Private investment firms face heat of regulator's crackdown

Private investment firms in China are facing tighter regulation as the country's securities market regulator steps up its crackdown on illegal activities.

According to the China Securities Regulatory Commission, 25,607 private investment firms registered with it as of Jan 15 manage assets worth 5.1 trillion yuan ($760 billion).

Typically, private investment firms in China are private equity firms, venture capital companies and hedge funds that invest in stocks and bonds in the secondary capital markets.

Of late, their investments have came under scrutiny for a variety of irregularities like incomplete and false information disclosure, selling investment products to unqualified investors (who did not have requisite level of funds), illegal fundraising, financial fraud, market manipulation and insider trading.

Hu Lifeng, a researcher at China Galaxy Securities Co, told Xinhua News Agency, "Many investment firms lacked sound internal corporate governance and many engaged in highly leveraged trading without proper risk control, which ended in forced liquidation and exacerbated the market volatility."

So, the CSRC has enhanced inspections and tightened regulations governing the day-to-day operations of private investment companies.

For their part, the authorities concerned in Beijing and Shanghai reportedly suspended registration of business licenses for investment firms and wealth management companies.

At least 27 investment firms were fined or subjected to administrative restrictions for rule violations after the CSRC inspected more than 140 firms last year.

Another 21 firms were investigated by the police for suspicious criminal and illegal activities, according to the regulator.

The crackdown followed the 2015 summer rout of the Chinese bourses that roiled global markets and portrayed China in poor light among the investor community.

"The regulation and self discipline of the private investment funds failed to keep up with the rapid development of their business," Hu told Xinhua.

Another aspect that seems to have riled the CSRC is the investment firms' propensity to misuse funds raised from their listing on the National Equities Exchange and Quotations, better known as the New Third Board, an over-the-counter share transfer system for non-public small firms and startups.

The government set up the NEEQ in late 2012 to support the cash-strapped small companies and startups. Listing on the NEEQ is not via an initial public offering, so it does not make the firm concerned a public company.

It is suspected many investment firms may have funnelled money raised from the NEEQ into speculative trading on stock exchanges or to form illegal or unauthorized funds, instead of sticking to their stated objective of investing it in small firms and startups.

A controversial case in point is China Science & Merchants Investment Management Group, a high-profile NEEQ-listed private investment firm.

After scooping up 9 billion yuan from the NEEQ, it played the A-share market, where the yuan-denominated stocks of companies based in the Chinese mainland are traded on the Shanghai and Shenzhen bourses by mainland citizens.

What raised brows all over was its aggressive play. Local media studied China Science & Merchants's filings and estimated it may have invested at least 4 billion yuan in 16 listed companies between July and August last year.

The company's share market investments attracted attention also because they seemed to be inconsistent with its assurance to its investors it will invest 60 percent of the NEEQ proceeds to set up new private equity funds, 30 percent in funds for mergers and acquisitions, and structured funds (which do invest in stock markets), and the remaining 10 percent in new emerging strategic industries and to replenish its capital.

China Science & Merchants was among the companies that received warnings and administrative restrictions from the CSRC. The company was pulled up for violating the rule of information disclosure. It did not make sufficient disclosure about its fundraising plans and how it would use the proceeds. China Science & Merchants declined to comment for this story.