CHINESE regulators have sought for years to get to grips with the US$2.9 trillion trust industry, a corner of the country’s shadow banking sector that offers bigger returns than regular bank deposits but can be fraught with risk.

Their fears were underlined in August when trust companies linked to financial giant Zhongzhi Enterprise Group missed payments on several high-yield investment products. The revelation comes at a sensitive time, with many investors already worried about the state of the world’s second-largest economy.

What are these trust companies? They are loosely regulated firms that pool household savings to offer loans and invest in real estate, stocks, bonds and commodities.

No other Chinese financial companies operate across all of these asset classes. The sector was once seen as a safe place for wealthy Chinese to park their money for hefty returns. But trust firms have defaulted on billions of dollars of investment products in recent years and the industry has shrunk by about 20 per cent from its peak in 2017, when regulators began clamping down on the nation’s shadow-banking excesses.

What is Zhongzhi?

Zhongzhi is a shadow banking giant with interests in trust companies, wealth management and private equity. The Beijing-based firm was founded in 1995 by Xie Zhikun, who built the firm into a sprawling empire. Xie died of a heart attack in 2021, just as Covid-19 and pandemic lockdowns slowed China’s economy and increased volatility in its capital markets.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Today it manages about 1 trillion yuan (S$187.1 billion) in assets. One of its most important investments is a 33 per cent stake in Zhongrong Trust, which has 270 products totaling 39.5 billion yuan coming due this year, according to Use Trust data.

The average yield on those products amounted to 6.88 per cent, compared with the benchmark 1.5 per cent one-year deposit rate paid by banks.

What’s gone wrong at Zhongzhi and Zhongrong?

Three firms said on Aug 11 that they had failed to receive payments on products issued by companies linked to Zhongzhi, including Zhongrong.

Zhongrong has disclosed little to the public about its situation, though it has said it’s aware of forged letters being shared on social media saying the company is no longer able to operate. The firm has reported them to authorities, according to a statement on its website.

In one unverified letter circulated on social media, a wealth manager at Zhongzhi apologised to his clients, saying the group’s wealth arms have decided to delay payments on all products since mid-July.

The incident involves more than 150,000 investors with outstanding investments totaling 230 billion yuan, according to the letter.

Chinese stocks slumped in response and the yuan depreciated toward its weakest level this year.

What is the government doing about it?

China’s banking regulator, the National Financial Regulatory Administration, set up a task force to gauge the outstanding debt and risks at Zhongrong, according to people familiar with the matter.

The regulator required Zhongrong to report its plans for future payments and available assets that can be disposed of to deal with the liquidity crunch, the people said.

Why does it matter to China? President Xi Jinping’s government is under pressure to shore up confidence in China’s economy. Investors have been alarmed by the country’s slow pace of recovery from Covid-related restrictions and persistent weakness in its giant real estate sector.

Loans extended by Chinese banks fell to the lowest level since 2009 in July, in a sign of waning demand from businesses and consumers.

One of the nation’s largest property developers, Country Garden Holdings, is on the brink of default.

The crisis at Zhongzhi feeds perceptions that poorly regulated parts of China’s banking industry may be ill-equipped to cope with those problems, increasing the risk of “contagion,” where an upset in one area of the finance industry can quickly cascade and cause a broader crisis of confidence.

While the financial distress in real estate has been relatively contained, troubles at trust and wealth management firms have greater potential to spread to “mom-and-pop” investors, wealthy individuals or corporations. 

Is the property crisis at the root of Zhongzhi’s problems?

It’s not yet clear. What we do know is that China’s trust companies offer investment products linked to real estate developers, and in the past have defaulted on them.

Real estate accounted for 11 per cent of Zhongrong’s 629 billion yuan of trust assets under management, according to its annual report.

Last year, it was among firms that bought stakes in at least 10 property projects, betting that unfinished homes will eventually yield cash to pay off some of the US$230 billion in property-backed funds they have issued to investors.

The hoped-for real estate market rebound has so far failed to materialise. BLOOMBERG