China needs more than just rules to tackle bond defaults

[SINGAPORE] In a bond market where investors once received ham as interest payment, the challenge to rein in unruly borrowers is imaginably tough.

That's the daunting task Beijing faces now.

In response to a surge in bond failures, Chinese regulators have taken unprecedented steps in recent weeks to restore investor confidence via more efficient and transparent handling of defaults.

The moves, led by the nation's first set of draft rules on tackling souring bonds, betray a sense of urgency among policymakers to tame wayward debtors who often get away with inadequate disclosure, constant repayment delays and protracted bankruptcy proceedings.

Failure to do so would hinder Beijing's efforts to foster well-functioning capital markets to modernise an economy still predominantly funded by bank lending.

It's easier said than done.

Despite the toughened policy stance, the regulators' latest pledges remain rich in generalisations and short on details such as how to enforce punishment for misbehaving defaulters and help investors recover losses, analysts say. Tidying up the mess also requires beefing up China's nascent bankruptcy law.

In draft rules jointly released Dec 27, China's central bank, economic planning agency and securities regulator called for improving the mechanism of handling bond defaults. They stressed the importance of creditor meetings and urged custodian banks, underwriters and ratings agencies to shoulder more responsibilities.

"The guidelines, which mostly cover broad principles in dealings with defaulted bonds, show the issue has received enormous attention at the national level," said Yang Peiming, a Shanghai-based partner at Llinks, a Chinese law firm.

However, the draft rules lack execution details, which means it now requires China's supreme court to follow up with more concrete measures, he said.

Regulators also have rolled out guidelines in recent weeks on trading defaulted bonds and are expected to publish rules on swapping them for new debt.

The country's supreme court also has taken some early action, drafting rules aimed at better scrutinising bond underwriters' behaviour.

BOND MESS

Beijing has come a long way since allowing the first domestic bond to go bad six years ago, seeking to instill stronger discipline in a market long accustomed to state-led bailouts. Still, it's China's bondholders that are bearing a higher cost of messy defaults while borrowers often face limited or no punishment.

Onshore bond defaults reached 134.1 billion yuan (S$25.98 billion) last year, hitting a fresh record for the second consecutive year, according to data compiled by Bloomberg.

Out of the 414 onshore bonds that had defaulted by the end of last year, only 74 completed "proper debt restructuring", according to Tan Chang, an analyst at China Chengxin International Rating Co.

The recovery rate on defaulted bonds since 2018 has fallen to 3.9 per cent, from 24 per cent in the four years prior to that, Shanghai Chongyang Investment Co said in a research note dated Dec 27.

HIGH-PROFILE CASES

Since its first local bond default in 2016, China City Construction Holdings, a Beijing-based builder, has remained mum on how it intends to restructure its onshore debt or repay investors. Its unusual silence has continued despite an official ruling in June 2017 to suspend the firm's bond issuance in China's interbank market due to its insufficient disclosure.

The habit of keeping investors in the dark is also prevalent among China's politically influential state-run enterprises: Among the 21 SOEs (state-owned enterprises) that had missed local bond payment as at the end of October, 14 hadn't followed up with repayment plans, according to Guoshen Securities Co.

In a more blatant example, Jiangsu Hongtu High Technology Co fabricated an approval from bondholders to allow it to extend the maturity of one of its bonds in 2018. It took five months before the authorities acted and imposed a one-year ban on the electronics manufacturer's future bond issuance.

In many other cases, helpless bondholders, who usually have little say in China's murky debt restructuring process, find themselves left with no better option than to accept forced repayment delays.

UNORTHODOX APPROACH

Some cash-strapped borrowers went for an unorthodox approach: Chuying Agro-Pastoral Group Co, a pork producer from central China, offered bondholders its ham or "ecological" meat products as coupon payment in 2018. Some investors agreed.

Tianjin-based Bohai Steel Group Co made good on its offshore bonds in 2017 after defaulting on onshore debt in the previous year, which was seen as a sign that offshore investors were prioritised over onshore ones.

To improve the situation, China needs to do more to improve its 13-year-old bankruptcy law, among other things, said Llinks' Mr Yang.

"It's a problem now that some issuers, who clearly meet requirements for a bankruptcy, can't start the proceedings due to local authorities' concern over social stability," he said.

Mr Yang also called for more stringent bond covenants that better protect investors, such as specifying compensation for bondholders if issuers transfer major assets away after completing bond deals. "Putting in those clauses can lend investors more support in legal battles," he said.

BLOOMBERG