Author: Blue Fire AI – bluefireai.com
As foreign investors sail into China’s stock and bondmarkets, 2020 marked the edge of the map. Safeguards and backstops long taken for granted may no longer exist, and the market offers just as much danger as it does opportunity. Those investing in China will know corporate scandal and collapse are not new.
Those investing in China will know corporate scandal and collapse are not new. Take, for example, Kangmei Pharmaceutical. One of 2019’s highest-profile cases, it was able to survive a $12bn accounting fraud through a combination of three factors: government support; lenient regulators; and a forgiving market.
The company was able to retire debt rather than defaulting (thanks to government pressure on its creditors), was hit with a negligible fine ($84,000) and though the shareprice is down 92% from the peak, it remains listed.
To many, Kangmei represents about the worst case scenario. But if 2020 was anything to go by, there may be much worse to come.
SOE defaults: A worrying new phase
2020 marked a significant change on multiple fronts. The first: a wave of defaults among China’s state-owned enterprises (SOEs). These companies, previously thought to be backstopped by the government, made up about 35% of China’s 2020 defaults and Q4 in particular brought some high-profile shocks including Yoncheng Coal, Tsinghua Unigroup, Huachen Auto – the parent company of BMW’s China partner Brilliance Auto, and Shandong Ruyi – the so-called ‘LVMH of China’.
Bank breakdowns: Another cause for concern
Another major event was China’s first commercial bank bankruptcy since 2001: Baoshang Bank. The collapse has since triggered a huge – if quiet – reckoning within China’s SME bank sector, with a wave of mergers taking place and more ‘encouraged’ by the state: perhaps to help dilute bad loans as much as twice their publicly stated amount and stave off further collapses.
Exchange delistings at a record pace
While the headlines have focused heavily on US moves to delist Chinese companies, it’s also worth noting that the Chinese themselves have been busy delisting names: 16 delistings on local Chinese stock exchanges last year represents the highest number since 1999.
Ratings agencies under pressure
As if all this weren’t depressing enough, recent weeks have seen fines, suspensions and investigations hitting China’s largest ratings agencies: most notably Golden Credit, related to the Shandong Ruyi’s defaults, and China Chengxin, who rated Yongcheng Coal AAA at the time of default.
With 98% of all outstanding credit issuers in China rated AA or above, there has long existed a cosy supportive relationship between China’s corporates and ratings agencies but even this now looks to be changing.
China Inc. won’t protect your portfolio
If there is one clear message from 2020, it is that you cannot rely on China Inc. to cover your back as they have in the past.
Exchanges are willing to delist your stocks. Agencies may have to downgrade them. Cheap funding from banks may be less freely available than it was in the past.
Local governments don’t have the budget to bail out your holdings, and most importantly of all, the central government may not want them to.
As seen recently with the delay in Ant Group’s high-profile IPO, China is not the US. Their strategic priority is not to reward market participants at all costs, and it is clear the moral hazard underpinning many investors’ China portfolios is set to be challenged.
Investors will need to chart their own course
In an environment such as this, investors will need to find a new way to avoid pitfalls in their China portfolios.
Sell-side research and financial media does not exist for China the way they do for more mature capital markets, and due to this immaturity (capital markets have only been open for 20-30 years) the transmission of information is light-years away from what it is in the West.
In addition, supply of experienced investment talent is a huge limiting factor for anyone operating in China.
For a small minority – those with the right expertise, people and tools – this creates an incredible opportunity.
For everyone else, the coming year marks a voyage into the unknown.
Doug Reay is managing director of Blue Fire AI