Author: Zheng Jun, China Railway Trust Co., Ltd.
Synopsis:
- The method of "looking, hearing, asking, and cutting" in traditional Chinese medicine is applied to trust due diligence, and through the four dimensions of looking, smelling, asking, and cutting, the internal and external data of the enterprise are collected, and the management personnel at all levels of the enterprise are visited and inquired about, so as to verify the implementation of the internal control of the enterprise, and make predictions on the future production and operation of the enterprise, so as to scientifically predict the financing risk and risk consideration, which can effectively reveal the hidden risks, and then provide a strong guarantee for the investment decision of the trust company.
Trust due diligence is an indispensable part of the trust company's investment decision-making process, and it is essential to assess the potential risks and returns of investment projects.
What is trust due diligence?
Due diligence, referred to as due diligence, generally refers to the process in which the parties to a transaction investigate and understand the other party's business status, business conditions, project conditions, shareholders, actual controllers and senior executives through relevant professional methods, means or tools, so as to eliminate relevant risks. Due diligence plays a key role in the conduct of business by financial institutions, and if financial institutions, as fund providers, fail to conduct due diligence, they can easily fall into risks and lead to capital losses. Under the regulatory requirement of "the seller is responsible, the buyer is responsible", since the trust funds come from the settlor and need to bear the fiduciary responsibility, it is particularly important for the trust company to perform its duties and due diligence in the due diligence.
Trust due diligence personnel should have good professional ethics and professional competence, and be able to abide by the principles of independence, objectivity and impartiality. Trust due diligence should follow the principles of diligence, honesty and trustworthiness, use various due diligence methods to comprehensively, objectively, prudently and timely reflect the true situation of the subject of capital use and the relevant transaction entities, and design corresponding transaction structures and risk control measures based on the results of the due diligence.
"Look": Collect information and analyze the needs of investors
The "hope" in due diligence refers to understanding the situation of the proposed investment project by observing and analyzing the financing needs and other materials provided by the financier, so as to obtain more information and understand all aspects of the project, and provide a reference basis for comprehensive judgment and evaluation.
The financing needs provided by the financier include the financing plan or financing application, the business plan of the proposed investment project, financial statements and other relevant information. The content usually includes the company's introduction, the introduction of the main products or services, the core management team, the company's industry or market overview and the company's competitiveness, the company's financial analysis, financing needs and financing plans (fund raising and investment methods and exit plans), etc.
Checking information is one of the things that must be done to understand a company. Information will not exist independently, there must be related nodes, if there is fraud in the enterprise, there will not be a seamless lie to take care of all the nodes, should try to find the suspicious points in the target information from the data, obvious contradictory information and mistakes that violate common sense, etc., and then take this as a breakthrough point, follow the vine, and seek the truth.
For example, when reviewing the financial statements of the financier, it is necessary to pay attention to whether there are unreasonable figures, abnormal trends or potential financial risks. Review the company's documentation to see if the terms are reasonable, whether the risks involved are properly managed, and whether there are potential legal issues. Observe the company's core team to understand the educational background, work experience, professional skills of the core management team members, as well as the stability of the core key executives. Observe the company's employee turnover and turnover rate, a high turnover rate may indicate management issues or employee dissatisfaction, which can affect the company's stability and performance.
Here is an example of Muddy Waters' investigation of Focus Media. Muddy Waters analyzed Focus Media's six-year M&A and restructuring data, and finally unearthed the relationship chart of the high-level personnel involved in these M&A and restructuring cases, thus revealing the inside story of Focus Media's acquisition cases.
"Smell": Conduct background checks on the respondents
"Smell" in due diligence usually refers to understanding the basic information of the financier by understanding the evaluation and reporting of the financier by external or third parties of the respondent. In this process, the credit risk and reliability of the financier should be comprehensively assessed in combination with other survey results, and the privacy protection of relevant subjects should be respected, relevant laws and regulations should be complied with, and applicable ethics should be observed.
