Workout in progress
Defaults are no longer taboo in China as the government gives freer rein to market forces, opening up new opportunities for restructuring advisers.
After years of assuming that the Chinese government would never allow state-owned enterprises to default on their debts, investors are now waking up to the idea that it is possible to make a loss on SOE bonds, just as the market is opening up to foreign investors.
Ever since Shanghai Chaori Solar Energy Science and Technology missed a coupon payment in March 2014, becoming the first Chinese issuer to default on onshore bonds, a string of borrowers have run into difficulties, including state-owned companies like Baoding Tianwei Group, a manufacturer of power equipment that failed to make an interest payment in April last year.
So far, most issuers who have defaulted on their bonds have found a way to redeem them at par and no one has yet imposed a haircut on creditors. But that could change as the state takes a step back from providing implicit support.
Market participants believe that the Chinese government applies pressure behind the scenes to encourage tidy resolutions, even when it decides not to take over an SOE issuer’s obligations itself. This could take the form of providing assistance for the acquisition of a stricken company, as in the case of Chaori, giving it the funds it needs to repay bondholders, or putting pressure on the bond underwriters to make investors whole and protect their own reputations and standing with the government.
“The hiring of advisers onshore, although a relatively new concept in China, is becoming more prevalent due to increasing complexity of onshore restructuring plans and there is a clear trend that parties wish to ensure they are represented and advised accordingly to protect their interests.”
An International Monetary Fund working paper in June 2015 noted that “creditors appear to be more focused on implicit guarantees than underlying credit quality”.
Increasingly, though, the Chinese government has signalled that defaults are a healthy part of market development and shown that not all SOEs will receive the same level of support if they run into difficulties.
“Moody’s expects the central government’s increased tolerance for SOE defaults will prompt more caution among onshore investors and banks in lending to such companies, in turn raising their costs of funding, particularly for weaker SOEs,” the rating agency wrote earlier this year.
Investors may now need to rethink their previous assumptions that companies in certain sectors will always be supported.
“People believe the Chinese government would not allow companies in the steel sector to fail because it might cause unemployment problems,” said Joep Huntjens, head of Asian debt at NN Investment Partners. “That’s a dangerous strategy for investors, because they could default on their debt and not close down operationally. That would be painful for bondholders, but not necessarily for employees.”
Onshore vs offshore
As the state attempts to distance itself, companies in all sectors, including SOEs, are beginning to take responsibility for their own restructuring process. This is likely to make workouts more complex, and is catching the attention of specialist consultants.
“Chinese companies cannot and should not only look to the state, the local government and banks for assistance,” said Michael Chan, a director at restructuring and insolvency adviser Borelli Walsh in Hong Kong. “In order to resolve the bond default, management and stakeholders including creditors, suppliers, employees, shareholders and government have to work hard and work closely together to establish and facilitate a restructuring and rescue plan.
“Chinese companies were not used to it, but they are progressively picking up the importance of the role of restructuring advisers.”
Previously, restructuring advisers were involved only with offshore debt, but now that onshore defaults have become a reality, they are in demand for domestic transactions as well.
“The hiring of advisers onshore, although a relatively new concept in China, is becoming more prevalent due to increasing complexity of onshore restructuring plans and there is a clear trend that parties wish to ensure they are represented and advised accordingly to protect their interests,” said Marcus Paciocco, managing director, corporate finance and restructuring, at FTI Consulting in Shanghai.
As the new wave of onshore restructurings moves ahead, with market forces replacing state intervention, China’s legal frameworks may also need to catch up.
“It’s fair to say the bankruptcy system is less tested in China,” said Huntjens. “In the past, they did not allow onshore bonds to default, so the need for clear bankruptcy laws was less obvious.”
Past restructurings of offshore bonds from Chinese issuers will not be much of a guide. In those cases, onshore creditors had first claim over a company’s Chinese assets and were made whole, while holders of offshore bonds were left to fight over the remainder, normally facing a hefty haircut.
As China’s interbank bond market opens up to foreign investors, that raises concerns over whether overseas investors would be treated the same as onshore ones in the event of a default there. Several DCM bankers said that it would be impossible to differentiate between different types of bondholders after a default, but some market watchers have not ruled it out, despite the effect it would have in damaging foreign investor confidence.
“Regarding the interbank bond market, we would anticipate that, due to the more sensitive nature of such defaults, foreign investors may be more likely to be treated equally,” said FTI’s Paciocco. “However, investors need to factor in that onshore favouritism can always be a risk factor.”
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