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China ordering investment firms, online lenders to shut offices to head off social unrest

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China's authorities, seeking to forestall potential social unrest due to growing failures of investment firms and online lenders, are ordering many to break leases and close their storefronts on busy streets - lest they become magnets for protesters.

[SHANGHAI] China's authorities, seeking to forestall potential social unrest due to growing failures of investment firms and online lenders, are ordering many to break leases and close their storefronts on busy streets - lest they become magnets for protesters.

And that's not all. Registration of all new companies with finance-related names was suspended nationwide in April, according to people familiar with the matter who asked not to be identified because they're not authorized to speak publicly.

In Shenzhen, office building management now must submit contact information for employees of all finance industry-related tenants to the local security bureau.

Local governments from Shanghai to central Henan province have put up new signs outside residential compounds to warn the public against illicit fundraising activities.

The government, which had been encouraging the flourishing of investment firms and online lenders in the past two years to give small businesses that can't get bank loans alternative funding - and to expand investing options for millions of Chinese - had largely failed to put regulations in place that would have prevented failures.

The burgeoning ranks of peer-to-peer online lenders, or P2Ps, began opening storefronts on busy streets or in luxury office buildings to garner investment from the general public, hiring thousands of staff to sell products promising extraordinary returns. 

Other bricks-and-mortar firms sprang up offering wealth-management products with big payoffs, and many of those moved online, too, giving visibility to what was previously the nebulous and hidden world of shadow banking.

Now, with almost 1,000 online lenders having collapsed in the past year and fraud becoming more prevalent at China's countless wealth management firms, authorities are acting to curb their growth and head off potential instability.

"The tightening control against P2P lenders highlights the growing concerns of the government that such operations can get hairy and out of their control," said Hu Xingdou, an economics professor at the Beijing Institute of Technology.

"Such P2P operations could involve hundreds of thousands of people, and could easily cause social unease if the companies run out of cash."

Private wealth manager Credit Hengchang, which operates branches in more than 30 Chinese cities, had to close three offices in Hangzhou at short notice on government orders, said a person familiar with the matter.

Its operation in southern Guangdong province was probed by local police, while its offices in central Henan province received tighter auditing and more frequent visits from the government, the person said. A representative of Hengchang didn't respond to a request to comment on the measures.

All over Hangzhou, a relatively wealthy city 175 kilometres from Shanghai, evidence of the crackdown is visible. In the downtown central business district, only financial institutions that need regulatory approval, such as banks and brokerages, can stay.

At Golden Plaza, a high-end office tower on Hangzhou's financial street, investment and wealth-management companies had snapped up almost 30 per cent of the 26-floor building and pushed up its rents by about 15 per cent in a year through last June, according to commercial real estate agent Tao Libin, whose office is on the ground floor.

Then things started to unravel as angry investors, mostly the elderly, started showing up to demand their money back from some failed firms, and police visits became more frequent, Mr Tao said.

The district government forced the companies to break leases and leave the downtown area late last year for fear that more failures would stoke social unrest and hurt the image of the city where the G-20 summit is to be held in September, he said. Now all those finance startups are gone, leaving massive vacant space and the rent plummeting, Mr Tao said.

Investigations by the police, as opposed to financial regulators, are an indicator that authorities now fear demonstrations against investment firms could turn into anti- government sentiment.

In Guangdong province's Foshan, the city's vice mayor Huang Zhihao said in an interview in April that police were taking the lead role and working with local governments to head off instability.

"We feel a strong sense of urgency to solve the problem," he said.

In Shanghai, the city government required heightened monitoring of firms engaging in investment, wealth management and online lending, and said office buildings, technology parks and business centers will be held responsible for the tenants they brought in, in order to "curb risks from their origin."

In China, wealth-management products offer high short-term interest rates and aren't officially guaranteed. The range of products offered by the unregulated collection of P2Ps, investment firms and wealth managers can include anything from an engaged couple directly seeking online funding for a wedding on guarantee of repayment after cash gifts are received, to high-yield loans for risky property or mining projects that used to be offered as part of what was known as the shadow banking world in cities such as Wenzhou, Shanghai, Beijing and elsewhere.

