Chinese Securities Firms Are Ballooning, Will Become Another Crisis

Chinese securities firms saw their assets under management (AUM) balloon to 1.2 trillion yuan at the end of 2012, up from 280 billion yuan at the start of 2012, according to the latest data from Securities Association of China.

And 80 - 90 percent of that is coming banks, according to Caixin Online, which has some China watchers worried.

As Chinese regulators forced trust companies to scale back their cooperation with banks, securities firms have benefited.

Banks have been increasingly invest their money and their clients' money in a wider range of financial products like the controversial Chinese wealth management products (WMPs). And banks have taken advantage of the fact that loans made through the securities firms don't impact their loan quota. Caixin Online explains how this works:

"In a typical bank-to-securities company asset management agreement, the bank entrusts the securities firm with funds raised from wealth management products, and the securities firm uses the money to buy the bank's notes or invest in other types of financial instruments.

The arrangement allows the bank to shift assets off its balance sheet and circumvent lending restrictions. The securities firm, in return, charges the bank a fee for using its service."

A quick reminder: The Chinese trust industry more than doubled in the past two years to about six trillion yuan by the end of September 2012 and got on the radar of regulators.

GMO's Edward Chancellor and Mike Monnelly have previously pointed out that "given their generally low credit quality and widespread exposure to real estate, trust products can be seen as China’s equivalent to subprime mortgage-backed securities."

But these trust companies were highly leveraged and considered risky, and in an effort to curb shadow banking, Chinese regulators ordered them to cap the value of trusts tied to bank loans at 30 percent of their total outstanding products and required banks to include loans made through trust companies on their balance sheets.

The way securities firms are working with banks, however, is reminiscent of the cooperation between banks and trust firms. This practice of moving money off banks' balance sheets is adding to concerns about China's shadow banking system and its impact on China's economic recovery.

Experts point out that regulators could change their stance on security firms and crack down on them as well.