By Li Baohua (李保华) and Hu Zhongbin (胡中斌)
Issue 576, July 2, 2012
Market, page 17
Translated by Tang Xiangyang
Original article: [Chinese]

The number of investors with A-share accounts worth over 10 million yuan has decreased by 20 percent over the past 16 months, private equity firms are also having a hard time attracting investment and banks are finding it difficult to attract enough funds to meet their quarterly deposit ratio targets - it seems as though, in a flash, all the big investors have disappeared from China's capital markets.

Data from the China Securities Depository and Clearing Corporation Limited (CSDC) revealed that in April the capital gathered by private equity firms dropped by 70 percent compared to last year. Likewise, in an attempt to attract large clients, banks have been forced to increase their overnight lending rate to 1 percent.

While big investors may be vanishing from traditional financing markets, an emerging array of innovative financial products are starting to attract these major players.  

The Disappearance of Big Investors

By the end of April, the number of A-share holders with individual accounts worth over 10 million yuan stood at 18,800 - 4,519 less than at the end of 2010. The Shanghai index has fallen by about 15 percent over the same period.

"The market declines have shrunk investors' assets, but a larger amount of funds have actively choosen to exit the A-share market" an anonymous source with a securities company said. Other sources working at private equity firms agreed with this sentiment.

According to Zero2IPO (清科数据库), a research company that caters to China's VC and PE sector, the number of private equity funds established by Chinese and foreign venture capital and private equity institutions fell to only 15 in May.

"Private equity used to be very profitable industry," said Kong Qiang (孔强), a partner at Broad Hi Capital (秉鸿资本). "However, as capital markets waned and returns fell, investors and institutions are becoming more practical. Investors who got in early, still haven't gotten their money back and new investors aren't investing much, this is has had a real impact on private equity firms."

In China's private equity market, limited partnership company structures (LPs) are mainly established by private entrepreneurs and wealthy individuals. However, the EO has learned that from the start of last year, many limited partnerships have been falling short on the amount of capital they had originally committed to invest by around 10 to 20 percent.

Banks are facing a similar problem. Since it's already the middle of the year, they're competing with each other to attract deposits so that they can meet the loan-to-deposit ratio targerts set by regulators. The EO has learned from an unnamed deputy manager of a bank branch in Shenzhen, that some banks in the city have raised their overnight rate from 0.5 to 1 percent. Despite this move, some are still finding it difficult to attract capital.

New Investment Opportunities

Old Chen (not his real name) is the president of a sailing club in Shenzhen. Responding to a request from members, the club founded an asset management team at the beginning of the year to seek low-risk, high-yield investments. It's already invested almost 2 billion yuan in less than half a year.

Chen explained that the team mainly does equity pledge projects – a loan system where borrowers put up assets as collateral worth more than the loan itself.

"It's almost risk-free," said Lao. "And the annual profit is around 11 percent - two or three percentage points higher than that of similar trusts recommended by banks."

His group uses trust channels owned by its own members. Normally the management fee is just 0.5 percent, compared to the one to two percent it would cost to go through ordinary channels. Banks will also charge two percent as a trust subscription fee.

"Our way not only saves money for our members, but more importantly, we can do the due-diligence ourselves and have better risk control," Lao said.

The deputy president of the Shenzhen bank branch quoted above said that banks have to charge high trust subscription fees because the money flows to the trust company once investors join. Even if the trust company has an account at a single bank, the capital would be categorized as an interbank deposit rather than being factored into the loan-to-deposit ratio.

Publicly available data shows that by June 13, there were already 702 equity pledge projects with 128.1 billion shares pledged - 5.2 times higher than during the first half of 2011.  

More money has also started flowing into guarantee companies and markets where investors have the first chance to buy newly-issued securities (primary markets).

"We promise our customers an annual profit ratio of over 15 percent," said the chairman of a large guarantee company.

"Though lots of guarantee companies have problems now, we're still trusted by the investors. It's not difficult to gather investment."

His company requires the value of collateral on a loan to be higher than the amount of money borrowed. This usually means the borrower company puts up its shares as collateral and then buys them back after the debt is repaid. The borrower also has to show that its monthly profit margin exceeds the amount of interest on the loan.  

"Our products are risk-free," the chairman of this large guarantee company boasted.

He went to say that his company couldn't survive off the spread between interest they paid on their loans and the interest they charged borrowers. He further revealed that most of the capital Shenzhen's guarantee companies had was now coming from private investors.

In most cases, banks serve as the middlemen between guarantee companies and borrowers.

A research report from CITIC Securities (中信证劵) shows that the scale of China's private lending market had exceeded four trillion yuan by the end of 2011, accounting for somewhere between 10 to 20 percent of total outstanding bank loans.

Some investors with professional knowledge are entering primary markets. For example, a board member of a company listed on ChiNext, China's Shenzhen-based growth enterprise board,  has shifted to equity investment after finding that the returns earned from being involved in a limited partnership weren't as good as he has imagined.

Why They're Going Elsewhere

Wang Liang (王亮), the head of Taihe Investment (太和投资), explained that most traditional big investors will invest their capital in wealth management products. However, if you purchase these financial products through official banking channels, you're currently charged by both the banks and the companies [that issue them].

"The profits our customers receive may only be half of what creditors have paid," he said. "At the same time, going through either banks or trust companies also raises the risk of being exposed to moral hazard [making risky gambles with others' money]. That's why big investors prefer to use these relatively simple financial products on their own."

A due-diligence report obtained from a bank by the EO showed that, while the creditors' financing costs were 18 percent of the borrowing, the trust company got 1 percentage point, the bank got 8 percentage points, while the client only got 9 percentage points.

Currently, as fewer customers are buying financial products from banks, "purchasing fees" for these wealth management products are climbing as high as 20 or even 25 percent of the investors annual returns.