China fund defaults expose foreign partners to shadow banking risk

Analysts warn that they may not enjoy the implicit state guarantee extended to other parts of the sector.

Foreign joint venture partners of Chinese mutual fund companies fear they will have to bail out investors in one of the shadiest patches of China’s shadow banking system, following two defaults by lightly regulated subsidiaries peddling complex investment products.

While defaults of wealth management products (WMPs) issued by Chinese banks and trust companies have ended in some form of government rescue, there is no precedent for how problems with fund management company (FMC) subsidiaries will be resolved.

In many cases, the arms-length nature of the relationship between parent firm and subsidiary means the former may be unaware of how much risk the latter has taken on. Analysts warn that they may not enjoy the implicit state guarantee extended to other parts of the sector.

Story continues below this ad

“This can lead to a capital call on the parent, and that’s the doomsday scenario for a lot of these joint ventures, that and the reputation risk,” said an executive at a major FMC joint venture, who spoke on condition of anonymity.

Industry insiders who spoke to Reuters saw that scenario as a likely outcome, given that the agency regulating the subsidiaries is the China Securities Regulatory Commission (CSRC), which has jurisdiction over their mutual fund parents — but none over banks — and so could force them to cover losses.