Turmoil at Zhongzhi sparks alarm over China’s $3tn shadow finance sector

This week, the spotlight on the messaging platform hosted by the Shanghai Stock Exchange has been on payment defaults by a vast financial conglomerate as investors engage with companies directly.

"Dear investor," stated Shanghai Chemspec, a chemical company, in one of many corresponding messages aiming to reassure investors, "we have not made any purchases of wealth management products from Zhongrong or Zhongzhi."

Zhongrong, a major participant in the shadow financing market known as the trust industry, with partial ownership by investment group Zhongzhi, is facing uncertainties regarding its stability. These doubts further contribute to the growing anxieties surrounding China's economy, as it continues to grapple with the aftermath of the Covid-19 pandemic and the challenges of recovery.

Last week, two publicly traded companies announced that Zhongrong had not fulfilled its obligation to repay trust products. These products provide individuals and businesses with higher profits compared to traditional banks. Prior to this announcement, there had been ongoing rumors regarding missed payments to retail investors by Zhongzhi's wealth management businesses. These businesses channel billions of renminbi into savings products.

According to CreditSights analyst Karen Wu, the market did not experience a high level of panic when the financial crisis was limited to Zhongzhi wealth management companies. However, with the emergence of Zhongrong, the crisis has actually gained momentum and intensified.

As shadow funding frequently finds its way into the Chinese property market, the troubles faced by the Zhongzhi group have exacerbated concerns about the potential ripple effects of a decline in the once-thriving real estate sector. This downturn has already led numerous developers to default.

According to a former high-ranking employee of a mainland China bank, the trust industry in China typically gathers funds from both companies and individuals at more lucrative interest rates compared to banks. He further noted that, in general, trust companies might have an excessive reliance on the real estate sector.

According to Xiaoxi Zhang, an expert at Gavekal consultancy, information from the China Trustee Association reveals that out of Rmb23tn in trust products, Rmb1.1tn ($152bn) was invested in the real estate industry. Zhang states that the actual amount is likely much higher since trust funds are usually channeled through numerous intermediaries before reaching developers. Additionally, there is a lack of data regarding trust loans to local government financing vehicles.

Following the failure of Country Garden, the largest privately owned housing construction company in China, to make its bond payments last week, experts at JPMorgan have cautioned about the potential for a detrimental loop in real estate funding. This could exacerbate the financial strain on property developers and those who lend to them outside of traditional banks.

The experts also mentioned that Zhongrong possessed a grand total of Rmb629bn in assets, with Rmb67bn specifically allocated to the property industry. "Details regarding the individuals or organizations who owe real estate debt are not provided," they stated. "Therefore, we must assume that any debt related to real estate poses a potential risk."

According to Zhang from Gavekal, it appears that although regulators have taken action against shadow banking, such as its role in funding real estate and its connections to traditional banking, the overdue payments at Zhongzhi indicate that the financial burdens of property developers and local government financing entities are starting to impact China's overall economy.

Zhongzhi, an organization situated in Beijing, was established in 1995 by Xie Zhikun, an individual who rose from poverty to become a successful entrepreneur, acquiring his wealth through ventures in the timber and real estate industries. When Xie passed away in 2021, Zhongzhi had investments in six financial institutions and four wealth management firms, alongside various business interests spanning from mining to new-energy vehicles. Following his demise, Liu Yang, Xie's nephew and former chairman of Zhongrong, took over the reins as the new leader.

The four financial investment firms owned by Zhongzhi, whose total assets are estimated to be worth trillions of renminbi by Chinese media company Caixin, have received significant attention on Chinese social media platforms. A letter expressing regret for failing to make timely payments, penned by a representative of an investment enterprise associated with Zhongzhi, has been widely circulated across the internet.

There was no response from Zhongzhi when asked for a comment. Similarly, Zhongrong, who recently claimed that their corporate seal, official letters, and other documents had been fraudulently replicated by criminals, did not provide any response when asked for comment.

During a casual gathering with investors at Zhongzhi's main office last week, a member of the Zhongrong board clearly communicated the extent of the issue, as reported by two attendees.

According to a board member, three out of the four wealth management firms ceased their payments in June. These firms, including Zhongzhi, had invested in various assets such as listed companies, real estate endeavors, debts, and other properties located in lower-tier cities. Subsequently, the fourth wealth manager also discontinued their payments as confirmed by two investors.

Indications of disapproval from individual investors in the retail sector can be observed.

In the beginning of August, the authorities were notified about an incident taking place at Zhongzhi's main office, as individual investors were attempting to address certain concerns with the management team. Both the investors and the police present at the scene refused to provide any specific information regarding the matter. On Wednesday, the individual investors aimed to officially file their grievances with the authorities based in Beijing.

An investor based in Yunnan, China, who had invested in Zhongrong products, informed the Financial Times that he was owed approximately 6 million Chinese yuan. "These assets were all acquired through sweat and toil... But now I have been left with nothing," lamented the investor.

An individual, who preferred to keep their identity hidden, shared that their parents had made investments in Datang, which is one of the four financial management firms operated by Zhongzhi. The person disclosed that their parents work at a power plant situated on the eastern shore of China, where nearly all employees have invested in the same scheme. As per the investor, they were informed in early July that the payments would be postponed for a duration of 10 days. However, the said payments have not been received by the investors till now.

"It's quite unbelievable how they believed it was completely secure," the individual expressed. "No contact has been established with any Zhongzhi employees, whatsoever."

An official communication sent to investors of Datang company, and scrutinized by the Financial Times, details a one-year offering named "Zhongzhi Shicheng" which guarantees an 8 percent profit in the event of an investment up to Rmb3mn.

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According to Wu from CreditSights, the wealth management products in China frequently fail to provide sufficient information about the assets they are based on. This lack of disclosure leaves investors unsure about the nature of these assets.

According to Zhang from Gavekal, if the market downturn persists, problems with debt in the real estate industry will unavoidably appear in different areas, such as commercial banks.

"If that occurs," he remarked, "Zhongzhi might still be perceived as a warning sign or indicator of potential danger."