Chinese real estate companies this month reentered
the high-yield space. But bankers and lawyers have warned there
are significant risks in the structuring of Chinese offshore
Although Chinese real estate companies have
actively participated in the high-yield bond market –
with a $1 billion Regulation S offering by SOHO China this week
– their structures offer little recourse to offshore
investors in the event of a default.
Speaking at a high-yield conference co-sponsored by
Latham & Watkins and the Asia Securities Industry &
Financial Markets Association (Asifma), market participants
warned that the subordinated structuring of these instruments
meant that they are equities and that they carry enormous
A senior lawyer at a Chinese law firm made it clear
that these high-yield bonds are not Chinese bonds but rather
British Virgin Island (BVI) or Cayman Island bonds –
offshore jurisdiction bonds that then invest in the equity of
the Chinese company. This means the bond investors are in a structurally subordinated
"I believe the Chinese government knows this and is
fine because it isn’t interested in the moral
obligation that might be attached to foreign debt," he
Offshore holders only have stakes in the offshore
holding company or special purpose vehicle. They do not have
any security over the Chinese company’s underlying
assets. Therefore they are subordinated to onshore creditors,
and have few legal options if the company defaults.
There have been examples of disastrous defaults in
the last few years but few situations in which offshore holders
have had recourse.
"This is a stupid financial instrument from a
credit point of view and to some extent is like the structured
credit products which were at the heart of the global financial
crisis," the panelist commented.
The abysmal recovery rate from these instruments is
a significant concern.
"I leave it to you to decide what you think, but
keep in mind that out of 110 issues in the offshore Chinese
bond market, eight have already defaulted, which gives you a 4%
default rate and only a 7% average recovery rate," he said.
Moreover panelists noted that it is in an
issuer’s interest to immediately default on an
instrument. Although it makes financial sense, it is unlikely
because legitimate real estate markets need capital on an
ongoing basis; a default would mean that the company would be
unable to access the capital markets. It could also affect an
issuer’s listed company if listed in Hong
But there are precedents for multiple defaults.
The panelist observed that in the Asian financial
crisis in 1997-98, there was a string of so-called strategic
defaults by companies in Southeast Asia. These were defaults by
companies that didn’t have to default but chose to
default – often because their peers were
He predicted that this could be the same in China
as bank lending becomes more complicated.
But another panelist said that Chinese companies
might be unfairly targeted because of Muddy Waters and other
groups. "It is unfair to attack all Chinese issuers when
Indonesian corporate governance is also a concern," he
For more on Asia’s capital markets,
please attend IFLR’s Asia Capital Markets Forum on
Thursday, 15 November at the JW Marriott Hotel. More
information can be found here: http://www.iflr.com/ACM2012
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