During the background investigation process, information from news reports, industry magazines, academic research, social media and other channels can be consulted to understand the operation, reputation and performance of the financier and its related parties. Pay special attention to reports of negative news, legal action, or violations. Verify the borrower's credit report and background check results to understand their credit history, debt status, repayment ability and compliance status, etc. Understand the reputation and rating of the financier in the industry, including the rating of professional rating agencies, the evaluation and feedback of investors, the type of audit opinion issued by the accountant on the company's financial report, and the reason for changing the accounting firm.
Generally speaking, enterprise credit inquiries (including the three types of non-performing loans and loans of concern) can be conducted through channels such as the National Court Judgment Debtor Information Inquiry (http://zhixing.court.gov.cn/search/) and the National Court Judgment Defaulter List Information Inquiry (http://shixin.court.gov.cn/). At the same time, supplemented by corporate public opinion inquiries (including background investigation of controllers), the collected public opinion content is evaluated and analyzed, the authenticity, objectivity and accuracy of the report are judged, and the key information, attitudes and emotions are identified. There may be some fundamental reasons behind public opinion, such as product quality, company management and other issues. Therefore, when analyzing public opinion, it is necessary to explore the reasons and root causes behind it, which will help to understand the business style and strategic issues of the target company, and provide more comprehensive information for the assessment of relevant risks and opportunities.
Again, let's take Muddy Waters' investigation report as an example. When investigating Dongfang Paper, Muddy Waters compared the photos of Dongfang Paper's factories with those of rivals Chenming Paper, Sun Paper, Nine Dragons Paper and Huatai Paper, and found that Dongfang Paper could only be regarded as a workshop. By comparing the product sales price and gross profit margin of Dongfang Paper and its competitors, it is found that the gross profit margin of Dongfang Paper's products is at an impossible height, and the profitability level is seriously inconsistent with the industry.
"Ask": on-site due diligence, ask and ask key questions
The "question" in due diligence usually refers to the process in which the due diligence personnel go to the investment and financing enterprise, the project site, the collateral site, etc. to verify the relevant information, and further understand the background of the trust project in an all-round way through visits, meetings, on-site investigations and other means.
Through interviews with the management of the target company, the on-site due diligence personnel understand the information of the target company's business philosophy, strategic planning, organizational structure and key decisions, and evaluate the management's ability, sense of responsibility and decision-making level. Evaluate the sustainability of the profit model and the effectiveness of the operational process by asking questions to the business personnel of the target company to understand its business model, product or service characteristics, sales channels, and supply chain management. Through the improvement and implementation of internal systems, we evaluate internal control risks, etc.
Through the method of "asking", the investigator can directly obtain the oral expression and feedback of the relevant personnel, so as to further understand the internal situation, business process and risk status of the target company. However, it should be noted that appropriate communication methods should be adopted during the questioning process, respecting the rights and privacy of the respondents, and ensuring the accuracy and reliability of the information. At the same time, it is also important to ask specific, targeted questions that are specific to the purpose and focus of the investigation, and avoid overly broad or irrelevant inquiries to save time and improve efficiency.
The methods of on-site investigation include but are not limited to the observation of the company's production and business sites, the review of on-site data, and the interviews of key business personnel. Observe the production site, understand the product production process and process, pay attention to the saturation of the production line, the maintenance of machinery and equipment, etc., and pay attention to the work appearance and mood of the staff. When checking inventory, keep an eye out for slow-moving products and backlogs, and check for safety hazards or environmental issues. Inspect the company's internal control systems, pay attention to whether the production site is in order, whether the department configuration is sound and reasonable, and whether there are various systems for publicity.
During the on-site due diligence, it is necessary to compare the observed actual situation with the information publicly released by the company to find out whether there are logical contradictions. Here is an example of the financing needs of a listed company that the author contacted in early 2017. The author conducted on-site sampling due diligence based on the "inventory of 9.654 billion yuan, an increase of 39.6% over the previous year" in its financial report. During the due diligence inquiry, its management personnel did not interpret the proportion of various types of inventory (jewelry, precious metals, rough stones, etc.) inconsistently, and learned that its inventory valuation method was also inconsistent. During the random inventory check, the handling staff failed to count some of the sampled inventories on the grounds that the valuables were stored separately. After investigation, the author believes that there are great doubts about the company's inventory, and decisively rejected its financing request. Later, the company was exposed to financial fraud and other news, and the company has now been delisted.
