Creditors in China See Strong-Arm Tactics From Local Govts

(Bloomberg) -- Two years after China’s top banking regulator pushed for market-based workouts for defaulted bonds, local authorities are still putting a heavy hand on negotiations, a review of recent episodes shows.

The evidence from several of the record number of defaults this year suggests local officials are moving to keep troubled business from failures that could unleash waves of job losses and the attendant social and economic damage. For investors considering diving into the riskier parts of the world’s third-largest bond market, it’s a reminder of some of the idiosyncratic surprises that await.

At the heart of the interventions has been provincial sway with creditor committees set up to negotiate work-out plans for defaulted borrowers. Particularly in cases of larger firms seen as important to the regional economy, government officials have gone as far as asking creditors not to take legal actions against the defaulter and to maintain credit lines. China’s local bond failures have reached a record of over 50 billion yuan ($7.3 billion) this year.

“There are not many things Chinese creditors can do during the debt-restructuring process, as creditor committees are largely under the influence of local governments,” said Zhang Wenliang, a partner at Merits & Tree Law Office in Beijing with two decades’ experience in distressed-debt restructuring. “Social stability always comes first” for the officials, he said.

Among the examples this year:

The involvement of the local officials contrasts with the tone of rules set by China’s banking regulator two years ago, which require creditor committees to go about debt restructuring in a “market-based, lawful and fair” manner.

Calls to Jiangsu, Shanxi and Zhejiang provincial government offices went unanswered. There was no response to a faxed request for comment to the China Banking and Insurance Regulatory Commission.

Beijing has followed up on its 2016 move -- part of a broader effort to phase out the assumption of implicit government guarantees for debt -- by developing a judicial infrastructure to handle the rising number of defaults. Court-mediated bankruptcy reorganization and liquidation is still rare, however, and remains the last option for creditors because it could entail greater losses, Everbright Securities Co. said Sept. 19.

At this stage, official interventions are a necessary method to calm creditors and encourage solutions for temporary liquidity crunches, says Ivan Chung, an associate managing director at Moody’s Investors Service in Hong Kong. As legal mechanisms get established, “market-oriented approaches such as court-supervised restructuring or negotiations among creditors -- without government intervention -- should be more common,” he said.

Court-based restructurings do occur, as evidenced in the case of Dongbei Special Steel Group Co., where bondholders took a 78 percent haircut.

Ultimate post-default debt repayment rates have been lower in China than the global norm -- read about that here.

That’s not been the template in the case of Sunshine Kaidi New Energy Group Co.’s default. Local officials in Hubei province organized a creditor group and asked financial institutions not to withdraw lending or file lawsuits, the 21st Century Business Herald reported in June. Calls to Kaidi went unanswered and the Hubei government’s press office declined to comment.

“Creditors are sometimes forced to withdraw lawsuits -- which is against the law in itself,” said Zhang, the attorney.

To contact Bloomberg News staff for this story: Tongjian Dong in Shanghai at tdong28@bloomberg.net;Yuling Yang in Beijing at yyang329@bloomberg.net

©2018 Bloomberg L.P.

With assistance from Editorial Board