- China's rising corporate defaults are jolting the country's US$15 trillion bond market, but post-default resolutions in the country are improving.
- A series of high-profile defaults by state-owned enterprises are getting quicker judicial resolution, and more privately owned enterprises are likely to follow.
- We believe authorities want such cases to serve as examples. As more entities are allowed to default, investors will have more transparent and predictable means to recover their investments quickly.
Trialed in 1986, expanded in 1991, and updated in 2006, China's Enterprise Bankruptcy Law has only this year become important to international investors. The trigger: precedents set by landmark defaults involving U.S. dollar bonds, and growing recognition in the country that court action may be preferable to out-of-court negotiations that drag on for years.
S&P Global Ratings sees these cases as positive for China's credit markets. They raise transparency, facilitate resolutions, and make outcomes more predictable. We anticipate more such cases as defaults rise in China.
The highest-profile debt events this year shed light on what to expect on Chinese defaults. They establish a key template for debt workouts as China improves its restructuring, resolution, and recovery regimes. International investors will find these changes encouraging as more enter the country's bond market, the world's second largest with about US$15 trillion outstanding.
Why Post-Default Events Vary Widely
China's debt market is huge, but international investors only hold some 2.4% of the country's onshore bonds. This low participation, despite the opening of Bond Connect three years ago to encourage foreign buying, is partly due to high uncertainty and poor outcomes in default cases. The recovery process is slow and unpredictable. Transparency on debt resolutions would give international investors more confidence to enter this market.
Chinese defaults have had widely varying outcomes. This is not because the legal framework lacks specificity. Rather, creditors and officials have pushed for different options, often seeing bankruptcy courts as a last resort.
In our view, this is due to the limited experience of lenders and investors, given the short history of China's bankruptcy law and of defaults in the country's bond market, which saw its first case only five years ago.
Fear of a low recovery is also a likely cause, given courts that administer liquidations are not required to maximize the sale price of the assets to be liquidated. This motivates creditors to seek out-of-court settlements that they believe will provide a higher recovery.
Differences Arise Between State-Owned And Privately Owned Entities
State-owned enterprises (SOEs) appear to be adopting more structured debt workouts than privately owned enterprises (POEs).
This could be due to the example set by Peking University Founder Group Co. Ltd. (PUFG), China's biggest SOE defaulter. Investors are following the case closely, due to its ownership by China's oldest university and the direct involvement of central authorities (see "Landmark China Default Tests Two Popular Bond Structures," published Sept. 18, 2020, on RatingsDirect).
The People's Bank of China and the Ministry of Education are leading the restructuring. Investors believe the PUFG case will set a standard for legal claims on state-owned issuers after a default.
Just months after PUFG entered court-administered restructuring in February 2020, court actions emerged for other high-profile SOE cases, including Qinghai Provincial Investment Group Co. Ltd. (QPIG) and Tewoo Group Co. Ltd. (see table 1 in the Appendix).
By contrast, well-known POE cases such as China Minsheng Investment Group (CMIG) and Wintime Energy Co. Ltd. and its subsidiary Huachen Energy Co. Ltd. have seen little legal progress following their defaults two years ago (see table 2).
Mixed Messages Create Confusion
Defaults in China are typically--but not always--preceded by news of financial or operational distress. As many companies do not comment on such news, the situation can confuse investors, especially if positive developments are mixed in with negative headlines.
For example, PUFG issued a Chinese renminbi (RMB) 1.55 billion bond, then defaulted less than two months later. QPIG repaid a US$300 million bond in each of the two quarters prior to its default. Such actions may have assured investors, but the signals were ultimately misleading.
Wavering government support, typically in the absence of official statements, adds to the confusion for distressed SOEs. Reports that the state may step in with support might be denied soon after, as was the case for QPIG months before it defaulted.
Ambiguous Reporting Precedes Decisive Defaults
China has limited experience with bond defaults, which are often not reported as such in the media.
International investors view a failure to pay interest or principal on time and in full, or a distressed bond exchange, as a default. However, reporters in China often call these events delayed or partial payments, or agreements to defer or reduce payments.
