Investors seeking to recover capital from a growing number of companies defaulting on debt repayments in China face numerous challenges in seeking redress, speakers at a conference in Hong Kong said on Wednesday.
Among the hurdles are the country's deficient legal framework, substandard bookkeeping, deep subordination in the capital structure of Chinese companies issuing offshore bonds, and political interference.
“There will be a lot of bankruptcies and restructurings and creditors will take a hit," said Ying Wang, a senior director at credit rating agency Fitch speaking at the Borrowers and Investors Forum. "Most of all I hope there will eventually be more clarity and consistency from a legal perspective so investors know which approach to take … This is very much lacking at the moment.”
There have been relatively few defaults in China to date as the government has sought to limit the potential for social instability.
“If you’re a provincial governor and you have a shiny new plant built in 2008 that employs 6,000 people and is of the biggest contributors of taxes also, how are you going to close it? Here lies the conflict between what Beijing says on one end and what local governments need on other end to maintain political and social stability,” said Fergal Power, a partner at KPMG Restructuring.
However, defaults are gradually becoming more common in China as economic growth continues to slow and President Xi Jinping’s administration seeks to inject more market discipline into corporate thinking.
“This is a systematic risk for China and a systematic opportunity for the country as well to improve efficiency,” said Tun Lin, executive vice president from private equity firm Hony Capital, which has invested in state-owned enterprises across China.
The pain in China is particularly acute in the heavy industrial sectors and at companies that have been impacted by the slump in commodity prices including those coking coal, steel mills, cement manufactures, and, indirectly, shippers.
“We saw an increased number of defaults last year and we expect defaults to continue to increase given the challenging industry environment, especially in heavy industries such as metals and mining,” Christopher Lee, the chief credit ratings officer for Greater China at Standard & Poor’s, said at the conference.
KPMG estimates that across Asia Pacific there is around $160 billion of US-dollar denominated bond debt that will need to be refinanced in the coming 12 months.
“There will be a lot of corporates struggling to refinance,” KPMG’s Power said.
Legal framework
In the major cities of China there are now dedicated bankruptcy judges after changes were made to the country's bankruptcy law back in 2007. But there is still a lack of experience in the provincial courts.
“We can generally state bankruptcy regimes in most Asian jurisdictions are not particularly creditor-friendly versus the US or where most investors come from,” said Florian Schmidt, head of debt capital markets at boutique investment bank SC Lowy.
The difficulty mainly lies in getting judges to accept cases, which are miniscule in number compared to how many companies just disappear, KPMG’s Power added.
“Judges are unwilling to accept cases that may prove to be challenging, either too high profile or may not assist a local government,” Power said.
Judges have to close a certain number of cases by the end of each year. So if they feel it can’t be resolved within six months they may not accept it in May, he said.
Subordination
Even when a case is taken on by the courts, holders of Chinese offshore corporate bonds find they have to wait a long way down the list of creditors in the event of a bankruptcy, behind onshore banks among others.
In China it's also not unusual for equity holders to retain significant value, basically because they control the company’s chop -- the official company seal used by management to legally authorise documentation. By contrast, equity holders in the US would normally see their investments wiped out in the case of bankruptcy.
Historically, recovery rates of such capital are between 30 and 40 cents on the dollar for onshore secured debt. Offshore debt trades at lower levels as the recovery assumptions are less, SC Lowy’s Schmidt said.
Offshore bonds issued by Chinese miner Hidili Industry International Development, which defaulted on its repayments last year, are trading at 14 cents on the dollar. Those of coal trader Winsway Enterprises Holdings, which failed to pay interest on dollar bonds for a second time in October, are trading at 11 cents on the dollar.
Building a case in China for recovering assets following a default can be hampered by unreliable company accounts but is not insurmountable, delegates at the conference heard.
“Gather a scrubbed set of numbers and really understand the sponsors, their motivation, who they’re connected to and who they not connected to, and pull all that together to form strategy for recovery,” KPMG’s Power said.
