The Chinese Securities Regulatory Commission (CSRC) has reportedly warned fund management companies against linking distribution of mutual funds via securities companies to agreements on broking trades.

According to some fund management executives, in the past few weeks the CSRC has read the riot act to fund houses behind closed doors. Its concerns were sparked by record-sized fund launches in March which saw some fund houses, including newcomer Citic Trust and joint venture Fortis Haitong Investment Management, raise up to Rmb13 billion, far surpassing previous deals. Shenyin Wanguo BNP and SGAM Fortune Trust also introduced successful products at that time, and March and April saw a total of Rmb91.2 billion ($11.4 billion) of new assets raised.

These funds did well in part because the stock market had been enjoying a rebound after several depressed years, but also because for the first time, securities brokers proved to be aggressive distributors. Until then, funds were sold either directly or through the big commercial banks. Banks have proven to be difficult partners, despite their big networks, as frontline staff often don't understand funds and customers aren't familiar with capital market products.

Brokers are newcomers to the funds game, but as they find their traditional broking and investment banking businesses in steep decline, they have quickly embraced the fee-based income from fund sales. Brokerages combined have over 4,000 branches throughout China, and their customers are familiar with stocks and taking risk, so while they lack the size of banks, they do bring advantages.

The problem is that the typical arrangement, according to fund execs, is for a fund house to agree to trade a multiple of the asset amount sold by a securities house during a fund launch said to be eight times. This was not an issue when brokers were small players in fund distribution, but the overwhelming success brokers achieved earlier this year has rendered these agreements ridiculous.

"Some fund managers promised trades many times more than their assets under management," says Zhang Ning, managing director at Boshi Fund Management in Shenzhen. "Those contracts will never be fulfilled."

As a result, the CSRC wants to eliminate future conflicts of interest, and has spread the word that such deals won't be tolerated.

Tian Rencan, CEO at Fortis Haitong in Shanghai, says the firm does not enter into these kind of arrangements, although he acknowledges such practices do occur. "We use an analyst voting system to allocate trading blocks," he says. Tian says most brokers know they can benefit from fee-based income but some were greedy and wanted to trump that business with trading commissions. The need for fee-based income will still motivate securities companies to sell mutual funds, even without deals related to trading, he says.