The language is ambiguous, but the defaults that follow are not. For example, media reports on Tewoo noted discussions with creditors to "convert" short-term debt (below one year) to something longer term. Three months later, the entity simply defaulted.
Asset Freezes Signal Start of Legal Actions
After the first default event, creditors often apply to local courts to freeze the assets of the debtor.
In Wintime's case, the court froze assets a day after the first default event, while PUFG took four days, and CMIG took a month. These actions were meant to secure the collateral underlying the debt, and they signaled the start of legal actions.
Delayed Payments Are Not A Path To Resolution
Defaulted companies in China sometimes make partial payments on interest or principal after a default. This may happen a few days (in the case of QPIG), a few months (CMIG), or a year (Wintime) after the initial default (see table 2).
While this reflects a willingness to pay, the issuer's inability to pay soon catches up with it. In no case have we seen issuers fully repay bondholders in this way without an organized legal or out-of-court process to restructure the defaulted bond. We see these payments as moderately positive, but not indicative of a path to resolution.
From a rating perspective, any reduced or delayed payments beyond those allowed by the terms of the bond, such as any grace period, constitutes a default.
Creditors' Meetings First Step In Engagement
The first out-of-court creditor or bondholder meetings are typically held within three weeks to three months of the first default event. In cases of extended inaction by stakeholders, such as QPIG, it may take a year or more for the first meeting to occur (see table 2).
These meetings are the first steps in engaging creditors to reach resolution. The meetings may be held to give notice to investors of an issuer's inability to pay, or to seek agreement to extend the date or reduce the amount of upcoming interest or principal payments (see the examples of PUFG and CMIG in tables 1 and 3).
It is important to monitor the developments of all creditor meetings. In out-of-court processes, the two creditor groups--bank lenders and bondholders--typically meet separately and do not coordinate demands. As the two groups' interests may not be aligned, outcomes for one may be negative for the other.
Distressed Tenders Equivalent To Default
An important development is distressed SOEs' increased use of tender offers, or offers to buy back outstanding bonds at discounted prices to reduce their debt burdens. Such offers are typically made months before the first default event, but sometimes months after (Tewoo). In extreme cases, the tender offer may come up to a year after the default (QPIG).
Tender offers after defaults tend to be at steep discounts that reflect the bonds' traded prices rather than the issuers' ability to pay. Tewoo's tender prices ranged from 30-60 cents on the dollar; QPIG offered 30-40 cents. The offers were largely in line with the traded levels of their bonds at that time (see table 1).
Such tenders are typically bad for investors. After a default, issuer transparency and bond liquidity are often low to nil. This may translate into punishing discounts on the bonds' traded price. The issuer's ability to repay the bonds may be substantially better than what the bond price indicates, as a result.
When an issuer is in distress, we see tenders or other forms of payment delays or reductions outside the terms of bonds to be equivalent to defaults. This is irrespective of creditors' willingness to accept the tender terms. The event constitutes a default even if an issuer has not defaulted outright on interest or principal due (see "Rating Implications Of Exchange Offers And Similar Restructurings," published May 12, 2009).
The Petition That Kickstarts The Court Process
While out-of-court processes vary widely in events and timeframes (see tables 2 and 3), in-court processes are well structured. The bankruptcy law is specific on the set of actions to take in a resolution proceeding, which typically starts with a petition for a court-administered reorganization (see table 4).
The petition is filed by a creditor against a debtor with the relevant local court. The court will decide to accept or reject the case within 15 days of the filing. It will serve notice within five days of reaching its decision, and will appoint an administrator on acceptance.
Under the regime, the debtor has to report to the court its assets and liabilities within 15 days of the notice, and the creditors need to file their debt claims within three months from the date of acceptance.
Acceptance or rejection of the claims provides the first indication of the scope of potential recovery from the court process. Rejection of overseas bondholders' claims could leave them at the end of the queue, receiving little to no value from the restructuring or the liquidation. PUFG's keepwell claims were an example, where news of the rejection immediately and severely hit the affected bonds.
