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Management of Risks Associated with Asset Management Business of Securities Companies

Sources of Risks in Asset Management Business

Legal and Compliance Risks

Risks Associated with Guaranteed Return Because of inadequate internal control systems, guaranteed return in entrusted wealth management has turned fiduciary wealth management into a high-risk type of business. Although guaranteed return is explicitly prohibited in order to attract more investors, wealth management products nevertheless frequently come with a promised return, as well as hidden "principal protecting" provisions to ensure so-called low risk and high return.

Risks Associated with Malpractice in Investment Operation Chinese managers of entrusted assets fall behind professionals in overseas investment banks in terms of investment techniques, risk control capability, investment analysis, and judgment. Some of them are not conscientious enough in safeguarding clients' interests. This tends to lead to moral hazards in the asset management business of securities traders. It also leads to investment operation in breach of laws, regulations, or contracts, as well as engagement in high-risk business with entrusted assets, concentrated share holdings, or market manipulation through illicit transactions.

Risks Associated with Connected Transactions and Interest Transmission Due to loopholes in laws, asset owners are lacking in risk protection awareness. As long as they can get a certain amount of returns, they don't particularly care about how the entrusted assets are specifically operated. This creates opportunities for "connected transactions" in the asset management business of securities companies. The securities companies can engage in connected transactions to transit interests by benefiting their proprietary business at the expense of the client's interests, and they create risks by doing so.

Contract Risks Currently, a distinctive feature of assets entrusted to securities companies is that the amount is fixed within the term of entrustment. That is, at the beginning the owner deposits the assets into a special account in full, and then withdraws the original amount plus the receivable profits by the end of the term. It is usually not allowed to transfer the entrusted fund during the entrustment period. For the owner, such a management approach poses a great financial pressure because a large amount of funds have to be prepared in the early stage. In practice, however, due to considerations such as the timing of the initial investment, phased allocation of funds, and the timing of full-amount liquidation, the securities trader tends to sit on part of the entrusted fund for a fairly long period of time, failing to fully realize the time value of money. The larger the entrusted fund, the lower the utilization efficiency.

Assets are often entrusted on a short term basis, with quite concentrated expiration dates. Therefore, securities companies face great operational difficulties. Most of the entrusted investment management contracts signed by securities companies have a term of half a year or one year. Great overall risks in the capital market, a lack of variety in investment products, and a shortage of effective hedging mechanisms and tools make it difficult for securities companies to come up with robust and seamless investment plans that can generate favorable returns in such short periods. Such hasty short-term investment can hardly secure stable returns and is often accompanied by high risks. Once the poor performance of expiring funds leads to redemption difficulties, bank runs tend to take place, bringing about the risk of capital chain disruption for securities companies.

Market Risks With limited investment choices available, return rates of bonds and notes can hardly meet the needs of wealth management. Most entrusted assets are invested in stocks. The stock market is marked by big risks and unstable returns. Due to insufficient investment capability, entrusted wealth management contracts usually have short terms. It is very tough to operate in a way that achieves anticipated return in a very short period of time. Faced with the return rate pressure, some securities traders resort to bulk holding. This has exacerbated market risks in the asset management business. For example, Zheshang Securities adopted a concentrated investment strategy in 2012, and their asset management business did very well. However, when shares of LUDADI, a company in China, which Zheshang Securities held in large amounts, continuously declined by their daily trade limit, Zheshang's wealth management products were severely crippled. According to statistics from Wind Information Co., five of the six collective wealth management products operated by Zheshang Securities recorded negative income by the end of 2010. The worst performing product, JINHUI 2, saw its net value decline by 11.42 percent.

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