Fund Scandal Was ‘Wake-Up Call’ for Noah’s Shadow-Bank Shift

Only a year ago Noah Holdings Ltd. was a poster child for the dangers lurking in China’s $8 trillion shadow banking system. Now it’s at the fore of a historic shift in Chinese asset management, one that policy makers say is reducing financial risks in the world’s second-largest economy.

At the heart of the transformation is a government push to rein in opaque credit investments of the sort that embroiled Noah in scandal last year. The Shanghai-based firm slashed sales of such products to 1% of total offerings in the first quarter from about 80% a year earlier, focusing instead on investments tied to plain-vanilla stocks and bonds. Noah’s shift is noteworthy because it’s one of China’s largest independent wealth managers, historically among the least regulated of the country’s shadow financiers.

The failure of one of its credit products last year was a “wake-up call” at a time when regulators are working hard to shift the industry toward orthodox investments and to break implicit guarantees on returns, Noah said in a email to Bloomberg. Investors too are gauging risks better and have stopped chasing short-term fixed returns, the wealth manager said.

“It is an industry trend and Noah wouldn’t be the only one, with banks and trusts also transitioning away from non-standard products as regulations tighten,” said Xie Manqi, a Hong Kong-based analyst at S&P Global Ratings. “Noah is among the first batch to transform.”

Fund Scandal Was ‘Wake-Up Call’ for Noah’s Shadow-Bank Shift

Executives at Noah have spent the past year overhauling its business while fighting lawsuits linked to the failure of a 3.4 billion yuan ($486 million) instrument that left investors out of pocket.

Noah has alleged that it fell victim to fraud after missing payments on the product meant to be backed by accounts payable from a unit of e-commerce giant JD.com to Camsing International Holding Ltd., a conglomerate whose chairman was detained by police last year.

The asset manager last July accused Camsing of falsifying business contracts underlying its product and filed suits against both companies. JD.com has said Noah didn’t verify the authenticity of the contracts, revealing severe risk control flaws. Camsing and JD.com didn’t reply to emails seeking comments.

Wake-Up Call

Lily Du, a 43-year-old garment factory owner in Jiangsu province, said she was told investing 10 million yuan of her savings in the Camsing instrument -- issued by Noah’s asset management unit -- was “just like putting deposits in banks.” When the product ran into trouble, Noah extended its duration by as much as a year, but hasn’t yet paid up, she said.

“Instead of telling investors to know the risks, Noah should exercise better risk control,” said Du, who has approached AllBright Law Offices to recoup her money along with about three dozen other investors. “I don’t think I’ll ever buy anything from Noah or other independent asset managers again.”

Noah said by email that Camsing was a “fraudulent case of a huge amount” that was under criminal and civil procedures. Still, the instrument’s failure forced the firm to realize that “highly risky single-counterparty non-standard assets are not sustainable,” it said.

Following the scandal, Noah jettisoned such offerings, focusing instead on investments based on publicly traded securities like stocks and bonds, sales of which grew 500% to 19.1 billion yuan in the first quarter from a year earlier. Chief Executive Jingbo Wang said in May the firm’s product suite would be weighted 80% toward standard products going forward.

The changes are taking a toll. The aggregate value of financial products distributed by Noah’s wealth unit dropped 17% in the first quarter due to the product shifts. Half as many high net worth investors made transactions compared with a year ago, though mutual fund clients surged. The firm’s U.S.-listed shares are 34% below where they traded before the scandal broke.

Noah had 170 billion yuan of assets under management at the end of December and distributed 78.5 billion yuan of financial products last year. The company’s total number of registered clients rose 17% from a year earlier to over 321,000 as of March.

Gu Huijun, chief analyst at Suning Institute of Finance, estimates that top players like Noah have an edge given their existing clients, though with exotic offerings now discouraged, product variety and high-quality advice will be critical for survival.

Target of RulesWhat New Rules for Asset Managers Mean
Implicit guaranteesFinancial institutions cannot guarantee principal, returns when products run into difficulties.
Non-standard assetsInstitutions must abide by liquidity requirements and quota limits for non-standard investments.
Matching maturityRules limit mismatches in the maturities of investment products and underlying assets.
TransparencyFinancial institutions aren’t allowed to be channels for each other’s asset management products to evade regulatory curbs.

Prodding firms like Noah to pursue more conventional product lines is an important part of China’s three-year effort to tackle financial risks in the shadow banking system. The sector has been drawn into the purview of new rules due to the scrutiny of non-standard offerings and a clamp down on entities engaging in financial activities without proper licenses, including independent wealth managers.

With the new guidelines set to cover all asset management products by year-end, other types of shadow financiers are also falling in line.

Nearly half of bank wealth management products -- which account for a quarter of shadow banking assets -- have shifted to a net asset value-based model, where investors bear the risk of market fluctuations, compared with 15% before the new guidelines were unveiled, figures from research firm PY Standard show. In June, savers in state bank issued high-yield WMPs saw their first-ever losses -- declines they would have been shielded from in the guaranteed-return era.

Fund Scandal Was ‘Wake-Up Call’ for Noah’s Shadow-Bank Shift

Shadow banking assets have shrunk by $1.7 trillion in the past three years, according to Fitch Ratings. The economic fallout of China’s coronavirus lockdown has prompted policy makers to ease up a touch, with credit from the sector rising in first quarter.

The banking regulator said earlier this month that the risks from shadow financiers and cross-holdings of financial assets reduced significantly, creating some policy flexibility given the challenges from Covid-19.

For independent wealth managers, Noah’s shift likely marks the end of an unfettered period of growth. Regulatory scrutiny is forcing firms to downsize the most profitable part of their businesses at a time when the risk of defaults among legacy products has risen as the economy slows, according to Liu Shichen, Shanghai-based head of research at Z-Ben Advisors.

“Mounting defaults have imposed a level of pressure on many independent asset managers that they can’t digest,” he said. “There is very limited room to grow under the tightened regulation.”

©2020 Bloomberg L.P.

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