The path to resolution: What investors can expect
This year's high-profile debt resolution cases were significant in that they encouraged the adoption of the more transparent legal process. Yet, none of these have reached full resolution. What comes next will follow the steps laid out in the bankruptcy law (see table 4).
The reorganization plan, which marks the tail end of the court process, needs to be filed by the debtor or administrator within six months of acceptance of the petition.
The court will call a creditors' meeting to approve the plan within 30 days of receipt. If the plan is not approved, the court can end the proceedings and declare the debtor insolvent.
The declaration of insolvency will be followed by the liquidation of the debtor's assets, for which the administrators will formulate a plan "quickly" and execute it in a "timely" fashion.
Completion of either the reorganization plan or the liquidation plan marks the end of the court process, and resolution. The entire process could take one to two years, which is comparable to international standards, and significantly faster than most previous Chinese restructurings.
These and other less well-known cases show that out-of-court processes create much of the uncertainty about debt resolution in China. Cases can remain in limbo for years as these processes drag on.
More Cases Will Bring Better Practices
We believe the need for resolution, particularly in the state sector, will motivate issuers and investors to adopt in-court processes laid out by the bankruptcy law.
As such cases cumulate, better practices are likely to emerge in China's domestic and international bond markets. SOEs are increasingly choosing the structured in-court approach, and we anticipate more POEs to follow.
This will provide more predictability in resolutions, and is clearly good for investors at home and abroad. To the extent it builds confidence and stimulates liquidity for China's bond markets, it will be good for issuers too.
|Key Events Before And After Default For State-Owned Enterprises--Select Cases In 2020|
|Peking University Founder Group Co. Ltd. (PUFG)|
|Oct. 10, 2019||(53)||Issued: RMB1.55 billion two-year domestic bonds at 6.5%|
|Dec. 2, 2019||0||Default: failed to repay RMB2 billion onshore commercial paper due Dec. 2, 2019 (RMB19s)|
|Dec. 6, 2019||4||Freeze: court froze shareholdings in two key subsidiaries|
|Dec. 20, 2019||18||Meeting: with holders of RMB19s, agreed to extend to Feb. 21, 2020|
|Dec. 26, 2019||24||Freeze: by court on more shares in two key subsidiaries|
|Feb. 14, 2020||74||Petition: lender Bank of Beijing Co. Ltd. filed reorganization petition to Beijing court|
|Feb. 19, 2020||79||Petition: accepted by court.|
|Feb. 19, 2020||79||Administrator: appointed by court, includes PBOC, Ministry of Education, other regulators|
|Feb. 21, 2020||81||Default: failed to repay RMB19s and coupon of US$310 million FRNs, triggered cross-default|
|Feb. 21, 2020||81||Claims: called for creditors of the group to file claims to the administrators|
|Feb. 21, 2020||81||Suspension: trading of U.S. dollar bonds suspended on HKEX from Feb. 21, 2020|
|Apr. 14, 2020||134||Default: PUFG said it was not able to pay any interest or principal on debt due to restructuring|
|Apr. 20, 2020||140||Investors: administrators began soliciting strategic investor to join the restructuring|
|Apr. 21, 2020||141||Claims: deadline for creditors to file claims to the administrators|
|Apr. 30, 2020||150||Meeting: of bondholders held for the first time|
|July 31, 2020||242||Restructure: four key subsidiaries lined up for merging|
|Aug. 3, 2020||245||Claims: calls for creditors of key subsidiaries to file claims to the administrators|
|Aug. 19, 2020||261||Claims: administrators rejected claims of keepwell bonds on onshore group parent|
