March 14, 2013 / 4:01 AM / 7 years ago

China widens monitoring of brokers' murky channel business

BEIJING/SHANGHAI, March 14 (Reuters) - China is stepping up the monitoring of security brokerages’ channel business, which guides client funds into off-balance sheet investments, concerned that it could be a hidden systemic risk, a senior official from the securities watchdog said.

Ouyang Changqiong told a news conference during the National People’s Congress in Beijing that the common brokerage practice of acting as an intermediary between their clients and investment projects - similar to how trust funds cooperate with banks - could pose a bigger danger to economic stability.

“Nothing has happened yet. But the hidden potential risks in this sort of business are worth paying attention to,” he said.

The China Securities Regulatory Commission (CSRC) has, therefore, required brokerages to report every month on where the funds are coming from and where they are being ultimately invested, Ouyang said, adding that the regulator will also scrutinise brokerages annual reports.

“There’s growing concern over the quality of brokerages’ shadow banking business, which helps channel depositors into businesses such as real estate and manufacturers, which are highly vulnerable to the health of China’s economy,” said an analyst at a brokerage in Shanghai, who asked not to be named because he is not authorised to speak to the media.

“These assets are outside the balance sheet, loosely regulated, and are not actively managed by brokerages.”

The channel business model is not unique to Chinese stock brokerages; securities brokers in developed economies provide similar services to their clients, and Ouyang of the CSRC said that the business does not qualify as “shadow banking.”

Chinese brokerages are particularly desperate for new products to sell in a saturated and competitive market, and the CSRC has made numerous incremental moves to expand their product portfolio and lower their cost structures.

The channel business model has been especially popular.

Assets under management (AUM) at Chinese brokerage houses exploded in 2012, to 1.9 trillion yuan ($305.8 billion) up from 281.87 billion yuan at the end of 2011, and Reuters analysis of the data shows nearly 1.6 trillion yuan of it came from channel business.

In China’s case, regulators’ concern about the model is founded on problems uncovered in similar products founded elsewhere in the financial system, in particular in wealth management products (WMPs), which Bank of China chairman Xiao Gang famously called “Ponzi schemes” in 2012.

Several WMPs collapsed in late 2012, and retail investors who thought their products were guaranteed by the banks that sold them were distressed to discover that the bank was a mere intermediary.

On the financial side, Beijing is concerned that such channels could be used to misallocate and misprice capital, for example, by investing in residential real estate even as regulators try to crack down on speculation, or providing funds to troubled local government financing vehicles (LGFVs).

Domestic media have reported that China’s banking regulator will start monitoring banks’ off-balance sheet financing activities concerning LGFVs this year.

$1 = 6.2138 Chinese yuan Additional reporting by Samuel Shen in SHANGHAI; Editing by Jacqueline Wong

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