Will China's trust companies that currently operate in the shadows undergo the dramatic restructuring that the country’s Trust and Investment Companies have experienced in the past twenty years?

As China’s economy changes rapidly, we ask whether the trust companies that currently operate in the shadows will undergo the dramatic restructuring that the country’s Trust and Investment Companies (TICs) have experienced in the past twenty years—will they get ‘TIC’d? Sara Hsu, an assistant professor of economics at the State University of New York at Paltz, lends us her expertise on the subject.

China’s trust companies are wily institutions. They currently hold over nine trillion renminbi (RMB) in assets under management, and they are quite apt at skirting regulation. Before 2010, trusts gladly removed risky bank loans from bank balance sheets and repackaged them as securities for banks to sell to customers. When this practice was banned, trusts continued to extend loans themselves or through third parties and sell them to banks to bundle as wealth management products. Many borrowers are companies that are too risky to qualify for a bank loan—not a good sign.

As of the second quarter of 2013, trusts had invested 35% of their funds in infrastructure and real estate projects, and another 21% was invested in financial institutions and products. These sectors stand to lose as growth stalls—real estate and infrastructure are starting to slip because property price growth is declining, and financial institutions will likely decline as credit growth slows. Only 29% of trusts’ funds are invested in industrial and commercial enterprises—real economy firms that may stand a chance at remaining profitable. So there is reason to worry.

Even if a decline in underlying loan quality does not result in the sector’s decline, a recent report by McKinsey and Company confirms that, as the financial sector is reformed and other institutions are allowed to use the trust structure, up to 88% of trust revenue would be at risk. This would mean that trust companies would have to find a new business model—or perish.

Today’s trust-industry conditions parallel those surrounding China’s TICs, which began operating when the reform period began, and incurred significant losses in the real estate sector in the late 1990s.  Trusts are a recent manifestation of TICs, similar in that they invested in a wider range of assets than commercial banks. Some of the TICs, including Guangdong International Trust and Investment Corporation (GITIC), suffered bankruptcy in the late nineties; all were ordered to stop business and become recertified in 2000. In 1999, GITIC represented the biggest bankruptcy in China to date. The company had borrowed billions of dollars in foreign currency and expanded into real estate, hotels, and securities trading. Holders of GITIC debt suffered the fallout from the firm’s bankruptcy in 1999, despite the fact that the institution was believed to be “too big to fail.”

The China Banking Regulatory Commission, which took over the regulatory role for the TICs in 2003, established many guidelines for their operation. A serious investigation into the TICs was launched in 2004, and a number of scandals were uncovered; by 2005, the number of TICs had unsurprisingly diminished.

The reincarnation of TICs as trust companies is a result of a 2007 regulation that improved corporate governance and restricted the use of trust companies’ own assets. With the CBRC as a regulatory body, new regulations, and new names, trust companies became quite appealing to the Chinese public. Between 2008 and 2013, trust industry assets under management increased more than seven-fold. Without quite realizing that these companies have a tendency to encumber excessive risks, taking on loans that banks might be prevented from extending directly, the public has viewed trust products simply as deliverers of yield.

The difference between the TICs and the trusts is that risk among trusts is concentrated among domestic, rather than foreign, holders of trust assets. CBRC officials have been adamant that (domestic) holders of shadow banking products, particularly wealth management products, are the ultimate bearers of risk. In an increasingly market oriented economy, allowing institutions and individuals who take on risks to bear the cost of the risks will likely be more commonplace. And why would the government prop up a flagging industry that has behaved badly in the past, should the economic climate turn sour? The simple truth is that it seems unlikely. The trusts are in danger of joining the TICs in yet another restructuring debacle. This may be the least surprising event in China’s restructuring mix. 

* Sara Hsu can be reached at hsus@newpaltz.edu or on +1 845-255-1059.