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China’s finance guns tidy up after bond default debacle

(ATF) The aftermath of the Yongcheng Coal bond default has not yet settled, and more intermediaries are being investigated. These include banks, securities firms, accountants, rating agencies and anyone else involved in the sorry saga, which led to a tsunami of woes for China’s corporate bond sector.

After investigation into Haitong Securities, the Association of Dealers (China National Association of Financial Market Institutional Investors) issued an announcement on Tuesday November 17 seen by ATF, stating that they found the Industrial Bank was looking into Yongcheng Coal and Electricity Holdings Group and conducting interviews with a number of intermediaries.

Lead underwriters such as China Everbright Bank and Zhongyuan Bank, plus China Chengxin International Credit Rating Co, and Sigma Certified Public Accountants are suspected of misbehaviour – that is, violating the “self-discipline of the interbank bond market.”

Yongcheng defaulted on a 1 billion yuan ($151.8 million) bond on November 10, just weeks after it sold fresh debt. The state-owned enterprise had a AAA rating, so the sudden default of its Yongmei bonds spurred a tidal wave of panic and a selloff in China’s corporate debt market. (“Yongmei” means “Yong-coal” in Chinese and is a short-form for the company name).

The market jitters heightened funding costs for many corporate borrowers and threatened China’s nascent economic recovery. Many bonds were affected and saw sharp falls in value, as reported by ATF.

SEE: Wave of China bond issues cancelled as defaults trigger market panic

China Brokerage news reported that due to progress made in handling of the chain of default incidents, notably statements from authorities to protect market confidence, tension in the bond market had been greatly eased.

The paper said many analysts had called for defaults “to be more orderly” to help the market grow. Disorderly defaults destroy credit accumulated for more than 10 years, China Brokerage wrote. Only when the defaults are brought under control and order is maintained with strengthened market discipline will the Chinese bond market develop more healthily, it commented.

Yongmei bond intermediaries under investigation

On Thursday evening (Nov 19), the Association of Dealers said they would investigate intermediaries related to Yongcheng Coal’s bonds. The institutions being investigated include lead underwriters such as the Industrial Bank, China Everbright Bank and Zhongyuan Bank, as well as China Chengxin International Credit Rating Co Ltd and Sigma Certified Public Accountants.

On Nov 18, the Association said it discovered that Haitong Securities and its related subsidiaries were suspected of helping the issuer to put out bonds in violation of regulations, as well as suspected market manipulation, involving non-financial corporate debt financing instruments on the interbank bond market and corporate bonds on the exchange market.

It vowed to investigate Haitong Securities and its subsidiaries. If they were suspected of disrupting market order, or market manipulation, the Association said it would impose sanctions and transfer them to relevant departments for “further processing”.

Default came 3 weeks after successful bond issue

On November 10, Yongcheng Coal announced that due to a shortage of liquidity, it could not repay the full principal and interest on “20 Yongmei SCP003” at maturity. That constituted a substantial default. Doubts about the group’s breach of contract focused mainly on why this occurred – less than a month after it successfully conducted a bond issue – “20 Yongmei MTN006”, on October 20.

The lead underwriter at that time was Industrial Bank and Yongcheng Coal’s credit rating was still AAA. But, the day after the default on November 10, China Chengxin International decided to lower Yongmei Group’s credit rating from AAA to BB, and only then included the firm on a watchlist for possible downgrade.

The default highlighted, once again, the problem of due diligence by intermediaries in China’s bond sector.

‘Structured issuance’ draws attention

The Association of Dealers, which is a self-regulatory body under the central bank, said it had found that Haitong Securities and its related subsidiaries were “suspected of providing assistance for issuers’ illegal issuance of bonds”, and views were given on whether there are “self-financing” issues, such as structured issuance of Yongcheng Coal’s bond issue.

On Wednesday Nov 18, the Association issued a notice emphasising that issuers are prohibited from directly or indirectly subscribing to bonds that they issue. To crack down on violations of “structured issuance”, it said it would strengthen management requirements for underwriting agencies and investors, and clearly prohibit assistance in violating market rules.

