A YEAR after China’s financial regulators squared up to the systemic perils of “shadow banking,” the threat is shifting to a booming corporate bond market and risky borrowers’ debt is finding its way into products aimed at retail investors.

    An opaque network of trust companies and non-bank lenders had grown their annual market to a hefty 2.9 trillion yuan (US$450 billion) in loans before regulators stepped in, spooked by rising defaults on wealth management products (WMPs) backed by such high-interest shadow lending.

    Now the high risk borrowers who took those loans, such as unlisted real estate firms struggling with a stagnant property market and financing companies backing local government investment, are finding a new avenue of funding after regulators began allowing unlisted companies to issue bonds on public exchanges.

    New corporate bond issuance leaped to 914 billion yuan in the third quarter, accounting for 29 percent of all new credit, up from 381 billion yuan and just 8 percent in the first.

    And the profile of new borrowers looks strikingly like the patrons of the shadow banking set.

    Of the 57 firms posting bond listing announcements in Shanghai in October, 23 were local government owned project or infrastructure investment firms.

    The Central Government engineered the freeing up of the bond markets as a transparent alternative funding route and the credit crunch that followed its clampdown on shadow banking guaranteed a high take-up.

    But wealth managers are now turning these bonds into leveraged high-yielding products and selling them to investors desperate for returns after a real estate slump and summer stock market crash.

    Data from CN Benefit, a research firm tracking wealth management sales, show that 60 percent of new bank wealth management products were linked to debt and money market instruments in September, up from less than half in the first quarter.

    Demand is hot for these products and the higher the yield, the higher the risk, which is amplified if the fund’s assets are partly bought on credit, or leveraged.

    Colight Asset Management, a private fund offering bond-backed WMPs, raised more than 40 million yuan in just four days in November from an 8.7 percent yielding, 400 percent leveraged bond-based product, according to customer service staff member Chen Xun.

    Much bigger companies such as Pacific Asset Management Co. and Agricultural Bank of China also offer similar high-yielding leveraged products.

    Investors, however, assume that products offered by big names are relatively safe.

    “The risk of default is very slim,” said a 45 year-old business manager in Shanghai surnamed Pan who invests in WMPs on an exchange backed by China’s second-largest insurer, Ping An Group. “I’m sure such a big company as Ping An will make sure investors can get their money back.”

    Inflows to bond mutual funds have also risen.

    Typical of such funds is the Great Wall Long Term Profit Gradated Debt Fund, whose top three holdings are all sub-AAA-rated local government fundraising company bonds. The firm adds leverage by borrowing cheaply in the bond repurchase market, fund documents show.

    “So for instance you can take 2 billion yuan in government debt as collateral and receive 750 to 800 million in cash, and use that to buy more debt,” said an underwriter at an international bank in Shanghai who asked not to be named. (SD-Agencies)