Huarong’s woes are a warning to lazy investors
Irreverent foreign analysts have dubbed him “Hua-Wrong.” But the problems plaguing China Huarong Asset Management, the country’s largest troubled debt investor, are deadly serious.
Its former chairman Lai Xiaomin was executed for corruption in January, he has not been able to file his financial statements since March, his Hong Kong-listed stocks are suspended, and some of his perpetual bonds are trading below 65 cents. per dollar.
Huarong insists he can make payments on debt and says the delayed accounts will allow him to complete a still mysterious “transaction”. But the company’s woes pose a difficult problem for Beijing’s efforts to reduce risk in its financial markets and serve as a warning to those who pour money indiscriminately into Chinese companies.
One of the four “bad banks” created in 1999 to manage distressed loans accumulated by major lenders, Huarong remains majority-owned by the Ministry of Finance, although it has spread to everything from brokerage to private equity in through shadow banking. Its $ 22 billion dollar-denominated bond is very popular with blue-chip foreign investors who thought its size and official ties amounted to a government safety net.
Lai’s arrest in 2018 called into question the underlying value of Huarong’s assets, and no one knows whether the central government is still ready to back it up. After all, Beijing has spent five years trying to reduce corporate debt and allowed a series of state-owned companies to default on their debt. But few are as large or systemic as Huarong, with assets worth 1.7 billion rmb ($ 260 billion).
“This is the quintessential test of Beijing’s willingness to impose market discipline on the financial sector,” said Curtis Milhaupt, professor at Stanford Law School who studies Chinese corporate governance. “I don’t think they can let Huarong down. . . but maybe they’ll impose haircuts on bondholders and equity. Fears that government support might not materialize or be limited to domestic investors led Fitch and Moody’s to lower Huarong’s credit rating.
So far, the impact on the wider Chinese market has been relatively small. But the saga suggests that Beijing is seriously considering forcing investors to pay more attention to the actual holdings and financial strength of the companies they support, even if that means some companies fail.
“The government is doing this because it realizes it. . . to grow effectively, you have to allow the market to do so. . . allocate capital to more deserving companies, ”says Charles Chang of S&P Global.
Financial services companies and foreign investors are eager to participate. China’s size, rapid wealth creation and rapid resumption of the pandemic make it one of the most attractive markets in the world, despite growing political tensions with the West.
However, there are pitfalls ahead. Many Chinese companies are difficult to assess. Their accounts are often published only in Chinese, and many do not include the metrics most commonly used by international analysts.
National rating agencies tend to be extremely generous: more than 80% of non-financial issuers are rated AA twice, according to S&P. And the quality of Chinese auditors has come under scrutiny in the United States, which is poised to kick foreign companies from its stock exchanges unless they allow U.S. regulators to review their financial audits. The past scandals at Luckin Coffee, Kangde Xin and Sino-Forest clearly show that the risks are not just theoretical.
Beijing is sending signals that it means business. Last year, Liu He, Chinese vice premier, warned that there would be “zero tolerance” for corporate malpractice, and regulators are urging underwriters, national rating agencies and auditors to disclose the results. risks more quickly.
China’s shift from state support to disciplined debt markets is unlikely to be smooth. “Mature” Western markets have taken generations and multiple regulatory cycles to achieve current levels of transparency, and consumer advocates argue that these are insufficient. Even U.S. and European governments balk at systemic failures, as the 2008-9 bailouts of General Motors and AIG, the Greek debt crisis and the massive central bank interventions last year show. Beijing will be tempted to pass all or most of the losses back to foreign investors, even if this could discourage capital inflows.
This is why the fate of Huarong arouses such great interest. The state’s next move will shed more light on the black box surrounding so much Chinese investment.
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