Is China’s Financial System About to Have It’s ‘Too Big to Fail’ Moment?

China has been a market powerhouse for over a decade now. All thanks to their hybrid system of state control and rampant capitalism, they’ve built a towering economy.


But the country’s monstrous economic growth looks to be teetering.


Proof of this lies in the recent seizure of the company’s 4th largest insurance company: Tomorrow Holding Company.


In a story first broken by Bloomberg (paywall), it appears that all is not right with the world’s second-largest economy.

  • Nine firms controlled by disgraced businessman Xiao Jianhua’s crumbling empire, Tomorrow Holding Co. were seized by Chinese authorities.
  • The total assets of the firms were more than 1.2 trillion yuan ($171.5 billion) in value.
  • Xiao was taken into custody three years ago by Chinese authorities at Hong Kong’s Four Seasons hotel and hasn’t been seen in public since.

That’s scary stuff.


And it could be so bad that some are starting to question whether recent moves by China’s Communist Party rulers aren’t the first dominos to fall.
Because…

This Isn’t the First Time China Has Seized a ‘Too Big To Fail” Firm

Granted, it’s not often China seizes major corporations. Since 1995, only 12 additional firms have ever been seized, but what’s important is that half of all seizures have occurred in the past year.


But why seize the companies when you already had taken their founder into custody a full three years ago?
The answer, at least partially, could be additional fallout from Covid-19.


We’ve known since 2017 that China’s insurers have been problematic. And with China’s stock market near all-time highs, the market simply hasn’t priced in the disruptions to lending and liquidity that these firms have been creating.


For example, Huaxia Life—one of the seized firms—has become the fourth largest insurer in China over the last decade. But they were selling policies that weren’t in line with regulations, and they were improperly disclosing policyholders’ information. In fact, at the end of 2019, Huaxia held close to 600 billion yuan in total assets. This is despite its assets-to-equity ratio stood at a massive 26 times.


With COVID causing the worst bond rout in a decade during 2020’s second quarter, Huaxia Life’s book value shrank 23% QoQ – incredible.
So one can see why China’s regulators began to act…

Your Bottom Line

According to investment group CLSA, 11 insurers—holding about 15% of the market and 2.4 trillion in yuan—are “walking a tightrope” with regulators. In fact, were their asset value was a mere 2-5% less than what they showed in 2019, their surplus capital would vanish.


It simply goes to show that if the government ever needed to rescue all these companies at once, the overall cost would be exorbitant. And if the government couldn’t rescue them all, they’d have to dump their assets, which would inevitably threaten the financial system.


Put simply, we could be about to witness the ‘popping’ of the bubble that has become China’s Shanghai’s Stock Exchange Composite Index (SHCOMP):

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