Chinese courts take center stage as defaults rock $ 17 billion bond market


Updates on Chinese Business and Finance

For decades, one of the last places anyone in China would want to be is before a judge. However, in certain areas of commercial law, signs of modernization are appearing.

The courts have long been synonymous with the most gruesome trends of the Communist Party: political purges, crackdown on dissent and corruption and, more recently, hostage diplomacy.

The cruelty of the courts has manifested itself again this year. In January, they imposed the death penalty on Lai Xiaomin, the former boss of one of China’s largest asset management companies. Weeks later, Lai was executed.

Business affairs have taken a different turn. Chinese courts are increasingly taking center stage in orchestrating complex restructurings and bankruptcy proceedings of failing conglomerates. This paves the way for greater interaction with businesses and investors, including foreign groups with interests in the world’s second-largest economy.

The best example of nascent change, according to rating agencies and some investors, is the court-led restructuring of the Peking University Founder Group.

This high-level conglomerate was founded in the 1980s under the direction of a high-level computer scientist from Beijing’s first academic institution. It ran into problems after aggressively expanding into tech, finance, commodities, healthcare, and real estate. At the end of 2019, with onshore and offshore debt totaling around Rmb250 billion ($ 38.5 billion), the PUFG became the largest default on dollar-denominated debt in China for nearly 20 years.

Beijing courts last month approved a radical reorganization of the PUFG. A consortium of strategic investors, including Ping An, one of the world’s largest insurance groups, is set to take over profitable parts of the group under a new entity. Secured creditors will be reimbursed in full. The unprofitable units will go into a new trust, which will likely be liquidated.

S&P, the rating group, examined the judicial restructurings of nearly 50 defaulters in China. He praised the PUFG training for its pace and for maximizing the recovery of the best assets in the group. “[PUFG] accelerated its restructuring, underscoring the Chinese government’s desire for effective and market-based defect resolution. . . the speed of the deal and the high recovery rate will increase market acceptance of court-led training sessions, ”S&P analysts said.

The 581 days between the date of the initial default and court approval was well ahead of the average of 679 days, according to S&P research. The cash recovery rate for PUFG unsecured debtors was at least 31.4 percent, compared to an average of 23.7 percent.

Despite these improvements, foreign investors with weaker bargaining power remain at a disadvantage in the court-led process. In the PUFG case, the administrator failed to recognize about $ 1.7 billion in bonds held by foreign investors with so-called keepwell deeds.

The deeds are essentially promises made by Chinese overseas debt issuers to maintain the creditworthiness of their offshore subsidiaries. About $ 110 billion in outstanding Chinese debt has those promises, according to Bloomberg data. Ongoing lawsuits in Hong Kong, such as with chipmaker Tsinghua Unigroup, could provide insight into the applicability of the acts.

That said, PUFG notes are trading at around 40 cents to the dollar in Hong Kong – almost 30% higher than the recovery for unsecured creditors in China – indicating hope for a partial recovery.

And as more Chinese creditors see better results for collapsed state-linked groups under the court-led approach, S&P analysts predict the private sector will follow suit.

The key to the success of the PUFG case has been to centralize the process under the authority of an administrator, comprising officials from the central bank and the banking regulator. This progress is notable given that ineffective corporate recovery operations have long plagued China Inc, leaving investors and creditors of struggling companies in perpetual limbo.

There’s a lot at stake. Since late last year, China’s $ 17.5 billion bond market has been rocked by a growing number of defaults. This has drawn attention not only to policymakers in Beijing, but also to foreign investors who hold around $ 850 billion in Chinese dollar-denominated corporate debt.

While a more centralized process certainly helps, given the cloud over keepwell’s actions, foreign investors will want to ensure that their interests are given equal weight in Chinese courts.

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