* Regulators could force parent firms to pay - insiders
* "Doomsday scenario" for mutual fund JVs - executive
* FMCs created 2 trillion yuan worth of investment products
since 2012 - analyst estimate
* Most funds channelled to high risk borrowers
(Adds official data on structured product losses, clarifies
indirect relationship of Value Partners to defaulting firm)
By Pete Sweeney and Michelle Price
SHANGHAI/HONG KONG, Aug 26 Foreign joint venture
partners of Chinese mutual fund companies fear they will have to
bail out investors in one of the shadiest patches of China's
shadow banking system, following two defaults by lightly
regulated subsidiaries peddling complex investment products.
While defaults of wealth management products (WMPs) issued
by Chinese banks and trust companies have ended in some form of
government rescue, there is no precedent for how problems with
fund management company (FMC) subsidiaries will be resolved.
In many cases, the arms-length nature of the relationship
between parent firm and subsidiary means the former may be
unaware of how much risk the latter has taken on. Analysts warn
that they may not enjoy the implicit state guarantee extended to
other parts of the sector.
"This can lead to a capital call on the parent, and that's
the doomsday scenario for a lot of these joint ventures, that
and the reputation risk," said an executive at a major FMC joint
venture, who spoke on condition of anonymity.
Industry insiders who spoke to Reuters saw that scenario as
a likely outcome, given that the agency regulating the
subsidiaries is the China Securities Regulatory Commission
(CSRC), which has jurisdiction over their mutual fund parents -
but none over banks - and so could force them to cover losses.
The same sources said many foreign players were already
nervous about their Chinese partners' push into shadow banking -
in particular into opaque and complex structured products -
suggesting liability concerns could trigger the joint ventures'
The two recent cases that have rattled foreign companies
involve investment products that have been unable to pay
investors interest due at maturity.
The latest involves a default by a fund marketed by a group
of subsidiaries and partners of Noah Holdings, a
Chinese wealth management product (WMP) company listed in New
Domestic media reported last week that the fund had
experienced repayment problems with a 1 billion yuan ($162.5
million) WMP that was due to mature earlier this month.
A legal dispute between the participants has frozen 600
million yuan, with Noah alleging that the funds meant to pay off
investors were dishonestly redirected by one of the marketing
partners to invest in another project.
The dispute risks pulling in Hong Kong-based fund management
company Value Partners Group, which is indirectly
involved because it also owns a 49 percent stake in a firm that
in turns holds a stake in one of the subsidiaries concerned.
Value Partners said in a statement that was not a party to
the alleged misappropriation, and it did not expect the dispute
to have "a material impact" on its business.
Noah Holdings did not respond to requests for further
In a second recent case, Mirae Asset Huachen Fund Management
Co, a joint venture (JV) between South Korea's Mirae Asset
Financial Group Co and two Chinese FMCs, announced on Aug. 11 it
had failed to pay more than 32 million yuan worth of interest
due on trust loans in July due to project difficulties.
Mirae Huachen declined to comment when contacted by Reuters.
DESPERATE FOR PROFITS
There are around 68 fund management companies in China
operating subsidiaries dabbling in structured products - usually
a package of assets such as loans divided into tranches and
resold at different rates of return - and other WMPs, nearly
half of which are operated by joint ventures with foreign firms.
They include such big names as CITIC Prudential, UBS SDIC,
State Street Global Advisors (SSGA), Invesco Great Wall and Bank
of Communications Schroders, according to consultancy Z-Ben
Advisors, although not all are necessarily dealing in high-risk
Invesco confirmed it had such a subsidiary but said it was
not selling structured products. SSGA, which is in the process
of exiting its JV according to press reports, declined to
comment. The other JVs did not respond to requests for comment.
Most of the FMC subsidiaries were created to exploit
opportunities in China's burgeoning high-yield wealth management
sector. They have issued more than 2 trillion yuan ($325
billion) worth of structured investment products since they were
allowed to enter the market in 2012, according to estimates from
Shanghai-based fund researchers Z-Ben Advisors.
Many of those products are backed by loans given to some of
the shakiest borrowers in China, analysts say, because the prime
assets had already been repackaged into WMPs by earlier,
better-funded market entrants such as state-owned banks.
"By the time the FMCs were cleared to enter this business in
2012, all the pretty girls were taken," said Michael McCormack,
executive director at Z-Ben.
He said the FMCs in many cases had become de facto loan
underwriters, arranging bank loans for desperate companies - in
particular over-extended real estate developers - which were
then sliced into tranches, repackaged and resold to get them off
the bank's books.
Official data says that the majority of the more than 12
trillion yuan currently invested in Chinese WMPs is safely held
in bonds or time deposits, but around a third are put into
credit products, which includes the sort of high-risk,
high-yield loans currently being carved up and repackaged.
The report said that of the 31 products issued in the first
half of 2014 that lost money for investors, the "overwhelming
majority" were structured credit products and offshore WMPs.
To be sure, it is not certain that foreign JVs will end up
on the hook - regulators could let the investors who purchased
the products take the full hit if funds blow up.
But that would risk setting off a panic among domestic
investors and by extension risk a wave of bankruptcies among
desperate corporate borrowers who have few funding alternatives
to stay afloat.
Because the subsidiaries are technically middle-men, not
lenders, analysts say they have generally skipped executing due
diligence on the assets they packaged, and were only required to
maintain a negligible 20 million yuan in cash reserves.
"What's about to begin is a chain of passing the hat," said
Z-Ben's McCormack. "These subsidiaries weren't doing anything
different from anyone else in the business. They don't do any
due diligence either."
(1 US dollar = 6.1540 Chinese yuan)
(Additional reporting by Umesh Desai in HONG KONG and the
Shanghai Newsroom; Editing by Alex Richardson)