The path from debt and dishonor to being the latest must-have accessory in China’s financial sector is well-trodden and surprisingly short. It has taken less than a decade for banks and brokerages to be restructured, recapitalized and opened up to foreign investment.
Now it is the turn of the trust companies.
“The trust companies have traditionally been the bastard children of the financial sector,” said Min Tha Gyaw, a research associate at Shanghai-based fund management consultancy, Z-Ben Advisors. “The regulator came along and cleaned them up, and now all the banks are buying in.”
At the end of August, Barclays Capital became the fourth foreign player to take a direct interest in a trust company with its acquisition of a 19.5% stake in New China Trust and Investment for US$35 million. A month earlier, Royal Bank of Scotland took the plunge with Suzhou Trust and, at the start of the year, National Australia Bank did the same with Union Trust.
Ashmore Investment Management of the UK started the trend when it took a stake in Beijing International Trust and Investment at the end of 1997.
Morgan Stanley and Macquarie are thought to be close to securing trust company deals, but it is not only foreign players whose heads have been turned. A host of domestic financial institutions have bought in, some of them taking controlling stakes in trusts. China Construction Bank, Shanghai Pudong Development Bank and China Life are said to be among the early movers.
Road to reform
These investments mark the culmination of a remarkable turnaround for the trust companies. They started life as the financing tools for local governments’ policy initiatives, but poor regulation soon saw them used as cash props for pet projects. Investments turned bad and trusts ended up defaulting on the international bonds they had issued to raise money.
With the sector teetering on the brink in 2003-2004, the government stepped in. Regulations were revised, many trusts were closed, operating licenses were introduced and the trusts’ role in the financial sector was redefined.
But the foreigners who have bought into trust firms are not so forthcoming about their reasons for doing so. Ashmore declined to comment, National Australia Bank didn’t respond to inquiries, while Royal Bank of Scotland and Barclays Capital issued nondescript statements.
Ironically, the lack of clarity might speak volumes as to why these investments were made. China’s trust companies now have an investment scope that stretches far beyond those of other financial institutions – they can participate in lending, real estate investment trusts (REITs), equities, fixed income, securitizations, private equity and pension products. A new foreign investor could be forgiven for not knowing where to start.
“We have worked on about seven acquisitions in the last year and everyone has been in for a slightly different reason – it really comes down to the breadth of the licenses these trust companies have,” said Simon Gleave, head of KPMG’s financial services practice in China.
“A lot of foreigners are also hedging their bets. These are not big investments and the deals are not quite as messy as those in commercial banks.”
The diversity of the trust firms’ investment options has the potential to turn them into powerful wealth management platforms. Min of Z-Ben Advisors likens the trusts to strip malls – a one-stop shop for local banks that want to offer high-end clients a wider range of services. For example, a trust might set up a REIT and then its partner bank sells customers a product that invests in the REIT.
The trust structure also offers greater security, as the bank is effectively putting assets under the management of third-party trustee who is relied upon to put investor interests first.
“The trust companies are the one type of financial institution that is capable of investing without much regulatory restriction,” said Min. “A bank is not only buying into the trust but also its product design and manufacturing capability.”
Trusts may also raise investment funds themselves, but not everyone can join in. According to Wang Hao, a partner at Beijing-based law firm RayYin, individuals or organizations interested in participating must have US$150,000 in investible assets or US$30,000-US$44,000 in annual income over the last three years. Many of the fund managers who deserted mutual funds in the last year to set up their own actually offer investment products run under the auspices of trust companies.
“A lot of good fund managers crossed over, and one of the only legal ways to do private fund management in China is through a trust company,” said Lei Yong, a fund manager at Fortune SGAM Fund Management.
Data provided by Z-Ben Advisors shows a swing in trust company business toward securities-oriented investment. Loans accounted for 50% of business in 2006, but this slipped to below 20% in the first five months of 2008. The securities share has risen from 30% to nearly 60% over the same period.
However, foreign investors are likely to be as interested in the trust companies’ traditional business of project lending as they are the wealth management side, according to KPMG’s Gleave. The trust companies offer both an access route to wealthy individuals within China and a means of providing existing overseas clients with exposure to normally restricted areas – infrastructure and property projects are a prime target.
“A local authority might want to build a water treatment plant, but it can’t issue debt so it uses a trust structure. What is issued is quite similar to a bond, with investors drawing income over a period of time,” explained Gleave.
“It is one of the major ways that local authorities fund infrastructure projects.”
Although there are 54 trusts with operating licenses, only the leading players are allowed to participate in the more diverse investments. At present, approvals for securities underwriting, enterprise annuities and outbound investment are notoriously hard to come by. Potential investors must battle hard for stakes in the trusts deemed most likely to prosper.
RayYin’s Wang had a number of clients interested in buying into Suzhou Trust, but the level of interest was so high these clients were priced out of the deal.
It becomes more difficult to gauge the prospects for individual trusts and the sector as a whole when other factors are taken into account. While trust firms are the responsibility of the banking regulator, their wide remit means operations could tread on the toes of other authorities – and there remains some disquiet as to what they should and shouldn’t be allowed to do.
“I’m interested and I’m following it, but I would like to see more from the government on how these trusts should behave,” said Rex Auyeung, Asia CEO of Principal International, which already runs a fund management joint venture in China.
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