"Cut": Analyze the due diligence information and make predictions
The "cut" in due diligence usually refers to going deep into the respondent to verify its internal control operation, understand the future production and operation of the enterprise, etc., and make predictions about the future trend of the enterprise.
Through the financial analysis of the respondents, we can understand the past financial status and operating results of the respondents, and evaluate and predict their future development trends. There are many methods of corporate financial analysis, including DuPont analysis, trend analysis, ratio analysis, factor analysis, etc. Regardless of the analysis method, the focus is on the analysis of the respondent's asset-liability structure, solvency, operating ability, profitability, cash flow, non-recurring profit and loss, etc., and predicting their future solvency.
In addition to the analysis of the financial status of the enterprise, it is also necessary to analyze the specific operation of the funds, including the analysis of the industry and market where the project is located, such as the macroeconomic trend, the overall background of the industry, the current situation and forecast of industry competition, the output and price changes of the product, and the forecast of the project's own profit and cash flow. According to the forecast results, the plan and rationality of the use of project funds, the feasibility of capital arrangement, the economic benefits of the project, the sensitivity of the project, the stress test, etc., are analyzed, and the core indicators such as cash flow guarantee multiple, net profit margin of sales, and internal rate of return of the project are analyzed.
Judging the ability to repay in the future is even more important.
First of all, it is necessary to evaluate the source of repayment funds and the ability to repay. Analyzing the cash flow of the target company or project is the key to assessing the repayment ability. Through the analysis of the market prospects, industry trends, competitive environment, profitability, future cash flow and other factors of the target customers, the prediction of their future cash inflows and outflows, as well as the evaluation of the sustainability and stability of cash flows, predict whether the future enterprises or projects will have sufficient cash inflows to meet the needs of trust repayment. If the financier operates a large number of sectors, it is necessary to analyze the income of each sector and the degree to which it matches the repayment date, and then judge its repayment ability.
For other sources of repayment, it should be important to analyze their reliability. For example, in the case of refinancing, whether there is a credit approval from a relevant financial institution, whether there is an equity investment income/cash dividend, whether there is a clear amount and time of investment income or dividends, etc.
Secondly, it is necessary to do a good job in risk control and risk mitigation measures. Combined with the assessment of the source of repayment funds and the ability to repay, corresponding risk control measures and risk mitigation measures shall be taken.
Generally, the risk control of financiers is strengthened through two dimensions: the corporate governance level and the corporate operation level. For example, at the level of corporate governance, risk control is strengthened through the knowledge or final veto power of the financier's major matters (capital increase or decrease, amendment of the company's articles of association, investment and financing, guarantee, disposal of assets, etc.). At the operational level, the company strengthens risk control through capital supervision, entrusted payment, liability for breach of contract, etc. Risk mitigation measures refer to the use of risk control measures to reduce the frequency or impact of risks. Requiring the financier to provide pledges and guarantees that match the financing amount is a typical risk mitigation measure. Risk mitigation is often integrated into a bank's day-to-day operations. Risk mitigation tools should comply with national laws and regulations to ensure they are implementable, easy to implement and monetize.
Issues that need to be paid attention to in the application of due diligence
●Precautions of "look".
Information symmetry: Financiers often need to ensure that investors or financiers have access to accurate and comprehensive information to make decisions based on a comprehensive understanding.
Conflicts of interest and ethical issues: Trust beneficiaries may face conflicts of interest with their investees, other stakeholders or their own interests, which may affect the objectivity and independence of due diligence, and some due diligence may involve ethical dilemmas, such as issues of confidentiality and fair treatment of parties.
Privacy and trade secret issues: Financiers may be concerned that disclosing too much information may lead to trade secret leakage and competitive risks, etc., and need to sign corresponding confidentiality agreements.
