| On the Ground |

Analysts
Stephen Green, +86 21 6168 5018 Shen Lan +86 10 5918 8261
Standard Chartered Bank (China) Limited Standard Chartered Bank (China) Limited
Head of Research, Greater China Research assistant
Stephen.Green@sc.com Lan.Shen@sc.com

China – A lack of trust

04:15 GMT 14 July 2010

Trust companies have evolved into important financial intermediaries, especially for real
estate and infrastructure
Reported move to stop them selling to bank depositors will cut off an important funding route
It will push depositors to look elsewhere for a return, and borrowers to go underground

The China Banking Regulatory Commission (CBRC) has reportedly moved recently to stop trust companies from
marketing and selling their products through the branches of commercial banks (see www.eeo.com.cn/finance/
banking/2010/07/05/174569.shtml). To us, this looks like a big deal and we try to explain why.

Trust company 101

Trust companies are a jack-of-all-financial trades, and are almost impossible to define. Some are fund management
companies, others do private equity, and others behave like hedge funds or private banks. One might argue that trust
companies provide the financial innovation that regulators are ambitious for China to have, but do so outside the banking
sector, so that household savers are not impacted by any blow-ups. Their broad operating licence is usually combined
with tight limits on whom they can raise money from. They often raise funds from rich individuals and institutions; each
product a trust company issues has typically been limited to no more than 50 investors, though in 2009 the CBRC
relaxed this requirement. However, their client base began to change in 2008, when trust companies started to sell their
products through the banks’ retail branches. Chart 1 shows this growth of trust products sold at the banks.

Chart 1: Trust company products sold through the banks

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Volume, CNY bn (est.) Products

Note: Volumes are our estimates based on partial disclosures;

Sources: Web sources, Standard Chartered Research

Important disclosures can be found in the Disclosures Appendix

All rights reserved. Standard Chartered Bank 2010 http://research.standardchartered.com
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The products vary hugely in structure (as shown in Chart 2). Trust companies sold 3,935 separate products through the
banks in 2009, an average of 328 products a month. The banks take a commission of 1-3% and may participate in the
design of the product. The trust companies’ commission is much lower. The pace declined to 152 products a month in
January to May this year. In value terms, CNY 1.7trn (USD 250bn) worth of product was sold in 2009, and CNY 2.1trn
(USD 305bn) in the first five months of 2010. These are very large numbers. Last year’s total was equivalent to 17% of
official bank lending in 2009, and in the first five months of this year, CNY 2.1trn is equivalent to some 50% of official
bank lending.

Why the trust-bank boom?

There were at least three reasons for this boom in trust products sold through banks. First, cash-rich depositors were
frustrated with low deposit rates (around 2% for a one-year deposit), and trust companies were happy to offer 4% or
thereabouts, principal guaranteed. Second, even though banks’ commissions on these products are low, they did not
want their clients going to other banks, so they marketed them enthusiastically. Third, in some cases the banks were
able to sell their own loan assets on to the trust company, which repackaged them and then sold them as wealth
management products back to the bank’s own clients. This allowed the banks to manage their official outstanding net
loan position, which was subject to the loan quota. Chart 2 shows the breakdown of the types of products sold (by
numbers of products). Most of these products are short-term in nature (six to 12 months), so trusts would often attempt
to keep the funds by offering new products

Chart 2: The kinds of trust products sold at the banks

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Trust loans Bills Loan assets Bond Securities Portfolio Equity

Sources: Web sources, Standard Chartered Research

The three dominant formats have been:

Trust loans. These are loans extended by the trust company to one or more borrowers, which are then
repackaged and sold on. We understand that quite a few real estate firms have borrowed from trusts at 15-20%
annualised interest rates, given the banks’ inability (since late last year) to increase their exposure to this sector.
A bank that is unable to lend to a client itself may find a trust company that is willing to lend, and then sell the
asset through its own branches. We estimate that in 2009 some CNY 500bn (USD 72bn) worth of such
products were sold, and CNY 600bn (USD 88bn) in the first five months of 2010.
Loan assets, which are the banks’ loans, repackaged and sold on to investors. It is likely that these included
some infrastructure loans, including those to local government investment vehicles, LGIVs. (For the latest on
the LGIV situation see On the Ground, 5 July 2010, ‘China – Hanging out in Beijing.’) The volume of LGIVs
has declined this year, which we assume is because the CBRC made it much more difficult for banks to sell
their loans through their own branches, starting in December 2009. We estimate that in 2009, some CNY 650bn

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(USD 96bn) worth of such products was sold (compared to the official increase in banks’ outstanding loans of
CNY 9.6trn), but only CNY 100bn (USD 14bn) in the first five months of 2010.
Portfolio products are hybrid products where money raised is managed by the trust and allocated to a variety of
asset classes, which may include loans. They have been very popular this year. It is unclear how much of the
money raised in this way is finding its way back into loan-type assets, but given the depressed nature of the
stock market, we imagine loans are still popular.

These products have scale. We estimate the total amount of lending done by trusts and the total value of repackaged
bank loan products issued in the first five months of this year at CNY 690bn (USD 100bn), which is equivalent to about
one month’s bank lending. If funds from other products are indeed finding their way into loans, then this number would
rise. So, just as the banks’ credit has been limited, trust companies have helped fill the gap and make credit available to
companies turned away by the banks.

Back to boring products sold to rich people

The CBRC now seems to have banned the trust companies from selling products through banks. It appears that fears
about uncontrolled credit expansion and worries about how some of the loans were finding their way into infrastructure
and real-estate lending triggered this crackdown. In strict legal terms, if a product goes wrong (say a borrower defaults),
the buyers of the product would take the hit. In practice, many bet that the bank would come under pressure to safeguard
its customers and that the bank would likely be left holding the risk. Unfortunately, the banks officially do not have to
disclose much detail about these products since in theory they are not liable for them.

As we noted recently, this reported move by the CBRC will tighten credit conditions for industry, particularly for real
estate and infrastructure firms, which are now not allowed to borrow from the banks, and possibly others too (see On the
Ground, 5 July 2010, ‘China – Hanging out in Beijing’). It will encourage companies that need financing to turn to the
underground market, and will incentivise depositors to look elsewhere for a return.

As a result, trust companies will have to fall back on their traditional client base – rich individuals introduced by other rich
individuals. It is possible that those who bought their products in the banks will migrate over to continue to buy products
directly from the trusts, but without a distribution network we would not expect this to work well. The data is incomplete
since there appears to be no requirement for the trusts to publicly report their products, but Chart 3 shows the best data
we can find on the trust products sold through banks and those sold outside the banks. By far the larger part has been
sold through the banks. Banks will also presumably lose a hefty source of commissions.

Chart 3: Trusts in and out of the banks

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Via banks Traditional

Sources: Web sources, Standard Chartered Research

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As a result, for the moment at least, it looks like the trusts’ assets under management (AUM) will remain at their current
levels. As of November 2009, KPMG estimate that trust companies’ AUM totalled CNY 1.58trn (USD 230bn). This could
have increased by as much as CNY 1trn by May this year. However, AUM will fall as products start to redeem and
because trusts are unable to easily market and sell new products. The CBRC is also reported to be considering asking
trust companies to raise or put aside capital (calculated as a percentage of their AUM). They may be a jack-of-all-trades,
but it looks like the bank regulator has decided that, for the moment at least, trust companies need to look a little more
like boring banks.

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Disclosures Appendix

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Data available as of 04:00 GMT 14 July 2010. This document is released at 04:15 GMT 14 July 2010.
Document approved by: Nicholas Kwan, Head of Research, East

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