NOTICE: China’s bond defaults have reached maturity

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Chinese corporate bond defaults reached an all-time high of 116 billion RMB ($ 18 billion) in the first half of 2021 and are expected to increase in the coming months. Credit defaults are also on the rise, with defaulters having an average of RMB 8.7 billion of onshore bonds outstanding, according to Fitch. This is 1.6 times the size of defects in 2020 and three times the size of 2017.

While these are worrying signals for investors in the Chinese bond market, there are also signs that the regulations and infrastructure for market-oriented debt resolutions are developing, albeit slowly.

From real estate developer China Evergrande to China Huarong Asset Management, debt defaults, especially from state-owned companies, have rocked the global market. Zombie companies and insolvent local government financial vehicles are common default contenders, but the real estate industry could be hit hard.

All eyes are on Evergrande, who sits on a mountain of $ 300 billion in liabilities, and whether the Chinese government will decide to bail out the indebted company. As Chinese state-owned banks are the company’s biggest creditors, they feature prominently in the liability cascade and will be prioritized ahead of private investors, including bondholders.

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While the practice of government bailouts may have been common in the past, China is moving towards greater tolerance for flaws by unfit companies in an effort to push for market openness and discipline. State-owned enterprises have long been favored by the government and benefited from implicit debt guarantees. By drawing a line between what is systemic and what is not, the central government injects more credit risk into the financial system and makes investors think about their risk appetite, rather than relying on it. government to bail out distressed borrowers. It also sends a signal to businesses that they can no longer count on the government to help them.

The momentous task the Chinese government now faces is to ensure that defaults occur in an orderly fashion in its campaign to reduce risk. A number of initiatives are being taken to clean up the bond market.

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The main objective is to clean up the rating agency industry. In August, five central government agencies, including the China Securities Regulatory Commission and the China Banking and Insurance Regulatory Commission, released corporate rating rules detailing disclosure, corporate governance and standards. business operations. They are required to be strict on rating based on the probability of default and to reduce the proportion of well-rated bonds, a common practice for national rating agencies wishing to attract potential clients.

Another priority is to develop the legal infrastructure allowing courts to deal with defaulters. The judicial restructurings of defaulters are beginning to take shape as the market begins to accept the remedies. However, the legal precedents for bankruptcy proceedings are still new. For offshore bondholders, the process is slow and arduous. What will help in the future is the streamlining of documentation, whether for transfer or liquidation, to ensure that investors can make repatriations. It remains a challenge for offshore bondholders to find recourse when they are structurally subordinate to onshore claimants and face challenges such as delaying tactics and lack of transparency in the legal process.

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What is evident is that the Chinese government is steadfast in its goal of bringing its bond market and related regulatory and legal infrastructure to international standards, but the process to achieve the end goal will take time and a lot of patience. from investors.

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