower collateral protection than the banking industry, and that the trust firms' years of aggressive business expansion had amplified their risk. Many entities did not have sufficient financial resources to cover investments following issuer defaults.

"Trust firms' risks have been compounded by deficiencies in product design, including cashflow mismatch and concentrations of credit risk," said Ao. "They also have non-compliance issues, including mis-selling and the misuse of related-party transactions."


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