|Qinghai Provincial Investment Group Co. Ltd. (QPIG)|
|Sep. 14, 2018||(161)||No support: Qinghai government denied press reports it would take over QPIG|
|Sep. 26, 2018||(149)||Payment: repaid its US$300 million bonds due Sept. 26, 2018|
|Dec. 11, 2018||(73)||Payment: repaid its US$300 million bonds due Dec. 11, 2018|
|Feb. 22, 2019||0||Default: on coupon of US$300 million bond due Feb. 22, 2020 (USD20s), paid on Feb. 28, 2020|
|Feb. 24, 2019||2||Late payment: failed to pay RMB21 million bonds due Feb. 24, 2019, paid on Feb. 25, 2019|
|Mar. 6, 2019||12||Cross-default: said late payment of USD20s coupon triggered cross-default|
|Aug. 22, 2019||181||Default: on coupon of USD20s due Aug. 22, 2019, paid on Aug. 29, 2019|
|Sep. 4, 2019||194||Suspension: requested trading suspension of its bonds on HKEX|
|Jan. 10, 2020||322||Default: on coupon of US$300m bonds due July 10, 2021, triggering cross-default|
|Jan. 13, 2020||325||Meeting: with bondholders, QPIG said it could not pay USD 7/21s' coupon|
|Feb. 5, 2020||348||Tender: offer for USD20s at 41.19, USD 7/21s and US$250 million bond due March 22, 2021 at 36.7|
|Feb. 7, 2020||350||Meeting: with bondholders on tender offer, which ended abruptly amid complaints, according to press reports|
|Feb. 19, 2020||362||Tender: accepted by 56% of 20s holders, 33% of 3/21s, 69% of 7/21s|
|Feb. 21, 2020||364||Default: QPIG said it could not repay USD20s on Feb. 22, 2020, triggering cross-default|
|Mar. 22, 2020||394||Default: on coupon of USD 3/21s, triggering cross-default|
|June 19, 2020||483||Petition: Xining Intermediate People's Court accepted reorganization petition|
|July 10, 2020||504||Investors: administrators began soliciting strategic investors to join the restructuring|
|Aug. 28, 2020||553||Committee: of creditors met for first time to vote on asset sales|
|Tewoo Group Co. Ltd. (Tewoo)|
|Apr. 3, 2019||(113)||Extension: met with major lenders to extend short-term (below one year) loans|
|July 1, 2019||(24)||Default: a subsidiary failed to pay interest due June 21, 2019 on a bond|
|July 6, 2019||(19)||Committee: set up committee of creditors, local media reported|
|July 25, 2019||0||Default: on coupon of a bond (18 Haotong 01) issued by a subsidiary.|
|Oct. 21, 2019||88||Claims: creditor committee asked financial institutions to file their debt claims|
|Nov. 19, 2019||117||SBLC: coupon on 3.15% bonds due Dec. 1, 2020 (SBLC 20s) paid by SBLC provider ICBC|
|Nov. 22, 2019||120||Tender: offer to buy back 19s/20s/22s/perpetuals at 67/57/53/36, or exchange for 24s/26s/29s/39s|
|Dec. 11, 2019||139||Tender: results show of US$1.25 billion bonds offered, 57% tendered, 27% exchanged|
|June 1, 2020||312||SBLC: 20s coupon paid by SBLC provider ICBC|
|July 31, 2020||372||Court: Tianjin People's High Court accepted reorganization petition filed by onshore creditors|
|Aug. 5, 2020||377||Court: appointed liquidation committee as administrator, called the first creditor meeting|
|Oct. 12, 2020||445||Meeting: of creditors held for the first time|
|Sep. 16, 2020||419||SBLC: trustee of SBLC 20s demanded repayment by SBLC provider ICBC|
|Sep. 24, 2020||427||SBLC: provider ICBC repaid SBLC 20s in full|
|Note: Numbers in parenthesis mark number of days before default. RMB--Chinese renminbi. PBOC--People's Bank of China. SBLC--Standby letter of credit. FRN--Floating-rate note. HKEX--Hong Kong Exchanges and Clearing Ltd. ICBC--Industrial and Commercial Bank of China Ltd. Sources: Company filings, reports, media releases, S&P Global Ratings.|
|Key Events After Default For Select State-Owned And Privately Owned Enterprises|
|First default date||Court asset freeze||Late bond payment||First creditor meeting||First bondholder meeting||Offer to extend or tender bond||Court accepts reorganization petition||Debt claim to court||First court creditor meeting||Court accepts or rejects claim|