Now that much of the shadow banking business has moved online, the risk has grown and geographic scope has spread. Often the firms themselves don't reveal the underlying investments, simply offering returns that typically range from 8 per cent to 24 per cent - and sometimes higher.

"China's Internet finance industry has strayed too far from the mandate set by the government," said Yang Dong, a professor at Renmin Law School in Beijing.

"With its high funding and operating costs, yet barely existing risk control, the model to copy banks under the disguise of financial innovation and inclusive finance is fundamentally flawed and unsustainable. It's a shame that the government didn't act earlier."

In the past, investment firms could easily obtain operating licenses from the local business administration for engaging in financial activities without approvals from the nation's banking or securities regulators.

Shanghai-based Wealthroll Asset Management Co. was shut down by police on April 6 after raising more than 30 billion yuan (S$6.25 billion) from more than 130,000 investors.

Wealthroll, a seller of wealth management products nationwide, is being probed for allegedly raising public funds illegally by defrauding investors with fake investment projects and allegedly inflating revenue since it began operating in 2012, according to the official Xinhua News Agency. Among its products, one promised a 40 per cent return every year on condition that the principal can never be redeemed, according to its brochure.

Protesters took to the street after the shutdown, gathering near the People's Square, the base of the Shanghai government, and the Bund, the city's most popular tourist street, holding signs calling for the government to repay their "blood-and-sweat money." They were later dispersed by police.

Some investors blamed the government for shutting down a "legitimate and solid" enterprise because it has never missed a payment, according to postings and videos in one of the WeChat instant messaging groups formed by the victims.

"We should make this big because social unrest has political fallout," wrote an investor under the pseudonym "Give Me a Way to Live" in the message group, urging fellow victims to keep gathering and exerting pressure on the government. "That's the way to strike their nerve and get our money back."

Unlike the shadow banking crisis that hit the eastern Chinese city of Wenzhou in 2012, where most victims of failed shadow lenders were local, the collapse of Internet-based financing platforms is far more wide-reaching in terms of the number of people affected and the amounts involved.

Chinese consumers are more susceptible to fraud as only one-third of formal savers in the nation are financially literate and 48 per cent don't understand the concept of interest payments, according to a December survey by S&P Global Ratings.

In December, China's biggest-ever Ponzi scheme was exposed after Internet lender Ezubo defrauded more than 900,000 people out of the equivalent of US$7.6 billion in 18 months. The founders squandered the money on luxury items including cars and a pink diamond ring worth 12 million yuan, according to Xinhua.

Lu Xiaomin, a finance director in the Huizhou city government in southern Guangdong province, said in April that the Ezubo scandal was a wake-up call, and that the local government is taking action.

"We will pay more attention to the financing companies, to strengthen the monitoring and guidance to the firms," he said at a press conference in April.

"We will also work with associated parties to study the guidance of the central government to prohibit financial risks from happening."

China's cabinet on April 14 started its first campaign to clean up illicit activities in Internet finance, with the focus on areas such as third-party payments, peer-to-peer lending, crowdfunding and online insurance.

The China Banking Regulatory Commission in December laid out restrictionsfor the first time, banning such firms from taking public deposits, pooling investors' money or guaranteeing returns.

It may be too late. More than 90 per cent of China's almost 4,000 remaining lending platforms were promising their 2.9 million investors annual returns ranging from 8 per cent to 24 per cent in March, according to Yingcan Group, which tracks the data.

That compares with China's official deposit rate of 1.5 per cent, and comes a time when the economy grew at the slowest pace in a quarter century, while corporate borrowers' ability to service their debt has dropped to the weakest on record.

Such high returns are unrealistic in an economic downturn, and more platforms are bound to fail, Renmin Law School's Mr Yang said.

Back in Hangzhou's new central business district, 16pu.com, an Internet-based wealth manager established last year that is marketing a three- to 15-day product with an annualized yield of 16 per cent, was told by the police it must leave Dicara International Center, where it had rented 900 square meters, by May.

Its lavish reception area is decorated with statues representing traditional Chinese symbols of wealth and a large altar to worship the three Chinese gods of status, prosperity and longevity.

"We plan to move to another district," said a company executive, who would only give her surname as Tong. "But I don't know exactly where."

BLOOMBERG