From Money & Investment, Page 17, issue no. 386, Sept 22, 2008
Translated by Liu Peng
Original Article: [Chinese]

Shanghai-based Hua An Fund Management Co. is one of the casualties of Lehman Brothers' collapse.

Though the failed US bank has exposed Hua An to potentially high losses and possible pre-mature liquidation of its QDII (Qualified Domestic Institutional Investor) product, the seed of problems was partly sowed by Hua An itself through rapid expansion and internationalization in recent years.

Hua An was the first to introduce a mainland fund that could invest abroad in 2006 and appointed Lehman Brothers as its oversea investment adviser, thus had invested in dollar-denominated structured notes issued or guaranteed by the latter.

The notes are linked to various types of assets, including bonds, shares, real estate and commodities, managed by Lehman Brothers and its subsidiaries.

Holding these notes now has created uncertainties to Hua An's International Balanced fund, which came under China's QDII program that allowed Chinese to invest in foreign securities markets as a way to encourage capital outflows to reduce yuan appreciation pressure.

After Lehman Brothers, once the fourth largest investment bank in the US, filed for bankruptcy protection, Hua An announced it would replace the failed bank to assume responsibility for payment of the QDII fund to avoid its pre-mature liquidation. The Balanced Fund is due to mature in 2011.

The Hua An-Lehman Deal
As the Lehman Brothers and its subsidiaries acted as the Balanced Fund's adviser, guarantor and paper underwriter; Hua An had practically lost control of investment initiative for the QDII fund.

As a result, the nature of the Fund's investment strategy was that Hua An raised nearly 200 million dollars from domestic investors and then bought the equivalent value of structured notes from Lehman Brothers.

As a passive party in the investment deal, Hua An could only await the outcome of Lehman Brothers liquidation. Although it was three years from the Fund's maturing date, the product might withdraw from the market ahead of schedule.

Another bad news was that nobody knew where Hua An ranked in the liquidation preferences of Lehman Brothers. In the end, Hua An could suffer losses up to hundreds of millions of yuan.

Sources from Hua An expressed their worries: "The scale of losses could be beyond the capacity of a fund company."

If the losses were to be shared by investors, then two factors came into play: one depended on Lehman's liquidated value, and the other depended on Hua An's business conscience.

"The Fund didn't explain clearly to the investors (on how to distribute investment losses). Most of them thought that worse come to worse, their initial investment capital would remain," said one senior staff of Hua An.

The deal between Hua An and Lehman Brothers was promoted by Yao Yulin, who had over ten years of experience working in the Wall Street. He was once a partner in Berens Capital, he had also worked in Dow Jones and Goldman Sachs before he joined Hua An in 2004 as its vice-president, in-charged of the QDII products.

However, Yao left Hua An last year, bringing along with him a team of experienced analysts and researchers to set up his own fund company with considerable financial support from Lehman Brothers. Yao is still in the board of directors of China's Lehman Brothers.

Lessons Learned from Hua An
The present problem inflicting Hua An's QDII fund, though triggered by the collapse of Lehman Brothers, it was also partly stemmed from its own shortcomings.

For the past years, like many other players in the Chinese fund industry, Hua An had been pursuing a larger, stronger, and faster development, but had often neglected risks. There were evidences in the past of this trend taking root in the industry.

In 2000, media exposed the malpractices, including multiple funds joined hands in market manipulation and abused investors' money, in the relatively young industry. The concept of fund management company was only introduced in China in 1998.

In 2004, funds that allowed investors to buy into a basket of currencies became a new favorite in the market. Fund companies were locked horns in vicious competition, leading to many sidestepping regulations and disregarding risks management principles in their eagerness to win the battle. In the end, the industry incurred losses amounting to one billion yuan that year.

Last year, media widely reported malpractices among fund managers, who allegedly made personal investment in certain stocks when prices were low, and then they used investors' money to buy those shares in large block and push up prices, so that their personal investment would gain.

Though Hua An has a host of shareholders made up of private enterprises and operated independently, it also has close tie with government officials, who exerted much influence over the company's past restructuring and products innovation.

The interwoven politics-commerce interests had in 2006 dragged Hua An into the Shanghai pension fund scandal, which involved the embezzlement of some 3.7 billion yuan (474 million dollars) by Shanghai's Communist Party chief Chen Liangyu and bribery practices by numerous corporate figures, including the then Hua An managing director Han Fanghe.

Since 2002, many domestic fund companies had embraced joint-venture with foreign institutions, along came copy cat operation model of foreign assets management companies. The "duplicated" model lacked true understanding and blending of foreign experiences with local business culture and environment, this added risks to their operations.

"The bankruptcy of Lehman is a warning bell to the entire Chinese fund industry. Domestic fund companies will be more prudent in selecting foreign partnership in the future.

"Having the capacity to control risk is one thing, but to be able to identify risks needs the ability to read into macro economy signals through meticulous research," said one industry player.