Failed schemes pull down hundreds of thousands of investors

The posterchild for this business was a young woman from Zhejiang province named Wu Ying, who was charged of illegally raising RMB770m. She’s serving a life sentence

Local financing networks are unravelling across China as the economic slowdown bites into one of the weakest but most enduring links in the financial system – pulling hundreds of thousands of investors down with it.
These networks flourished as long as sentiment was high and rapid economic growth persisted. Now, however, investors are taking to the streets across the country as they seek to recoup their losses. Money ploughed into financing schemes that went bust in 2014 amounted to more than Rmb100bn (USD16bn).
Grassroots financing schemes operate in a similar manner to direct sales, with investors drawn in by the promise of high returns rather than, say, profits from selling cosmetics. Some are outright Ponzi schemes, while in others funds are funnelled into high-interest loans in the shadow banking sector or other unregulated investment projects.
Investors come from every rank in Chinese society. On Monday hundreds of well-heeled urban professionals who had purchased high-interest rate products from the Fanya Metals Exchange united with distribution agents who sold them in an unusual protest in the financial heart of Beijing. Meanwhile in the neighbouring province of Hebei, farmers are trying to retrieve their life savings invested with a rural businessman who promised high returns from better-quality wheat.
Such “illegal fundraising” is spreading from the wealthier east coast to central and western regions, according to data from the China Banking Regulatory Commission. FT research shows every province in China recorded at least one financing scheme collapse in the past 18 months.
“We are teetering at the tipsy-topsy edge of a crisis, so regulators need to be putting out fires here, fires there,” says Anne Stevenson-Yang, founding partner of investment researcher J Capital Research.
The CBRC office that monitors illegal financing attributes the schemes’ proliferation to China’s economic slowdown and tighter credit along the financing chain. Cross-regional cases doubled in 2014 against the year before, while cases involving more than Rmb100m tripled and schemes involving more than 1,000 people quadrupled, it says.
“Many factors that can lead to an increase in illegal fundraising will not change fundamentally in the short term. We estimate that currently and in the future illegal fundraising will still occur frequently,” according to a May CBRC report. “And in some regions, industries or areas, they will emerge violently.”
One of the largest cases reviewed by the FT involved an estimated Rmb8bn raised from 135,000 wheat farmers in three townships near the city of Xingtai, Hebei province.
The wheat farmers invested at least Rmb10,000 each – more than the region’s average annual household income – to buy into a “rural co-operative”. Members received discounts on fertiliser, rice and oils, subsidies for college students and the handicapped, and a gift of 100 packets of flour upon joining. The scheme’s collapse has devastated local families.
“There are people who left their children and wives to avoid creditors, and I even heard that one peasant committed suicide because he owes tens of million of renminbi,” says Hao Xiaochun, a 61-year-old farmer who borrowed Rmb200,000 to invest in the co-operative that he cannot pay back.
Pyramid schemes, multi-layered sales networks known as chuanxiao and other too-good-to-be-true investments have flourished for years in China, especially in rust belt regions such as the north-east. Chinese authorities ban direct sales and dole out harsh punishments to the organisers of failed schemes to ward off the kind of pyramid scheme collapses that convulsed Russia and Albania in the 1990s.
The best-known pyramid scheme in China was a $385m ant-farming business that embroiled 1m rural investors in the north-east before it collapsed in late 2007. Its founder was sentenced to death.
Around that time, lending restrictions in some sectors, chief among them property development, caused the informal or “shadow” lending business to boom, with interest rates well above the state-set rates in banks. Trust products, wealth management products and completely unregulated lending pools could offer higher interest rates by arbitraging the difference.
The posterchild for this new business was a young woman from Zhejiang province named Wu Ying, who was sentenced to death in 2009 on charges of illegally raising Rmb770m after a “cash flow problem” triggered her arrest. A coalition of businessmen and rights activists successfully campaigned to have her sentence commuted, citing the importance of private financiers to China’s private industry.
In the years since, the industry has proliferated. Several of the schemes that came to light in the past year were run by local government officials or their relatives, raising further worries about the ability of Chinese financial or judicial authorities to regulate shadow fundraising. In one case in the central city of Nanyang in Henan province, the founder was a policeman who killed himself after his scheme failed. Lucy Hornby, Financial Times, Beijing.

financing scheme probes

of 8,700 cases investigated by police in 2014, worth in total more than Rmb100bn:
1,267 involved investment or wealth management products (↑616% from 2013)
61 involved rural co-operatives (↑117%)
31 involved private equity (↑106%)

Additional reporting by Owen Guo and Anna Hsieh
MDT/FT Exclusive