China bond default boosts government debt reforms

A new corporate default this week has been welcomed as a step towards ending implied guarantees. The government push for more defaults comes amid increasing foreign demand for onshore renminbi assets.
China bond default boosts government debt reforms

China’s latest credit default in its public bond market has been seen as a positive development in its attempt to reform its onshore debt sector.

The rare default comes as government officials urge more such failures in order to end the system of implied guarantees.

The country’s authorities are attempting improve the investment environment to meet increasing global demand for onshore renminbi assets.

Baoding Tianwei Baobian Electric, a solar and wind energy equipment producer controlled by state-owned China South Industries Group (CSGC), on Tuesday failed to pay interest on a Rmb1.5 billion ($242 million) bond.

This was the second technical default in China’s onshore bond market this year, and the third credit default in the country’s bond market since the People’s Bank of China (PBOC) began regulation of corporate bonds in 1997. 

Privately-owned company Shanghai Chaori Solar’s failure to make bond repayments in March last year was the first onshore default, and then Cloud Live Technology Group missed payments earlier this month. Kaisa’s default this year was the first by a property developer in the offshore market.

“China’s growth is slowing down, and I believe more inefficient investments will fail so more debt defaults will be unavoidable. However, such defaults will not happen in a short period of time - investors have a long time to prepare for it,” said Meng Xiaoning, Hong Kong-based fixed income portfolio manager at CSOP Asset Management.

Baoding Tianwei’s default was not unexpected as investors have known about its failed solar and wind energy investments since last year, Meng added. He said he did not expect the two recent defaults to carry systemic risks.

“Private companies and small and medium-sized firms continue to face tight credit and high funding costs as lenders scrutinise credit risks,” said Christopher Lee, managing director of corporate ratings at Standard & Poor’s. Interest rate reductions and cuts to the reserve requirement ratio will ease overall financing conditions, he added.

Fund managers and rating agencies expect more defaults in China, but see them as helping to push forward reform of the onshore bond market. Chinese officials have called for more failed companies to default and end the culture of implied guarantees on both bonds and trust schemes. Meanwhile, last month the PBOC said it planned to further liberalise the interbank bond market as part of its financial reforms this year.

“In the restructuring following Chaori Solar’s default last year, investors’ interest and principle was repaid to them, which is why some investors still expect an implicit guarantee in corporate defaults,” said Ivan Chung, head of greater China Credit research at Moody’s Investors Service. Investors are eager to know if Baoding Tianwei’s parent company will rescue it this time due to its state-owned background, Chung added.

Meng said the Chinese government has stated it has no intention of intervening in defaults, and it would prefer the problem was resolved through market forces. But he saw more defaults as beneficial for credit ratings and pricing.

“Investors will be concerned about protection covenants and the debt restructuring process,” said Chung. “In the case of Baoding Tianwei, investors do not have much they can do as the bond covenants lack protection.”

Global investors’ interest in China’s onshore bond market has been boosted by the central bank’s easing policies and also investor demand for renminbi assets. Both Swiss firm Pictet and Singapore firm Lion Global Investors have launched onshore bonds via their renminbi qualified foreign institutional investor (RQFII) quotas, while UK firm Investec and Korean firm NH-CA Asset Management also plan to launch renminbi bond funds this year.

“Global investors have a high interest in onshore bonds, but they tend to invest in high-quality and interest rate-sensitive bonds such as those issued by the government, rather than corporate credits,” said Meng. China does not have a real high-yield-bond market while single A-rated credits have been considered to be risky. Low-rated credits currently offer a yield of 5.5%-5.6%, according to Meng.

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