China is on the cusp of changes in default settlement and recovery. On July 1, 2020, the People's Bank of China, National Development and Reform Commission, and the China Securities Regulatory Commission jointly released a notice on improving the default settlement mechanism in the domestic market. On July 16, China's top judiciary, the Supreme People's Court, released the minutes on resolving legal cases related to bond dispute.
The market has been calling for a more institutionalized and transparent default resolution system (see "China Bond Defaults: Becoming A Norm," published Nov. 25, 2019, on RatingsDirect). Bond defaults in China's onshore market this year have already totaled Chinese renminbi (RMB) 74.2 billion as of July 17, up 6.6% year-on-year.
S&P Global Ratings believes a practical, transparent, and efficient resolution system should be able to better protect bondholders' rights, as well as make recovery prospects more predictable and reasonable. We address below some questions on the new regulatory initiatives and how they could affect the default settlement and recovery process, as well as our expectations on the developing workout system in China.
Frequently Asked Questions
What's new with the recently released documents and how they could affect the default settlement process in China?
After record high onshore defaults in the past two years, China regulators sped up efforts to improve the mechanism for dealing with bond defaults. They drafted a circular and solicited public opinion last year. The official notice was released on July 1, 2020, and will take effect on Aug. 1, 2020. This notice, together with several other documents enacted last year by the National Association of Financial Market Institutional Investors (NAFMII), provides comprehensive principles and essential procedural components for default settlement. The key takeaways from these documents include the following:
- Reinforce the information disclosure requirement, making it more transparent and specific, because investors still suffer from limited and belated disclosure on repayment updates and post default resolution.
- Put more emphasis on the "bondholders' committee," which is a mechanism already in existence but not fully enforced. The bondholders meeting is a negotiation mechanism for investor and issuer to discuss key issues, including but not limited to advance repayment, extra information disclosure, revisions to prospectus and default settlement etc.
- Encourage diversified default resolution, especially debt restructuring out of court.
Meanwhile, the state's highest judiciary has provided specific guidance on handling legal cases related to bond disputes, especially defaults. The key improvements include higher standard of information disclosure and more practical judicial approaches to protect investors, such as having more explicit punishments for rule-breaking intermediaries, such as underwriters for making false representation about the issuers.
How are bond defaults in China's onshore market resolved currently?
Based on S&P Global Ratings' statistics since 2014, when the first bond default occurred in China's onshore market, more than 300 onshore corporate bonds issued publicly by about 110 companies have been in default. Less than 100 of those defaulted bonds have been resolved or accomplished repayment after the defaults. The common resolution methods include out-of-court restructuring, in-court restructuring, delayed repayment, and bankruptcy liquidation. Debt restructuring have accounted for nearly 75% of the onshore resolved defaults since 2014, and 50% of the debt restructuring are done in court.
Overall, the cash recovery rate of resolved defaulted bonds approximates 40.3%. For those resolved defaults, the average time consumed for the process was about 10 months. However, the cash recovery rate and time to resolution can vary widely, typically depending on asset quality, debt scale, regional practices, and government coordination (see table 1).
|Out-Of-Court Restructuring Offers Shorter Resolution Time|
|Average time taken to complete payment after default (days)||Max. time taken to complete payment after default (days)||Min. time taken to complete payment after default (days)||Average cash recovery rate|
|In court restructuring||679||1,816||56||23.70%|
|Out of court/self-organized restructuring (including exchange and extension)||171||1,682||0||33.20%|
|Out of court/self-organized restructuring (excluding exchange and extension)||707||1,682||159||75.90%|
|Note: Only the resolved cases are included. Defaulted bonds that have been exchanged or extended are regarded as resolved cases (resolved at the time of exchange offer or extension agreement completion) and incorporated in the statistics. Some of the resolved cases involve non-cash recovery, such as exchange, extension and debt-equity swaps. In those case, the cash recovery rate may be below the actual recovery rate. Delayed payment are missed payments and later repaid by issuer without having new agreement with creditors. Source: WIND, S&P Global Ratings.|
In relation to out-of-court bond restructurings, bondholders' committees have been occurring in recent years. The common motions in meetings for defaulted bonds include requiring the issuer to disclose related information and provide additional credit enhancement, or voting for the bond restructuring plan. However, resolution agreed by bondholders' committees carry little weight when it comes to enforcement. In some cases, investors receive only immaterial or even perfunctory responses from the issuers.
Among all the issuers who have defaulted on their publicly issued bonds, 35 bonds from 10 issuers have completed in-court bankruptcy reorganization. Although the number of completed cases is not large, we observe that the time taken for a default case to finish in-court restructuring has declined significantly from 2015 to 2019. That suggests improved efficiency of judicial reorganization for default cases and willingness of government to facilitate the defaulted resolution.
|Length Of In-Court Restructuring Process Has Declined|
|Year of first publicly issued bond defaults||Number of issuers with first-time default||Number of defaulted issuer that finished in-court restructuring||Average no. of days to finish in-court restructuring after default|
|Source: WIND, S&P Global Ratings.|
What can we expect on default resolution and recovery in China?
We believe recovery prospects could become more predictable in the future, if transparency of the workout regime continues to improve and the number of bankruptcy resolutions increases. With more default recovery cases, data will become statistically more representative for investors. In addition, we expect debt restructurings to become more efficient, particularly in the dispute resolution and litigation process. This could further shorten time to recovery.
These recent policy initiatives may lead to more debt restructurings. The government may take debt restructuring as a more socially cost-efficient resolution compared with bankruptcy liquidation or unconditional bailout in some cases. This would alleviate the debt burden on the issuer, keep the company afloat, maintain employment, and protect shareholders interests--at the cost of creditors. We expect the government to stay involved in debt restructurings and to seek a balance between stabilizing the economy and mitigating creditors' loss.
China regulators are encouraging more diversified default settlement approaches to improve the financial flexibility of highly indebted firms. This could lead to more defaults as borrowers and creditors restructure the borrowings, including by maturity extensions, off-the-market repayments, or bond exchange offers. These unconventional defaults (at least in the China capital market context) accounted for 15% of the total defaults in 2019. This proportion grew to 24% in the first half of 2020. However, in some cases, limited information disclosure impedes a better understanding of the issuer's credit condition. In our view, information transparency to all creditors and the market is crucial in preventing abuse of default settlement tools. We believe the regulator is likely to introduce more detailed and actionable regulations on this front to protect creditors' rights in order to draw more foreign investors to the onshore market.
- Link to the People's Bank of China, National Development and Reform Commission, and the China Securities Regulatory Commission joint notice: (http://www.gov.cn/zhengce/2020-07/02/content_5523472.htm)
- Link to the Supreme People's Court minutes: (http://www.court.gov.cn/zixun-xiangqing-241671.html).
This report does not constitute a rating action.
|China Country Specialist:||Chang Li, Beijing + 86 10 6569 2705;|
|Secondary Contacts:||Alex Yang, Hong Kong + 852 25333057;|
|Boyang Gao, Beijing (86) 10-6569-2725;|
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