The Tip of the Iceberg

An investigation that uncovered widespread investment fraud by the Kunming Fanya Metal Exchange in southwestern China’s Yunnan province is just the “tip of the iceberg” and will likely lead to the discovery of many similar scams amid poor government oversight in the country, according to financial analysts.

In February, authorities in Yunnan said Fanya had made unauthorized changes to trading platform regulations that allowed it to artificially inflate prices and attract funding from some 240,000 investors across the country, who later lost their money after the company defaulted last year.

But financial experts told RFA’s Mandarin Service that the Fanya incident was not an isolated case and that the operations of thousands of local exchanges in China must be investigated to crack down on similar scams that could leave investors broke.

Li Daokui of Tshinghua University said that the threat of default looms large over China’s financial industry.

“Fanya is only the tip of the iceberg,” he warned.

“In several years … China will have a local financial crisis trigged by default.”

Zhou Tao, an independent investment and wealth management specialist based in Shenzhen, told RFA that scams like the one engineered by Fanya “will definitely happen again” in China, only with different names or slightly altered investment schemes.

“So-called financial products or financial innovation with ‘Chinese socialist characteristics’ is essentially financial fraud and the victims are all those at the bottom of the society,” he said.

“In the future, besides improving the ability to identify scams, ordinary people should choose large national level investment platforms controlled by the government to protect their hard-earned money and avoid being cheated by those so-called ‘financial innovations.’”

According to Zhou, the likelihood of additional large-scale scams in the financial industry depends on the progress of regulation in China.

The governments of Yunnan province and its capital Kunming had both backed the founding of Fanya, which was also promoted by state-owned banks and the official media, leading investors to trust that the scheme had been thoroughly vetted.

“I believe the Fanya incident sounded the alarm—not only for society, but also for Chinese government regulators,” he said.

“If it hasn’t, these [financial products] with Chinese characteristics are going to cause the Chinese masses to suffer.”

Unhealthy environment

Other experts said Chinese authorities are more likely to cover up problems in the financial industry than to address regulatory concerns and that such practices, when combined with a lack of transparency in the market, create an environment that is conducive to fraud.

Mei Fengjie, an American expert on China’s economy, told RFA that China’s regulatory system does not provide for accountability in the financial market. The government should have taken responsibility for the Fanya scam because it had failed in its oversight of the scheme, he added.

“The Chinese government’s response [to similar cases] will be disordered and reactive when similar crises break out,” he said.

“It has no solution to solve problems from both the inside and out. In other words, when China’s regulators create problems … the government suppresses and covers them up instead of creating a standardized and effective regulatory system. This means cases like Fanya will continue to occur.”

Mei said that because China’s legal system is based on statutory law, which places emphasis on individual cases as a precedent, regulations cannot keep pace with the changing economic environment in the country.

“Therefore, policies that were enacted with good intentions end up fostering fraud,” he said.

Mei said he is aware of more than 200 companies that have defaulted under circumstances similar to Fanya and suggested that investors temper high expectations while seriously weighing the government’s involvement in financial ventures that offer huge returns on principal.

“[The rate of] private lending in China is between 20 to 30 percent, so in order to make money unscrupulous government officials give investment guidance to the public,” he said.

“The public lacks risk awareness because it trusts the government … In fact, the public first needs to guard against the government, followed by the scammers. The Fanya case and other similar cases all have received government endorsement and support.”

Trust in government

Financial expert Duan Shaoyi told RFA that investors cannot expect authorities to compensate them for their losses in the Fanya scam based on their trust in the government.

“Our government has told many lies, so how many officials can be held accountable for what they tell us,” he asked.

Duan added that many government officials do not deliberately deceive the public, but are simply too incompetent to protect it from fraud.

“The penalties for committing crime are very low in China and most government officials do not understand the economy, but are still placed in a position to manage it,” he said.

“This, and the public’s lack of relevant economic knowledge, will only result in the economy becoming worse over time.”

Reported by Wen Jian for RFA’s Mandarin Service. Written in English by Joshua Lipes.