In Depth: Trust Firms Search for New Business Out of Shadows

China’s 24 trillion yuan ($3.8 trillion) trust industry is feeling the chill as regulators clamp down on risks stemming from off-balance-sheet lending facilitated by collaborations between banks and trust firms.

Tighter regulatory controls are expected to slam the brakes on the trust industry after years of rapid growth, and the size of trust assets are expected to decline by at least 2 trillion yuan this year, an industry source told Caixin. Another source close to the regulators said authorities are hoping the industry can reduce its assets by half.

China’s trust industry has skyrocketed in recent years, with total assets managed by trust firms ballooning from less than 8 trillion yuan in 2012 to 24.41 trillion yuan by the end of September, according to data from the China Trustee Association (CTA).

Fueling the expansion is the thriving business in which trust firms act as intermediaries to help facilitate lending for banks, other financial institutions or individual investors. In a typical example, a bank collects money from its customers by selling wealth-management products and then invests the funds into trust products, which funnel the capital to borrowers that are usually restricted from the formal lending system, such as local government financing vehicles and real estate developers. Banks bear the risk, while trusts simply channel the money.

The so-called channeling business accounted about 55.66% of funds managed by trusts in the third quarter last year, contributing nearly 90% of the trust industry growth in that quarter, according to the CTA.

Regulators have moved to curb the channeling business as concerns have mounted over the rampant growth of shadow banking that allows banks to bypass lending rules and fuels the rapid build-up of corporate debt.

At a late January meeting, the China Banking Regulatory Commission pledged to put greater effort into reining in the trust channeling business, underscoring the policy goals set in a key document issued in December to regulate how banks and trust firms do business together.

The banking regulator’s moves echoed the proposed rules for the country’s $15 trillion asset management industry. Those rules are expected to soon add overarching requirements for asset management businesses operated by all financial institutions. Their goal is to tame shadow lending and cut financial leverage.

“A key task this year is to squeeze the channeling business. If the policies are strictly implemented, much of the business between banks and trusts will be in trouble,” said one source close to the regulatory bodies.

Trusts companies’ business with banks accounts for nearly 80% of the 14 trillion yuan channeling business, according to industry sources.

In the face of stricter scrutiny, some trust companies have taken action to control the size of the channeling business. Caixin has learned that several companies have either halted their channeling businesses or promised to stop after existing products mature. In late December, Citic Trust, one of the largest trust companies, said it will slim down its “channeling” business in 2018, or at least not expand it, and will try to negotiate an early termination of “channeling” contracts with other financial institutions. In January, China Fortune International Trust Co. issued a statement saying it will not expand its channeling business this year.

The company “has cut some channeling business with banks, and the size (of business) has shrunk a lot recently,” said one trust company employee.

Meanwhile, some trust firms have increased their risk provision for the channeling business with banks to come in line with the December policy document. The risk provision rose to 10.5% of total assets from 0.2%, the rate that most companies had adopted, according to a trust company source.

“Regulators are serious,” said Luo Kai, a trust manager. “It is a strict order to suppress channeling business, and trusts must follow it.”

The rise of channeling

From January 2013 to June 2016, trust company-managed assets for channel financing surged from 1.52 trillion yuan to 7.47 trillion yuan as banks, companies and high-net-worth individuals sought to invest customers’ deposits or their own cash in high-yield products outside the traditional banking system.

Trust companies’ channeling business continued to grow after the securities regulator in late 2016 increased scrutiny over the similar operations at brokerages and fund management companies. Investors ended up turning to trust firms as an alternative.

In the first nine months of 2017, trust firms’ channeling business grew by 6.11 trillion yuan. Over the last few years, the channeling business has made up an increasingly greater share of trust companies’ total business, rising from less than 20% of total assets under management to 60% by the end of September.

Some market insiders see the channeling business as a low-risk source of easy profits for trust companies. But others said the business allows institutions to bypass industry rules and undermine regulators’ goal of deleveraging the financial system.

Since the beginning of this year, the banking regulator has tightened its grip on the channeling business of trust companies. A source close to the China Banking Regulatory Commission (CBRC) said the regulator will take harsh measures against companies that ignore regulatory requirements.

By Feb. 12, the CBRC had issued fines and penalties to four trust firms for business violations. In 2017, the commission issued 24 punishment orders.

Seeking new opportunities

A trust company employee told Caixin that regulators’ requirements for reducing the channeling business are likely to cut the trust industry’s 2018 revenue by 20%. In 2017, the combined revenue of 62 major trust firms totaled 107.5 billion yuan.

Amid concerns over debt-driven investments, regulators have also tightened scrutiny on trust firms’ other businesses, such as real estate investment trusts and products for financing local infrastructure projects.

An employee from a Beijing-based trust firm said his company has put a moratorium on financing real estate and local infrastructure projects. By the end of September, real estate and local infrastructure investments accounted 10% and 15.5% of trust industry assets respectively, CTA data showed.

Industry experts said the time has come for trust firms to put more effort into boosting their risk control and asset management capabilities. Several industry sources said trust firms should shift their investment focus to emerging industries such as advanced manufacturing, environmental protection and healthcare, which all benefit from supportive government policies.

Some industry sources expected more trust firms to suffer a capital crunch this year amid the regulatory clampdown. “It is partly because of trust companies’ inadequate risk controls. But more importantly, it is because companies’ financing crisis amid tightening oversight may spill over to trust firms,” one source said.

CTA statistics showed that by the end of September, trust companies have risk exposure in 594 projects that involve 139 billion yuan.

Trust firms are anxious about their business this year as they strive to adapt to the changing regulatory environment, one trust company executive said. “(We feel) lost about what business to do this year,” he said.