Hong Kong’s Value Partners has said it is monitoring a fund misappropriation probe and potential default at the subsidiary of its China joint venture.
The case, which has attracted local media coverage and prompted comment by the China Securities Regulatory Commission (CSRC), underlines how little is known about the potential risks facing foreign fund managers in the nation’s fast-evolving asset management industry and raises worrying liability questions for investors.
The firm, which this year became the first home-grown Hong Kong fund house to reach $10 billion in assets, acquired a 49% stake in Shanghai-based KBC Goldstate Fund Management in a deal announced in March 2012.
The JV was subsequently renamed Value Partners Goldstate Fund Management, with Shenzhen-based Goldstate Securities taking a controlling 51% stake in the venture.
In February 2013, Value Partners Goldstate Fund Management set up a segregated account subsidiary named Shanghai Goldstate Brilliance, in which the JV owns a 65.5% stake. The remaining 34.5% is held by a Shanghai financial advisory firm whose English name AsianInvestor could not ascertain.
According to local media, Shanghai Goldstate Brilliance raised money for a fund and channelled investor money into a housing redevelopment project in Kunming, Yunnan Province. The cash-strapped developer behind the scheme is financed by a private equity general partner whose Romanised name is Shenzhen Wusi.
Earlier this month, Shanghai police froze Rmb590 million ($96 million) deposited in Shanghai Goldstate Brilliance’s account because the money was under investigation for suspected misappropriation.
Media reported allegations that a backer of a separate private equity venture managed by sunshine fund Shenzhen Jingtai had misappropriated money from investors and channelled that into Shanghai Goldstate Brilliance’s account.
Police action to freeze funds in the account caused Shanghai Goldstate Brilliance to miss an Rmb8 million interest payment linked to the housing project, which fell due on August 12.
In a statement the following day, the JV subsidiary said: “We should wait for the … court judgment as to the ownership of the Rmb590 million we received.”
In response to questions from AsianInvestor, a spokesperson for the subsidiary added: “We have received notification from Shenzhen Wusi that there will be a payment of not less than Rmb600 million that will be made to replace a [70%] stake in the Yunnan property developer. The equity stake [was initially] provided to us as a guarantee that backstops the risks [we face in our limited partnership investment].”
The spokesperson said that Shanghai Goldstate Brilliance had only learned from police that the source of the Rmb590 million had been from Shenzhen Jingtai. It has been reported that the same backer controls Shenzhen Wusi and Shenzhen Jingtai.
The case prompted a response late on Friday last week from the CSRC, which noted it had collaborated with the China Asset Management Association to conduct on-site assessments on select segregated account subsidiaries of fund management firms.
“The aim of these assessments is to prevent the ill-intended channelling of benefits related with these SA subsidiaries,” it stated on its website in an effort to reassure investors. “The [CSRC] will continue such on-site assessments of the eligibility of SA subsidiaries, related products and risk-management issues.”
In Hong Kong, a spokeswoman for Value Partners confirmed it had no representative in the management team of its China joint venture, although it was able to seek to influence the decision-making of senior managers there.
As a shareholder it does oversee the JV business via board representation and advises on compliance and risk management, if required.
“Value Partners has regular communication with [the China JV’s] management about the development of its asset management business, as well as its subsidiary’s trust business,” she told AsianInvestor. “We have been closely monitoring the [subsidiary] business through various tools and reports.”
She declined to respond to other AsianInvestor questions, including those related to potential liability issues for investors in Shanghai Goldstate Brilliance.
In October 2012, the CSRC introduced new rules allowing SA subsidiaries to invest in unlisted securities including private equity, limited partnerships, creditor’s rights (such as entrusted loans) and trust products. Subsidiaries are required to have no less than Rmb20 million in capital.
The rules were introduced in response to the need for product differentiation and diversification among the nation’s 95 fund management firms, many of which have hit a growth stonewall in recent years.
Chinese fund firms have since been setting up SA subsidiaries to capture growth opportunities away from public mutual funds.
The investment scope of SA subsidiaries overlaps with that of trust companies, which have become key players in China’s shadow banking sector. They have been servicing under-financed real estate developers and small-to-medium-sized enterprises (SMEs) that have been shunned by domestic commercial banks.
One China-based analyst who preferred to remain anonymous noted that SA subsidiaries had a far higher risk appetite than trust firms, having entered the non-bank financing segment during its post-2008 growth boom.
“Hence SA subsidiaries could be choosing risky projects to invest into, for example by partnering sponsors or investors of property and infrastructure projects,” said the analyst. “In many cases, the return they could get from these partnerships is dwarfed significantly by the risks they take on.”
There is speculation that the prospect of participating in China’s unregulated shadow-banking sector prompted State Street Global Advisors (SSgA) to exit its own Chinese joint venture, SSgA Fund, as reported.
It is understood that its former JV partner, Zhongrong Trust, had wanted to leverage its network and establish an SA subsidiary, but SSgA viewed it as too risky.