At China’s Zhongzhi, risky practices preceded the shadow bank’s collapse By Reuters

SHANGHAI/BEIJING/HONG KONG (Reuters) – Zhongzhi Enterprise Group, a former leader in China’s shadow banking sector that declared insolvency last year, has used aggressive and potentially illegal sales practices to shore up its operations as it which had plummeted toward collapse, according to records reviewed by Reuters and eight people with direct knowledge of the matter.

China’s real estate boom over the years has propelled Beijing-headquartered Zhongzhi to the top of the country’s $18 trillion asset management industry and made it a key player in a banking sector in shadow the size of the French economy. Asset managers such as Zhongzhi sell wealth management products to investors. Proceeds are then channeled by licensed trust firms such as its Zhongrong unit to developers and other companies that cannot access bank financing directly due to poor creditworthiness or other reasons.

Previously unreported details show that for about a year before its financial problems came to light, Zhongzhi units were paying profits to existing investors in wealth management products, using funds from new investors and promising individual investors lucrative returns that belied the group’s exposure to a the deepening of the real estate crisis.

Trust firms in China are known as shadow banks because they operate outside many of the rules that govern commercial lenders. But China’s top banking regulator said in 2018 that financial institutions, including shadow banks and asset managers, should not set up capital funds, to prevent them from using money from new sales to cover profits existing wealth management products, nor should they guarantee wealth returns. – management products.

Zhongzhi appears to have violated both requirements, two lawyers said after reviewing Reuters’ findings at the news agency’s request. Lawyers added that such misconduct can result in fines and prison terms of up to 10 years.

“The core of his suspected illegal action is raising money from investors through his licensed financial institutions to finance business operations and group expansion,” said Zhang Guanghui, a lawyer at Guangdong Suijia Law Firm.

Zhongzhi and its units identified in this story did not respond to detailed requests for comment on the practices outlined by Reuters.

Chinese officials were equally tight-lipped. China’s public security and justice ministries, which oversee police and prosecutors in Beijing, respectively, did not respond to questions about cases against people connected to the shadow bank. China’s National Financial Regulatory Authority and the central bank also did not respond to requests for comment on the practices of the Zhongzhi units.

Zhongzhi’s liquidity crisis became public when trust unit Zhongrong missed payments on dozens of products in the third quarter of 2023, fueling investor protests and concerns that China’s property collapse was spilling over into the 66 trillion yuan financial industry. dollars.

Zhongzhi eventually told investors in November 2023 that it was insolvent with up to $64 billion in debt. The group filed for bankruptcy in January as Beijing police investigated its business practices. In March, Beijing police said on WeChat that wealth management firms under Zhongzhi should cooperate with police and return any illegal income.

In August, prosecutors in Beijing said they had charged 49 suspects linked to Zhongzhi on suspicion of illegally siphoning public deposits, without giving details.

Public deposits entered Zhongzhi’s shadow bank operation through funds placed by investors in the wealth management products that Zhongzhi’s licensed financial units were selling. Reuters could not determine the specific warehouses or facilities prosecutors were referring to.

Interviews with current and former Zhongzhi Group staff and investors, as well as records reviewed by Reuters, shed new light on how the possibly illegal practices of its units exposed middle-class savers to the damaging consequences of the property collapse in China, despite efforts by regulators to rein in the excesses of the shadow banking sector.

The eight sources spoke to Reuters on condition of anonymity, citing fear of official reprisals.

rags to riches

Zhongzhi was founded in 1995 by Xie Zhikun, a tycoon who started out in timber and real estate before expanding into financial services.

In its heyday, Zhongzhi cashed in on China’s booming property market. It raised funds by selling high-end products to retail investors, while trust arm Zhongrong charged developers such as Country Garden an interest rate of more than 12 percent on one-year loans, according to four Zhongrong investment banking filings in 2017, reviewed by Reuters. Although this was not unusual for shadow banks, the benchmark bank lending rate was around 4%.

As business grew, Xie rubbed shoulders with developer tycoons, including China Evergrande (HK:) Group head Hui Ka Yan and Country Garden head Yang Guoqiang, according to the three current and former staff members. Both developers have since defaulted on debt repayments and building properties; Evergrande is going through a court-ordered liquidation process, and Country Garden faces the prospect of one. Neither responded to requests for comment about their ties to Zhongzhi.

