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.

A reckoning arrived on Jan 5, when one of the sector’s biggest players, Zhongzhi Enterprise Group Co, filed for bankruptcy, victim of a property crisis that’s bedevilled the world’s second-largest economy.

China’s banking regulator had vowed in November to use “strong medicine” to tackle major risks in the country’s financial sector. But the collapse of Zhongzhi in one of China’s biggest-ever bankruptcies still came as a shock to investors, given the government’s past willingness to throw an occasional lifeline to struggling firms. 

1. 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 heftier returns. But trust firms have defaulted on billions of dollars of investment products in recent years and the industry has shrunk by about 16 per cent from its peak in 2017, when regulators began clamping down on the nation’s shadow-banking excesses. 

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2. What is Zhongzhi?

It’s 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 it into a sprawling empire. Xie died of a heart attack in 2021, just as the Covid-19 pandemic slowed China’s economy and increased volatility in its capital markets.

It oversaw more than US$140 billion at its peak before succumbing to the property crisis. One of its most important investments was a 33 per cent stake in Zhongrong Trust, a major backer of troubled real estate developers.

The firm has 230 products totalling 25.3 billion yuan coming due this year, according to Use Trust data. The average yield on those products amounted to 6.73 per cent, compared with the benchmark 1.5% one-year deposit rate paid by banks.

3. How did the crisis unfold?

As recently as early August, investors began spreading the word on social media that they’d failed to receive payments from companies linked to Zhongzhi, including Zhongrong. The group then suspended payments on nearly all its products and hired KPMG to conduct an audit of its balance sheet, people familiar with the matter said at the time.

This led to volatility in financial markets and sparked rare street protests in Beijing. An audit in November found Zhongzhi Enterprise had debts of between 420 billion and 460 billion yuan (S$78.6 billion) and assets of 200 billion yuan. Zhongzhi Enterprise told investors it was “severely insolvent” and, on Jan 5, Beijing’s First Intermediate People’s Court said the company had filed for bankruptcy. 

4. What’s the significance of all this?

The troubles at Zhongzhi feed perceptions that poorly regulated parts of China’s banking industry may be ill-equipped to cope with a weakening economy and the problems in real estate. The risk is that an upset in one area of the finance sector quickly cascades and causes a broader crisis of confidence. Many trust products are backed by property projects run by struggling developers such as China Evergrande Group, and some have defaulted as a result of the real estate crisis.

Real estate accounted for 11 per cent of Zhongrong’s 629 billion yuan of trust assets under management, according to its annual report of 2022. It was among firms that bought stakes in at least 10 property projects in 2022, betting that unfinished homes would 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 materialize. 

5. Are such big bankruptcies common in China? 

No. The country’s highest-profile debt failures in recent years have been followed first by debt restructurings in an effort to avoid formal bankruptcy. HNA Group Co, a conglomerate that collapsed with billions of dollars of debt, completed its restructuring work in 2022. China Evergrande, whose default in 2021 accelerated the country’s property crisis and which has some US$327 billion of liabilities, is still struggling to avoid liquidation and hasn’t filed for bankruptcy.  

6. What is the government doing about it?

Chinese authorities in November said they opened criminal investigations into the money management business of the Zhongzhi group, days after its insolvency warning. Investors were also urged to file complaints online. The goverment is also trying to make sure that Zhongrong, one of China’s biggest trust firms, doesn’t suffer the same fate as its parent: People familiar with the matter told Bloomberg News in late August that Citic Trust Co, a unit of state-owned conglomerate Citic Group, and CCB Trust Co, backed by state-owned China Construction Bank Corp, would lead an effort to stabilise operations at Zhongrong. A similar examination by Citic of Huarong Asset Management Co. led to a US$6.6 billion bailout of the bad-debt manager in 2021. 

7. Why does all this matter to China?

Zhongzhi’s downfall is an unwelcome development for President Xi Jinping’s government as it tries to shore up confidence in the economy. Investors have been alarmed by the country’s slow pace of recovery from Covid-related restrictions and persistent weakness in real estate.

A slump in home prices deepened in 2023, with those in the secondary market falling by the most in nine years. Additionally, wages offered to Chinese workers in major cities declined by the most on record, underscoring persisting deflationary pressure and sluggish consumer confidence. BLOOMBERG