|PUFG||Dec. 2, 2019||4||18||18||79||81||150||261|
|QPIG||Feb. 22, 2019||2||325||348||483||553|
|Tewoo||July 25, 2019||88||120||372||445|
|CMIG||Jan. 29, 2019||31||170||57||175|
|Wintime||July 5, 2018||1||49||12||263||813||813||866||866|
|PUFG--Peking University Founder Group Co. Ltd. QPIG--Qinghai Provincial Investment Group Co. Ltd. Tewoo--Tewoo Group Co. Ltd. CMIG--China Minsheng Investment Group. Wintime--Wintime Energy Co. Ltd. Sources: Company filings, reports, media releases, S&P Global Ratings.|
|Key Events Before And After Default For Privately Owned Enterprises--Select Cases In 2020|
|China Minsheng Investment Group (CMIG)|
|Jan. 29, 2019||0||Default: failed to repay RMB3 billion 5.2% bonds due 1/29/19 (RMB19s)|
|Feb. 14, 2019||16||Suspension: issuer requested trading suspension of its U.S. dollar bonds on HKEX|
|March 1, 2019||31||Freeze: court froze RMB15 billion of assets between March 2019 and April 2019|
|March 27, 2019||57||Committee: of creditors chaired by Chexim formed to overseas asset disposals|
|April 8, 2019||69||Default: (a) failed to pay RMB904 million on bond due April 8, 2019, extended to April 19, 2019|
|April 16, 2019||77||Warning: CMIG said may be unable to pay RMB1.57 billion bond due April 21, 2019|
|April 18, 2019||79||Default: (b) Postal Savings Bank and Bank of Dalian demanded immediate payment of loans|
|April 18, 2019||79||Cross-default: triggered by (a) and (b) on US$500 million bonds due Aug. 2, 2019 (USD19s)|
|June 13, 2019||135||SBLC: trustee of US$300 million 3.25% SBLC bonds due 2020 (USD20s) demanded repayment|
|June 14, 2019||136||SBLC: trustee demanded repayment by USD20s' SBLC provider, CCB|
|June 18, 2019||140||SBLC: provider CCB repaid USD20s in full|
|July 18, 2019||170||Default: only partially repaid its RMB1.46 billion 6.5% commercial paper|
|July 23, 2019||175||Extension: solicited from bondholders to extend USD19s due date to Aug. 2, 2020|
|Aug. 22, 2019||205||Meeting: of bondholders agreed to extend USD19s due date to Aug. 2, 2020|
|Aug. 26, 2019||209||Default: partially paid RMB800 million bond due Aug. 26, 2019, paid the rest on Aug. 29, 2019|
|July 24, 2020||542||Extension: solicited from bondholders to extend USD19s due date to Aug. 2, 2021|
|Sept. 10, 2020||590||Meeting: of bondholders, who agreed to extend USD19s due date to Aug. 2, 2021|
|Wintime Energy Co. Ltd. (Wintime)|
|July 5, 2018||0||Default: on a loan and a RMB1.5 billion bond, triggered cross-default on 14 onshore bonds|
|July 6, 2018||1||Freeze: Wintime said its holding of 32% stake in Wintime Energy Co. Ltd. was frozen|
|July 17, 2018||12||Meetings: held with holders of 15 defaulted onshore bonds every one to two months|
|Aug. 23, 2018||49||Committee: of creditors set up, included CBIRC, PBOC, CSRC, 70-plus financial institutions, and representatives from the Shanxi, Henan, and Suzhou governments|
|Aug. 23, 2018||49||Investor: signed strategic agreement with Beijing Energy Holding Co. Ltd. (BEHC) on investment, asset injection, and reorganization|
|Nov. 7, 2018||125||Default: Huachen Energy Co. Ltd., a subsidiary with a U.S. dollar bond outstanding, defaulted on a RMB48 million loan|
|Nov. 30, 2018||148||Investor: Wintime said BEHC completed due diligence and was developing a reorganization plan|
|25-Mar-19||263||Restructure: payment plan agreed with holders of a RMB bond, two more were later restructured|
|June 17, 2019||347||Late payment: Huachen paid the coupon on its US$500m bond due 2020 (US$20s) a month late|
|July 19, 2019||379||Committee: of creditors held a meeting and agreed to the preliminary restructuring plan|
|Aug. 15, 2019||406||Investor: strategic agreement with BEHC, valid for one year, expired with no investment|
|Nov. 18, 2019||501||Default: Huachen failed to pay USD20s' coupon, did not pay later within the grace period|
