In Depth: It’s Curtains for China’s Local Financial Asset Exchanges

China’s regional financial asset exchanges (LFAEs) once facilitated local small and midsize companies and financial institutions in selling nonperforming assets. However, these exchanges are now being shut down as part of a broader regulatory effort to eliminate illegal fundraising activities. Financial authorities in several provinces including Hunan, Liaoning, Shaanxi, and the municipality of Chongqing revoked the business licenses of their official LFAEs in March, with others such as Jilin, Jiangxi, Shandong, and the city of Qingdao following suit in May. Shenzhen's LFAE voluntarily applied to exit the industry [para. 1][para. 2].

The number of authorized LFAEs had dwindled from 80 at its peak to 28 before the recent closures, as regulatory efforts consolidated these exchanges to one per province. All remaining exchanges are expected to shut down within a year except for Beijing’s LFAE, which will be transformed into a new business [para. 3][para. 4]. However, shutting down these exchanges won’t be straightforward due to outstanding legal disputes and investor losses from defaulted products sold through these exchanges. Investors can pursue lawsuits, but proving fault and obtaining compensation will be challenging [para. 5].

Established with the intent to provide a unified platform for disposing of state-owned nonperforming assets, the first exchanges were set up in Beijing and Tianjin in 2010. Initially, these exchanges were trusted and their products were considered creditworthy, but financial struggles led them to open doors to riskier, nonstandard financial assets, including privately issued fixed-income products [para. 6][para. 7]. These products, often corporate debt, promised higher returns than regulated financial institutions, attracting many individual investors despite greater risks [para. 8]. Unlicensed exchanges in smaller towns then exploited regulatory loopholes to offer similar high-yield but high-risk products [para. 9].

As government restrictions on real estate financing tightened, some property developers and local government financing vehicles (LGFVs) turned to LFAEs for funding. These exchanges became crucial for heavily indebted entities such as China Evergrande Group and Zhongzhi Enterprise Group. Despite a 2021 ban on LFAEs providing financing to real estate enterprises and LGFVs, fundraising continued on unofficial platforms [para. 10][para. 11][para. 12].

Local authorities failed to adequately understand and manage LFAEs, allowing them to proliferate as part of local financial infrastructure, leading to cycles of scandals and rectifications [para. 13]. The confusing landscape made it difficult for ordinary investors to distinguish between genuine and illegal platforms, increasing their vulnerability to financial risks [para. 14].

The local governments that shut down their LFAEs in March warned investors of the significant risks associated with trading on unlicensed platforms. More than 10,000 legal disputes related to LFAE products are currently going through the courts, primarily due to defaults on fixed-income products [para. 15][para. 16]. Zhongzhi, which alone has several hundred billion yuan's worth of outstanding products, filed for bankruptcy liquidation in November due to a financial shortfall of about 220-260 billion yuan [para. 17][para. 18][para. 19].

Some LGFVs continued to raise funds despite the official closure of LFAEs, taking advantage of the plethora of unauthorized exchanges. Addressing these unauthorized platforms will require local authorities to prevent illegal borrowing by LGFVs [para. 20][para. 21]. Guo Feng, an associate professor at Shanghai University of Finance and Economics, noted that illegal fundraising has been rampant partly due to covert or explicit support from some local governments, and interventions often come too late to prevent significant damages [para. 22].