Later on the same day, a fine was issued for “self-financing”, such as structured issuance of bonds. But the size of the fine, and who it was issued to, was not disclosed.

The issue of “structured” issuance has a long history. A Beijing bond practitioner from a brokerage firm in China told China Brokerage news that “in the past two to three years, with the increase in bond defaults, some issuers with low credit ratings have found it more difficult to issue bonds in the open market, and they have directly or indirectly subscribed for their own issuance of bonds, or bonds promised to be repurchased after listing, to promote the issuance of bonds. Although this grey operation is [done] to reduce the difficulty of issuance, it also conceals the substantial risks of bonds to a certain extent.”

Impact of default on bond market ‘relatively controllable’

The aftermath of the Yongmei bond default has affected the tense bond financing environment. The bond prices of many coal companies have fallen, and the issuance of corporate bonds in Henan and other provinces have been cancelled. In order to ease the sensitive nerve and market fragility, in addition to the central bank’s recent release of excess liquidity to ease the shortage of funds, relevant departments are also making positive signals to boost market confidence.

On November 18, the Shanxi Provincial Government held a special meeting for the heads of provincial state-owned enterprises and financial institutions. Wang Yixin, the vice governor in the province, said at the meeting: “If a provincial state-owned enterprise faces financial risks and has no countermeasures, it indicates that your financial director is incompetent. If someone has caused major financial risks and affected Shanxi’s reputation and image, then you, the main person in charge of the company, must bear the responsibility. The two main leaders of the provincial party committee and the provincial government attach great importance to the prevention and control of financial risks.”

Wang Yixin sought to defend the province’s efforts in risk prevention and control at local state-owned enterprises.

After the bond default, the industry has called for greater crackdowns on legal violations to maintain order in the bond market and avoid disorderly defaults.

Zhang Xu, chief fixed-income analyst at Everbright Securities, said that compared with other financing methods, bond financing is more convenient, has lower issuance costs, and fewer requirements for collateral. However, the above-mentioned features of bond financing are derived from its historically low default rate and orderly defaults. In recent years, the default of AAA-level entities has disrupted the previous order, and caused an increase in overall financing costs of the bond market. It has added difficulty, and reduced the quality and effectiveness of financial institutions in supporting the real economy. Orderly defaults help the market grow, but disorderly defaults destroy the credit accumulated for more than a decade. Only when defaults are conducted in an orderly fashion can it help strengthen market discipline and allow the Chinese bond market to develop.

Impact on Henan and coal industry

In regard to possible follow-up impacts from the Yongcheng Coal bond default, Tianfeng Securities Research reported that the incident had had a negative impact on Henan and the coal industry that could be difficult to change, but further credit risk exposure may be relatively controllable and will not cause unilateral cross-market contagion.

It said that macro-control, such as the central bank’s action, and interventions by local government officials (such as recent statements from Shanxi Province), were done to protect liquidity. It was believed that, in theory, credit risk would not spread in a disorderly way to “infect” other industries and other regions.

At the same time, from the perspective of top-level design, credit risk also should have a reasonable margin. The keynote of next year’s policy is to balance risk prevention and stabilise growth, rather than simple structural deleveraging, as in 2017-2018. Therefore, from the perspective of top-level design, the probability of further defaults is low, the report said.

The central bank’s official website announced on Thursday Nov 19 that the bank’s party committee and the Foreign Exchange Bureau’s party group met recently. Guo Shuqing, secretary of the People’s Bank of China party committee, said that building a modern central bank system required an improvement in the level of financial services in the real economy, plus a solid advance in financial reforms, improving modern financial supervision and deposit insurance systems, promoting two-way financial opening up, and accelerating financial digital transformation.

“We must implement the requirements for coordinated development and security, earnestly to maintain financial stability, and resolutely maintain the bottom line of avoiding systemic risks,” Guo said.

Chris Gill

With over 30 years reporting on China, Gill offers a daily digest of what is happening in the PRC.

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