Zhongzhi staff have reaped skyrocketing bonuses as the property boom has turbo-charged both growth and demand for rich, high-yield products, a current staffer and two former Zhongrong employees said. Xie gave huge sums to Fudan University, his alma mater, and organized summer getaways for top staff where he recited poetry, two of these people said. The university did not respond to questions about the unspecified donations.

Meanwhile, salespeople at Zhongzhi units valued the group’s connections to local governments and the support of its trust unit from state-owned Jingwei Textile Machinery Co., its largest shareholder, according to two investors and now-deleted state media reports. Jingwei did not respond to a request for comment on the nature of its involvement with Zhongzhi.

Xie died in 2021 at the age of 61 after a heart attack. That year also marked the beginning of the housing sector’s liquidity crisis, as Chinese regulators cracked down on debt-fueled construction by developers to reduce the risk of contagion to the wider financial sector.

In July of that year, a Zhongzhi unit’s sales pitch for a wealth management product masked the growing tension.

“This is a fixed return product,” a Hang Tang Wealth salesman wrote to investors in a WeChat group in July 2022, according to a screenshot of the exchange reviewed by Reuters. The sales agent guaranteed a minimum return of 6.2 percent on a three-month wealth management product for investments exceeding 1 million yuan, or about $140,000, exceeding 1.5 percent of local bank deposits.

The Zhongzhi unit “undertakes its full, unconditional and irrevocable obligation” to repay investors on time, the salesperson said, offering three up emojis.

The tactics and claims of the Zhongzhi salesmen attracted thousands of investors. But as developers across the country began to suffer cash flow problems, they defaulted on loans they owed to Zhongrong, the chartered trust unit. In turn, Zhongrong defaulted on payments owed to investors.

As difficulties mounted, Zhongrong’s board secretary Wang Qiang briefed dozens of angry investors at the company’s headquarters in Beijing in August 2023. Wang told them that funds from some Zhongrong wealth management products had been invested in projects that were no longer profitable and that the company was therefore struggling to pay buyouts, according to a recording of the meeting reviewed by Reuters, as well as four current and former Zhongzhi employees and two investors.

“There have been no product returns,” Wang said. “Without returns, what can we use to repay investors? Either we issue new products or we rely on the remaining cash”. But by July 28 that year, the money ran out, he added.

Pressed by an investor on whether Zhongrong has engaged in private equity business, which regulations prohibit, Wang admitted: “Some of the products have private equity characteristics.”

Zhongzhi has increasingly used such a practice since early 2022 as developers defaulted on loans and its coffers dried up, said one current and three former employees of the Zhongzhi unit. The effect, they said, was to hide Zhongzhi’s damaged position.

Wang could not be reached for comment via Zhongrong.

AFTER THE FALL

Zhongzhi’s collapse was largely precipitated by its huge exposure to loans to cash-strapped developers, many of whom turned to shadow banks to borrow as Beijing’s crackdown cut them off from high-street lenders, according to three current and former employees.

Zhongrong’s exposure to real estate investments accounted for 10.7 percent of total assets under management at the end of 2022, higher than the industry average of 5.8 percent, according to Citigroup. Zhongrong provided an almost identical figure in its 2022 annual financial statement.

The bankruptcy procedure is likely to take a long time. On June 28, a Beijing court said Zhongzhi’s bankruptcy trustee had requested the “substantial consolidation” and liquidation of the company and 247 affiliated firms. The administrator, Beijing Dacheng Law Offices, did not respond to Reuters questions about the lawsuit.

Some investors in Zhongzhi told Reuters they had given up hope of getting their money back.

Wang, a 51-year-old woman who owns a technology company in Shenzhen, thought she was “playing it safe” when she invested 1 million yuan in a four-year term product of a Zhongzhi unit, Zhonghai Shengrong.

The investment contract signed by Wang in May 2020, which Reuters reviewed, said the expected rate of return was 11 percent, compared with a benchmark three-year bank deposit rate of 2.75 percent. Funds raised from the product would go towards the unit’s “working fund,” the document said.

But a few months before Wang’s income was due, Zhongzhi declared insolvency.

“It turned out I was caught in a landslide,” she said.

(1 USD = 7.0850 renminbi)