|Dec. 7, 2019||520||Default: Huachen failed to pay the principal and coupon of an onshore bond|
|Jan. 2, 2020||546||Committee: Had another meeting and made some improvement on the restructuring plan|
|Jan. 22, 2020||566||Acceleration: holders of more than 25% of the USD20s demanded immediate payment|
|Apr. 21, 2020||656||Restructure: Huachen appointed PWC as restructuring adviser on the USD20s|
|Aug. 6, 2020||763||Court: a creditor filed a reorganization petition to the court in Jinzhong, Shanxi Province|
|Sept. 25, 2020||813||Court: the reorganization petition was accepted by the court|
|Sept. 25, 2020||813||Claims: called for creditors of the group to file claims to the administrators|
|Nov. 17, 2020||866||Meeting: of creditors held for the first time.|
|RMB--Chinese renminbi. SBLC--Standby letter of credit. Chexim--The Export–Import Bank of China. USD—U.S. dollar. CCB--China Construction Bank Corp. HKEX--Hong Kong Exchanges and Clearing Ltd. ICBC--Industrial and Commercial Bank of China Ltd. CBIRC--China Banking and Insurance Regulatory Commission. PBOC--People's Bank of China. CSRC--China Securities Regulatory Commission. PWC--PricewaterhouseCoopers. Sources: Company filings, reports, media releases, S&P Global Ratings.|
|Key Events Under The China Enterprise Bankruptcy Law|
|Filing||0||Creditors submit a reorganization petition on the filing date (Filing)|
|Confirmation||5||Court to confirm receipt of the petition (Confirmation) within five days of Filing|
|Objection||12||Opposition to the petition by any creditor to be filed within seven days of Confirmation|
|Decision||15||Within 15 days of Filing, court to decide (Decision) to accept (Acceptance) or reject (Rejection)|
|Administrator||15||Court to appoint an administrator upon Acceptance of the petition|
|Acceptance||30||Court can extend the period for making the Decision by 15 days, given approval by a higher court|
|Administrator||30||Court to serve notice to creditors (Notice) within five days of reaching the Decision|
|Objection||45||Objection to the Rejection to be appealed to a higher court within 10 days of receiving the Notice|
|Reporting||50||Debtor to report to the court its assets and liabilities within 15 days of the Notice|
|Claims||120||Court to set debt claims filing deadine, to be within 30 days to three months of Acceptance|
|Plan||210||Debtor/administrator to file reorganization plan (Plan) to the court within six months of Acceptance|
|Extension||300||Court may extend the Plan filing deadline by three more months after the six-month limit|
|Meeting||330||Court to call a creditors' meeting (Meeting) within 30 days on receiving the Plan|
|Approval||360||Administrator can ask the court to approve the Plan in 30 days if it's not approved at the Meeting|
|Insolvency||360||If the court does not approve the Plan, it can terminate the case and declare the debtor insolvent|
|Notice||370||Court to notify debtor within five days, and creditors within 10 days, of declaring insolvency|
|Liquidate||550||Administrator to "quickly" plan "timely" liquidation, which may mean six months from notice of Insolvency|
|Sources: China Enterprise Bankruptcy Law, S&P Global Ratings.|
- Landmark China Default Tests Two Popular Bond Structures, Sept. 18, 2020
- Peking University Ruling Raises Refinancing Risk On US$93 Billion Of Keepwell Bonds, Sept. 2, 2020
- Rating Implications Of Exchange Offers And Similar Restructurings, May 12, 2009
- Rating Government-Related Entities: Methodology And Assumptions, March 26, 2015
This report does not constitute a rating action.
|China Country Lead:||Charles Chang, China Country Lead, Hong Kong + 852-2912-3028;|
|Secondary Contacts:||Boyang Gao, Beijing + 86 (010) 65692725;|
|Chang Li, Beijing + 86 10 6569 2705;|
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