Credit Conditions Continue to Tighten; What's In Your WMP?

A couple points before getting to the story.

WMPs and trusts are two different things, though trust companies are involved with WMPs. Goldman explained it clearly:
A trust is not to be confused with a “wealth management product” (WMP). WMPs are available to a broader group of individuals, with much smaller minimum investments. They are typically sold through and managed by banks or securities brokers, with or without a guarantee of the payment of interest or principal (WMPs featuring explicit guarantees are booked on banks’ balance sheets; for other non-principal guaranteed products, implicit guarantees may be assumed by some investors). Funds from WMPs may be invested in a range of products including corporate bonds, trust loans, interbank assets, securitized loans, and discounted bills—so WMPs are best thought of as a “money market fund” or pool for other financial products.

The latest data on WMPs still shows investors moving into guaranteed products and shorter maturities. As banks have to take guaranteed products onto their balance sheet, they are less likely to lend the money to risky borrowers. With that as background, on to the news.

China targets trust firms in shadow-bank crackdown: sources
The new rules from the China Banking Regulatory Commission (CBRC) aim to reduce liquidity risks associated with off-balance-sheet WMPs by forbidding trusts from operating so-called "fund pools" that enable them to fund cash payouts on maturing products with the proceeds from new WMP sales.

......Regulators are concerned that liquidity problems with a single trust product has the potential to ignite systemic risk, said a trust industry executive who has seen the document. He said the document signals that liquidity risk will be a key focus for regulators this year.

"Fund pools" refer to pools of cash and credit assets from various different WMPs that banks and their trust company partners maintain.

Regulators have increasingly focused on such structures over the last year, targeting the liquidity risk posed by the practice of using proceeds from the sale of new WMPs to finance cash payouts on maturing products. China's securities regulator has compared such practice to a "Ponzi scheme".

Regulators want trusts to strictly match each WMP with a specific set of underlying assets, rather than pooling cash and assets from different products together into common pools.
Non financial corporations have already been caught up in this problem: Chinese Corporate Investors in the Dark as Trust Investments Falter; Borrow Short to Lend Long Strategy Falling Apart in 2014. One firm bought WMPs with idle cash, only to find their money tied up when the fund company ran into problems. Aside from the high risk involved with the investments themselves, the borrow short-lend long strategy is a game of musical chairs that can end badly even with good collateral. The pool strategy, if asset ownership is not clearly defined, adds more risk since it could tie up capital for longer periods in the event of a default.
Such risks came to the fore last June, when a nasty liquidity squeeze roiled China's interbank money market, sending short-term borrowing rates as high as 30 percent. Money-market traders at the time cited the concentration of maturing WMPs as one factor contributing to excess cash demand.

Trust companies and banks often rely on borrowing from money markets to fund payouts on maturing WMPs for a few days until they complete fundraising on new products.
Is the risky end of the trust market contained? We will find out.

Also relevant is this story: Hunan Pooled Trust Lowers Minimum Investment to ¥200,000; Tough To Sell Investors At Higher Minimums. The trust company in that case is issuing small trusts, with attractive yields and lower minimums to attract more investors, then using the money to invest in other trusts. Trusts are riskier than WMPs and its not clear if trusts will also be forbidden from using this tactic.

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