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China Takes Control Of Sichuan Trust As It Ramps Up Shadow Bank Clampdown

HONG KONG (S&P Global Ratings) Dec. 29, 2020--China's move to take control of Sichuan Trust Co. Ltd. signals a growing assertiveness with the sector. Officials said the entity was plagued with governance issues, resulting in a swath of defaulted trust products. S&P Global Ratings believes authorities' action on Sichuan Trust demonstrates China's intention to continue its crackdown on trust entities specifically, and the country's shadow bank sector generally, in 2021.

The Sichuan bureau of the China Banking and Insurance Regulatory Commission (CBIRC) has announced it will work with the local government to take over management of Sichuan Trust. It said that four out of the top five shareholders of Sichuan Trust were not cooperating with authorities to resolve risks.

The four major shareholders are Sichuan Hongda (Group) Co. Ltd., Sichuan Hongda Co. Ltd., Sichuan Haoji Food Co. Ltd., and Huiyuan Group Co. Ltd. All belong to the private sector.

China's central bank in its Financial Stability Report 2020 said that the possibility of default (of trusts or their products) could present spillover risks for related industries and markets.

"Sichuan Trust's corporate governance issues and the scale of its financial risk compelled regulators to take control of the entity, in our view," said S&P Global Ratings credit analyst Annie Ao.

According to a statement by the Sichuan CBIRC, Sichuan Trust failed to operate prudently and breached rules on related-party transactions. The major shareholders also failed to cooperate with regulators to manage related-party exposure.

Sichuan Trust faces an estimated Chinese renminbi (RMB) 20 billion to RMB30 billion of losses from its trust products under management, according to press reports. The products were sold to about 8,000 investors, including retail investors, according to the same reports.

"We see a low likelihood the government will provide direct financial support to investors of defaulted trust products. The government wants to break investor expectations it implicitly guarantees trust investments and wealth management products," said Ms. Ao.

The industry has established a fund (capitalized at RMB153.5 billion as of Sept. 30 2019) to cover trust company defaults in China. However, there is no established practice for how these funds might be used, or on whether any of the money might go to those holding investments managed by Sichuan Trust.

A Legacy Of High Risk

The default of the trust-of-trust (ToT) products issued by Sichuan Trust was partly due to the weak credit quality of the underlying assets. As of June 30, 2020, Sichuan Trust's outstanding ToT products amounted to about RMB25 billion, with most backed by real estate assets and company shares.

China's trust industry defaults rose in 2020. Soft economic growth resulting from the pandemic likely explains many of the cases. Regulatory action and COVID effects hit some sectors particularly hard, such as real estate and manufacturing, where most of the defaulted trust loans occurred in the year.

The trust industry has higher exposure to real estate developers, especially the weaker ones, and possibly lower collateral protection, than the banking industry. The trust firms' years of aggressive business expansion have amplified their risk. Many entities do not have sufficient financial resources to cover investments following issuer defaults.

"Trust firms' risks have been compounded by deficiencies in product design, including cashflow mismatch and concentrations of credit risk," said Ms. Ao. "They also have noncompliance issues, including misselling and the misuse of related-party transactions."

Timeline Of Key Events Leading To Regulators' Assumption Of Control Of Sichuan Trust
Event
May 2020 Trust product managed by Sichuan Trust is overdue.
June 2020 Multiple trust products managed by Sichuan Trust are overdue.
June 12, 2020 Senior management team announces that Sichuan Trust has a liquidity issue.
June 15, 2020 Investors protest at the headquarters of Sichuan Trust following discussions with the senior management team, the Sichuan CBIRC, and the Sichuan Provincial Bureau of Financial Work.
June 17, 2020 Sichuan CBIRC says it identified several issues with Sichuan Trust going back to April 2018.
June 24, 2020 Investors meet with company management. Sichuan Trust discloses that they have 45 outstanding trust-of-trust products worth about RMB25 billion. The company says it will try to collect RMB8 billion by the end of 2020 through a RMB1.5 billion new share placement, the sale of assets, and via the introduction of strategic investors.
July 6, 13 and 16, 2020 Sichuan CBIRC announces that there are serious noncompliance issues regarding the risk management, information disclosure, and related-party transactions of Sichuan Trust. The regulator takes enforcement measures on the company and sets up the Sichuan Trust Risk Management Team (STRMT) with the local government.
July 28, 2020 The third largest shareholder, Sichuan Hongda Co. Ltd., decides not to participate in the new share placement for Sichuan Trust.
Oct. 20, 2020 Sichuan Trust discloses that they have collected RMB2.3 billion through loans and asset sales.
Dec. 1, 2020 Investors meet with STRMT. Senior officials from Sichuan CBIRC promise investors that Sichuan Trust will provide a detailed plan for the repayment of money owed to investors, but the timeline is not clear.
Dec. 22, 2020 The Sichuan CBIRC and local government take control of the management of Sichuan Trust. CBIRC says it will take enforcement measures on the four major shareholders of Sichuan Trust to end their control of Sichuan Trust. CBIRC will also ask Sichuan Trust to hire third-party agencies to do a comprehensive review of its financial positions, and provide a debt workout plan.
CBIRC--China Banking and Insurance Regulatory Commission. Sources: CBIRC, Chinese press reports.

This report does not constitute a rating action.

The reports are available to subscribers of RatingsDirect at www.capitaliq.com. If you are not a RatingsDirect subscriber, you may purchase copies of these reports by calling (1) 212-438-7280 or sending an e-mail to research_request@spglobal.com. Ratings information can also be found on S&P Global Ratings' public website by using the Ratings search box located in the left column at www.standardandpoors.com. Members of the media may request copies of these reports by contacting the media representative provided.

Primary Credit Analyst:Annie Ao, Hong Kong;
annie.ao@spglobal.com
Secondary Contact:Ryan Tsang, CFA, Hong Kong + 852 2533 3532;
ryan.tsang@spglobal.com

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