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China’s shadow banking reform faces its first test

China's push to reform its shadow banking sector is about to get its first big test as one of the country's high-yield trust investment products appears set to default for the first time.

Investors in the trust, which has the unwieldy moniker "2010 China Credit / Credit Equals Gold #1 Collective Trust Product," likely won't be paid back at the end of the month after Industrial and Commercial Bank of China said it won't bail out the product it helped to market.

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The 3 billion yuan, or around $496 million, trust used its funds to make a loan to unlisted coal company Shanxi Zhenfu Energy Group, which has since collapsed.

While this isn't the first time a trust product has found itself with pockets to let, it could become the first to pass on the pain to investors, who widely perceive these products as having a guarantee from state-owned banks.

"They're treading a fine line," said Richard Jerram, chief economist at the Bank of Singapore.

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"There's a willingness to educate investors that this is not a risk-free product. It can't be a risk-free product if it's offering premium interest rates," Jerram said. The trust offered a yield of around 10 percent a year, compared with benchmark bank rates of around 3 percent.

"It would be useful if investors sustained some of the losses," he said. But at the same time, "they don't want to frighten people away from these products entirely, or create a run, or make it impossible to sell any future products," he added.

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"It's a small number in terms of value," he noted. "In terms of the message, it's a very dangerous game."

The amounts involved with this trust are relatively small. Trusts had around 10.1 trillion yuan under management at the end of the third quarter, according to the China Trustee Association


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