Chinese Trust Companies Learn Important Lessons the Hard Way
The large but young trust company industry in People’s Republic of China (PRC) is experiencing a severe crisis, comparable in some ways to the calamity that rocked American trust companies over a century ago in the Bank Panic of 1907. The very good news for clients of American trust companies such as Sunstone Trust Company is that the United States has had 114 years since its crisis to overhaul trust company law and regulation and to put the trust company industry on safe and sound footing.
Today, customers of American trust companies have peace of mind knowing that their trust company is carefully regulated, not allowed to make speculative investments or lend money. This is why failures in the American trust company industry have been exceedingly rare in the intervening century and why American trust company customers never, as a practical matter, lose their money due to imprudent management of their trust company. (Of course, people can and do lose money on the underlying investments, which is a risk all investors understand.)
In China, the trust company industry is mismanaged and hemorrhaging client assets. Many people have lost money they entrusted to PRC trust companies. In the best of times, only 11 of the 68 PRC trust institutions operating globally are large-scale private enterprise holdings. The remaining 57 PRC trust companies are directly controlled by central enterprises, local state-owned enterprises, and even the government. Of these, only three PRC trust companies have been listed.
Severe Credit Problems Are Emerging in Some Chinese Trust Companies.
In mainland China where the possible collapse of one of its largest companies is sending shockwaves through the stock markets and where trust companies are seen as a type of non-bank lender, severe credit problems are under the microscope.
Sichuan Trust Co. Ltd. Is a high-profile example. Investors entrusted $3.5 billion to that troubled PRC trust company which put investor money into the trust company’s “trust of trust” (TOT) products, which are invested in a wide variety of assets, including bonds, stocks and loans to private companies and local government financing vehicles.
At the time, such TOT products were legal. However, most of the underlying assets of the firm’s TOT products turned risky and the company needed to rely on funds subscribed by new investors to repay old investors, a classic sign of a mismanaged fund and / or one in which the insiders were engaged in wrongdoing. In the case of Sichuan Trust, investigators have found embezzlement of funds by shareholders and regulatory violations such as the firm’s inability to disclose the risk status of underlying assets and the firm’s improperly connected transactions.
An Endemic Problem.
The highly publicized problems at Sichuan Trust appear endemic throughout the PRC trust industry. Of the 68 authorized trust companies remaining, regulators have already punished nearly one-third of them for violations, including conducting illicit off-balance-sheet lending and illegal real estate investments, levying fines worth 22.5 million yuan (about $3,481,930 USD).
Essentially, these trust companies sold high yield TOT products to their clients, gambling on near-perfect performance from the underling borrowers, the bulk of which were high risk (and highly vulnerable) property developers, manufacturers, and local government financing vehicles. Only two trust companies had avoided defaults as of the end of 2019. As an industry, the government is cracking down on the practice of overpromising returns and underdisclosing risks.
The Many Important Differences vs. U.S. Trust Companies.
There are many important differences between PRC trust companies and the American trust company industry. First, American trust companies are asset managers and do not take deposits, lend money, or take credit risk. Americans learned the hard way that allowing trust companies to lend money with little effective oversight is a recipe for disaster. Since the 1907 Bank Panic, American trust companies rarely fail and even in those rare occurrences, customers do not lose their assets because trust companies are required to separate the trust company’s corporate assets from customer assets. This means that trust companies are structurally designed to never lose customer assets in a failure, something that deposit-taking banks cannot do. The rigorous regulation of American trust companies makes them less glamorous and even less profitable from their bank counterparts, but far more stable and strong.
The Stability and Strength of Sunstone Trust Company.
Sunstone Trust Company is strictly regulated by the California Department of Financial Protection and Innovation , and it is well-capitalized. Like other US trust companies, Sunstone does not lend money and has no credit risk. By design, Sunstone Trust Company is meant to last a century or more.
Sunstone Trust Company is developing and will offer “common trust funds” pursuant to long-established rules and regulations related to such funds. Sunstone’s Chief Fund Strategist, John Shen, has an exemplary track record in overseeing investment funds at Sunstone Management, Inc. Those Fixed Income Funds have never failed to pay interest as promised and to return principal to investors. Of course, past performance is no guarantee of future returns but Sunstone’s common trust funds are in experienced hands.
Mr. Shen’s prudent fund management, and Sunstone Trust Company’s commitment to full and honest disclosure to its clients about the risks of its funds, ensure that our clients make well-informed investment decisions. We encourage all clients and prospective clients to ask us questions, to carefully review disclosure materials, and to make an informed decision that you feel good about. We cannot guarantee that any investment you make will succeed. However, we do promise that we will comply with our capital requirements and the many laws that are designed to ensure we are safe, sound and here for the long term.