●Precautions for "smelling".
Data Reliability and Accuracy: The results of third-party assessments rely on the accuracy of the data and information used. If the data source is imperfect or the data itself is incorrect, the results of the assessment may be affected.
Subjectivity and bias: Evaluators may have subjectivity and bias, which can have an impact on the outcome of the assessment. The evaluator should take measures to reduce the impact of subjectivity and bias, such as adopting standardized evaluation methods, independent evaluation by multiple evaluators, etc., to improve the objectivity and reliability of the evaluation.
Authenticity of public opinion information: Public opinion information on the Internet may contain false, inaccurate or misleading content. Some of the information may be published in bad faith or falsely advertised, which may mislead or distort the results of the due diligence.
Privacy and compliance issues: In the process of public opinion monitoring, the evaluator needs to comply with relevant privacy protection regulations and compliance requirements, ensure that the processing and use of personal information complies with legal requirements, and take appropriate measures to protect information security and privacy.
●Instructions for "asking".
Respondent influence and bias: When conducting on-site due diligence, the evaluator may need to communicate and interview multiple respondents. However, respondents' influence and bias may have an impact on the survey results. Evaluators need to carefully select and manage respondents, ensure access to information from multiple perspectives, and analyze and weigh the reasonableness and credibility of different opinions.
●Precautions of "cut".
Complexity of internal control system: An enterprise's internal control system is usually complex and large, covering multiple aspects, such as financial management, risk control, compliance, etc. In the process of "cutting", the evaluator needs to fully understand and evaluate the internal control system of the enterprise, and faces difficulties in understanding and analysis challenges.
Uncertainty of future forecasts: The purpose of "cut" in due diligence is to predict the future trend of the enterprise, however, there is often uncertainty about future development. Enterprises are faced with a variety of internal and external factors, and the evaluator needs to carefully analyze and weigh various factors to avoid one-sided or overly optimistic forecasts.
Improve the application of "looking, hearing, and inquiring" in trust due diligence
In the face of problems such as information asymmetry, data reliability and accuracy, the construction of a science and technology financial ecological alliance should be accelerated on the basis of ensuring the principles of compliance, efficiency and security. Through blockchain and other technologies, the authenticity, safety and reliability of information data such as counterparty basic materials, underlying asset materials, collateral information, transaction text, audio, video, pictures, and geolocation can be realized. Realize the digitalization and intelligence of due diligence-related work, improve convenience, improve production efficiency, strengthen work collaboration, and continuously deepen the application of technology scenarios at the front end of business.
Using "big data + AI digital financial technology", based on internal and external data information, the basic information of the counterparty is collected, analyzed and public opinion monitored. For example, it can automatically obtain the basic information and business data of the counterparty, analyze the data of collateral, and violate laws and regulations. Strengthen the innovative application of artificial intelligence technology, use big data technology to dynamically collect and integrate internal and external information, break the situation that financial analysis is limited to internal data of enterprises, screen and integrate valuable data, and use cloud computing and other technologies to improve the efficiency of data interpretation and maximize the intrinsic value of data.
In general, the four diagnosis and treatment methods of "looking, hearing, inquiring and cutting" in traditional Chinese medicine are not isolated from each other, but are interrelated. The doctor will conduct a comprehensive analysis of the disease information collected through the four diagnoses, remove the false and retain the true, and make a comprehensive scientific judgment from the surface and the inside. In the due diligence process, through the collection of internal and external data of the enterprise, and the visits and inquiries of managers at all levels of the enterprise, the implementation of the internal control of the enterprise is verified, and the future production and operation of the enterprise is predicted, so as to scientifically predict the financing risk and risk consideration. The four methods can corroborate and complement each other to help reveal the real situation and potential risks of the enterprise. By observing and perceiving the external and internal situation of the enterprise, communicating and communicating with relevant personnel, asking targeted questions, and in-depth analysis of the information of the enterprise, a panorama is formed to help make scientific judgments and decisions.
(Editor in charge: Lv Jingjing)
