China's central bank calls on struggling companies to restructure debt outside courts

Chinese regulators are urging struggling corporate bond issuers to seek voluntary debt restructuring in talks with their bondholders as a way to avoid default, as regulators last week issued new rules that seek to enforce investors' protection amid rising defaults.

In building a more uniform, transparent approach for corporate bond issuers to handle a default, the People's Bank of China has called for more debt restructuring, a practice that has long existed in other markets but is still relatively new in China.

The notice, jointly issued with the China Securities and Regulatory Commission and the National Development and Reform Commission, also includes the role that bond trustees should play in pursuing claims on behalf of bondholders. The statement followed its initial consultation launched last December.

"The encouragement of debt restructuring using market mechanisms may give companies more time to avoid outright defaults," said Jenny Huang, Fitch Ratings' director in China corporate research based in Shanghai.

The notice has come amid expectations that onshore corporate bond defaults will rise in the second half, as the total principal amount of onshore bonds issued by private enterprises domestically rated below AAA coming due will swell to 361.2 billion yuan (US$51.1 billion), more than doubling from 164.1 billion yuan in the first half, according to Fitch Ratings.

As the repayment ability of private companies weakened significantly during the first quarter in light of the coronavirus epidemic crippling the country's economy, Fitch expects China's corporate default rate will rise from about 0.3 per cent during the first five months this year.

China's corporate bond market already showed signs of repayment failures this year, with examples such as Hainan Airlines, flagship of debt-laden HNA Group, defaulting on a 750 million yuan 270-day note that fell due in April.

"Issuers and bondholders can, through voluntary negotiations, restructure their debt through bond swaps or maturity extensions," the regulators said, adding that these restructurings would be one avenue towards achieving more efficient default management by corporate bond issuers that is based on free market principles.

Hainan Airlines was in talks with bond holders earlier this year. Photo: Reuters alt=Hainan Airlines was in talks with bond holders earlier this year. Photo: Reuters

The latest notice represents the regulators' attempt to reduce uncertainties that bondholders face in getting their money back from corporate issuers in the world's second largest bond market, at 70.23 trillion yuan (US$9.84 trillion).

Despite several index providers have included Chinese onshore government bonds as part of their global indexes since 2019, today very few foreign investors would venture beyond the highly rated government and policy bonds due to the uncertainty about the recovery after a bond default. China's first onshore bond default was only recorded in 2014.

"With as much as 28 per cent of the defaulted issuers which neither enter a bankruptcy process or pay back bondholders since China's maiden onshore bond default, there is a significant amount of defaulted payment that did not get recouped under the existing legal framework," said Huang.

A debt restructuring through bond swap and maturity extension could shorten the time needed for issuers managing their bond default, analysts said, as the local courts often face pressure from local governments which are often keen to avoid a struggling company falling into bankruptcy, on the grounds of preserving employment and social stability. Such intervention increases the uncertainties on whether investors could ever recoup their money.

But the flip side is that there is no guarantee that a debt restructuring would make bondholders whole even as the company succeeds in buying more time. Also, as issuers could avoid outright defaults, these restructurings tend to distort the real extent of China corporate default rates, said Huang. Credit rating agencies tend to label such debt restructurings as technical defaults.

One example is water and sewage treatment company, Beijing Sound Environmental Engineering, which became the first ever issue in March to complete an onshore bond swap. As it failed to pay back investors on a 500 million yuan note on time, which paid a 6.5 per cent coupon, it offered investors an option to swap their investment into a new bond paying 7 per cent. Chinese media, Caixin Global, reported in June that it still failed to repay investors' their principle from the new note that came due that month.

Still, a bond swap could improve secondary market liquidity for distressed bonds, Fitch said.

Corrects definition of private enterprises in paragraph five

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2020 South China Morning Post Publishers Ltd. All rights reserved.

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