In 1999, China established four asset management companies (AMCs) to clean up non-performing loans at the big state-owned banks. In a new twist, one of them, China Cinda Asset Management, is stretching the notion of disposing dud assets.

One of its charges was Hantang Securities, a mid-sized securities house in Shenzhen that was put into Cinda's custody in September, 2004 after it lost huge sums speculating in the bond market. Among Hantang's clients was PICC Property and Casualty, China's biggest non-life insurer, for which it managed nearly $50 million and has not been able to pay back.

Hantang's sudden collapse and takeover by Cinda occurred just after the securities company had inked a fund management joint venture with Australia's First State Investments. The JV company had an application pending with the China Securities Regulatory Commission (CSRC). The affair left a stunned First State without a partner.

Or so it seemed. Now market sources say First State's JV is back on - with Cinda.

Gossip has it that PICC, backed by its regulator, the China Insurance Regulatory Commission (CIRC) was initially the one that wanted to take over Hantang's JV with First State, a move opposed by the CSRC, which has fought a rearguard action against banks and insurance companies treading on its turf in funds management. Although CSRC has lost that war, apparently it won this particular battle, and PICC had to back off. But Cinda's management saw an opportunity.

If this deal goes through, it will be the first time an AMC, which is meant to dispose of bad assets and return whatever it recovers to creditors, has used a company's equity to create a new financial services business. The prospect is raising eyebrows among financial professionals, who think of AMCs as institutions with a limited lifespan, whose job is to recover the assets and close down; America's Resolution Trust Corporation, formed in the aftermath of the savings and loan scandal of the 1980s, is a good example.

But sources report that ambitious managers in China's AMCs do not want to lose their jobs, and instead are trying to transform these groups into full financial service players similar to investment banks. The AMCs have already been running all sorts of companies in many industries through similar debt-to-equity swaps, but this is the first time an AMC has starting running a financial institution.

One consultant says other Chinese financial institutions have approached him to seek foreign partners to buy their shares; these securities companies also have assets pledged to AMCs and need capital injections to get them back. The Cinda deal could, however, set a precedent for other AMCs looking to expand their empire. The consultant says Huarong Asset Management Company currently owns assets of a securities company now in talks with a foreign firm about selling a stake in a funds subsidiary.

"Huarong could convert its debt into equity in the JV," the consultant says, "although I haven't heard it will actually do so."

Is it legal for an AMC to go into business with the partners of a company in its receivership? Yes, if it is deemed a way to shore up the company for asset disposal. Cinda now has seats on the Shanghai and Shenzhen stock exchanges and has underwritten IPOs of companies in its custody, and has identified other assets to be pooled for eventual securitization.

In other industries, the AMC has sold stakes to foreign partners, and signed deals with foreign buyout companies such as Lone Star and Deutsche Bank. Its business scope may include "other businesses approved by the China Bank Regulatory Commission", which means anything goes if the regulators approve it.

But other market sources say a deal with First State is likely to take Cinda beyond any pretence of disposing an asset. Why would First State enter a JV with a partner that was simply involved in order to sell its stake to a creditor? One possibility is that PICC will have a role after all as a buyer down the line, but this is sheer conjecture. More likely, sources speculate, is that First State executives have gotten to know Cinda managers over the past year and are comfortable establishing a relationship with them.

What does seem certain, however, is that Cinda is getting into the mutual funds business, a move that other AMCs may watch with interest, although the revived JV will still have to clear CSRC approval.

Stephen Kenneally, director of regional business development at First State in Hong Kong, says First State is in negotiations to set up a JV in China, but would not confirm Cinda is its counterparty.