The China Securities Regulatory Commission (CSRC) has started investigations into private asset funds – among them Hangzhou Yuyao and Shenzhen Huisheng – for illegal practices, with the commission’s focus on multi-layered nested investments, false and misleading information in fund reporting, and violations of disclosure regulations.

The funds involved reportedly have total assets under management of 720 million yuan (US$101 million).

Other financial institutions under scrutiny include the managers of private securities investment funds and their fund of funds, custodians such as securities firms and banks, and distribution channels such as other fund managers and trust companies.

The regulation and supervision of the custodian industry is being questioned given the relevant authorities’ failure to ensure the veracity of fund reporting, payment instructions and other fund administration practices.

Some of the top 10 securities firms are reported to be involved, leading to further doubts regarding possible corruption cases.

With regard to the fund managers, the submitting of false information is primarily believed to be aimed at enhancing their fundraising capabilities by portraying impressive investment performance and high valuations, a practice exacerabed by current challenging market conditions.

Concerns have also been raised about certain companies offering structured investment instruments to attract risk-averse investors, especially state-owned enterprises.

However, this kind of multi-layer complex nested structure in China makes regulatory oversight challenging, according to a private fund manager, who notes that any even slight lapse in fund management at any layer poses significant – and often uncontrollable – risks.

As a result, insufficient risk management, coupled with information asymmetry, makes investors struggle to monitor product investments and fund flows effectively.

In addition, some of the investors may focus only on valuations – unaware of the possibility of false information disclosure – and, in doing so, overlook underlying risk management issues.

This has prompted fund managers and lawyers to call for a greater emphasis on comprehensive due diligence.

Trust companies in China, particularly after the rollout of new regulations tightening asset management, primarily serve as fundraising vehicles, according to a senior executive in the trust industry, who notes that the trustee and trustor may also sign dedicated arrangements through special trust contracts. In such a scenario, trust companies often play a limited role in executing risk control.

In cases where market performance falls short of expectations, investors bear the responsibility. However, if faced with fraudulent cases or misappropriation of funds, investors tend to hold trustees, before investment advisers, accountable.

To mitigate these risks, trust companies must enhance risk management, for example, by reinforcing supervision of underlying private funds or ensuring regular checks on private fund managers.