TWO months ago I went to a wealth management fair at the Shanghai Exhibition Center in the Jingan District. Apart from an overcrowded venue full of aggressive vendors, there was also no shortage of equally hungry investors determined to grow their wealth. Well, that's nothing new in a developing financial market where investment demand often outweighs supply.

What was interesting at the exhibition was the diversification of products displayed. They included traditional wealth management products offered by private banks, trust products packaged through trust companies, art collections, precious metal investments via brokers and high-end properties shown by estate agents. With the mainland stock market's performing poorly in recent years and with the low interest rates offered by banks, the general public is desperately searching for higher returns on personal assets.

According to a joint report by Boston Consulting Group and China Construction Bank, total investable assets last year surpassed 73 trillion yuan (US$11.7 trillion), an increase of 14 percent from the previous year. High net worth individuals accounted for 46 percent.

According to the report, the wealth management sector will drastically change within the next few years, with emerging players such as securities firms, trust companies and third-party wealth-management service providers with ambitious growth plans.

Shadow banks

In China, companies with wealth management products do not consider only millionaires, or even billionaires; they also target the middle class. In that segment, private banks are not the only players. There are non-bank operators, better known as "shadow banks," that provide investor services to retail customers. Shadow banking, estimated in size at 17 trillion yuan, represents 13 percent of the banking system, or one-third of China's GDP, according to a research report issued by ANZ China.

China Merchants Bank was the first bank to launch a personal wealth management service under the brand name Sunflower in 2002. Two years later, foreign and local banks started to enter this market. But it was not until 2005 that the government established a minimum investment entry of 50,000 yuan for all wealth management products.

From 2006, shadow banks emerged in this market, with disruptive results. They directly compete with traditional banks. Ironically, many of these shadow banks, such as trust companies, also partner with traditional banks, which treat their products as off-balance sheet assets. The high returns offered by shadow banks are far too attractive for deposit savers to resist.

With minimum entry criteria of 10,000 yuan to 50,000 yuan, you can have your pick of many investment choices. All offer annual returns of 8 percent to 15 percent, with a lock-in period of 3 to 24 months. In contrast to banks' wealth management products, which offer on average returns of less than 4 percent a year, these alternative investments are certainly attractive to many.

One type of wealth management that has created plenty of controversy in the media in the past two years is social investment, better known peer-to-peer (P2P) investment. These are loans packaged as wealth management products that are sold to investors. CreditEase, one of the leading investment firms in China, adopts a brick-and-mortar model that operates like a bank.

As with most P2P firms, investments are made online. With a few mouse clicks or a few taps on an iPad, investment decisions and executions are carried out. One of the key selling points of these products is their high yield and a minimum entry of 100 yuan. They may offer as much a 24 percent annual return, which is directly offered by the borrowers. The online P2P companies simply provide a platform for such transactions to take place.

One of the issues facing China's wealth management market is the shortage of financial professionals who possess solid wealth management experience and knowledge. After all, this is an under-developed and emerging market. In addition, a lack of professional ethics in the industry causes problems in an arena where inexperienced investors may be persuaded to invest in products without fully understanding the risk, or even are conned into Ponzi scams with Chinese characteristics.

Early December, alarming news broke out in the local banking industry. Huaxia Bank, one of the largest banks in China, refused to pay back their customers when a 100 million yuan wealth management product matured. The reason was simple: an unauthorized product had been sold to customers.

In this case, a bank manager had decided to distribute his own product under the Huaxia brand name. The Chinese banking regulator responded quickly by issuing a circular that requires banks to scrutinize third-party product sales, including trust products, investment funds and insurance.

Regardless of an individual's wrongdoing in breaching company policy, Huaxia needs to bear the responsibility because the transactions took place under its roof. Huaxia is not the only bank that has suffered from rogue branch managers. It would be wise for the bank to enter into settlement agreements with their victims swiftly, before reputations are further damaged and mainland investors move their assets away from banks.

New license

With the government's efforts in strengthening the governance of the wealth management sector, a new type of license has been issued for third-party fund distribution. It allows qualified agents to sell publicly listed mutual funds to the general public.

Noah, a Nasdaq-listed investment firm based in Shanghai and the largest third-party wealth management firm in China with assets of 30 billion yuan under management, obtained such a license early this year. This allows Noah to tap into the 2 trillion yuan mutual fund market in China. Traditionally, the mutual fund market has been dominated by banks. Although the new provision mainly focuses on third-party fund sales, it also includes wealth management and may one day become the basis for the laws that regulate this industry.

To steer the wealth management market onto the right path, Chinese regulators need to come up with more definitive directives, similar to what the government did with the banking, securities, fund management and payment industries over the past few decades.

Over the past 10 years, especially after the global financial crisis, new laws were passed and implemented worldwide. All were purposely designed to protect consumers and impose transparency on the products offered by financial institutions. With China's fast growing and underdeveloped financial market, practitioners often outpace lawmakers, operating in grey areas and finding ways to survive in this young and competitive environment.

It is in the best interest of the wealth management industry to be regulated, with greater clarity in the governance framework for operators, specifying their responsibilities and investor protection. This would help cultivate local financial advisors and act as a stimulus for global firms to expand their wealth management footprint in China.

All these will serve as the building blocks for advancing China's financial market and the government's plan to build Shanghai into an international financial center by 2020. Barring that, the currently overheated market is in danger of developing into a Chinese version of the subprime crisis.

Gregory Au-Yeung is currently chief information officer at VantAsia Finance, a foreign owned financial institution that specializes in consumer finance in China. Prior to joining VantAsia, he held senior positions at Morgan Stanley and State Street Bank in China and other Asian locations. He is also a visiting professor at Fudan and Zhejiang University. His email address is greg@auyeung.com.cn