Expect more forgeries, fakes in China debt mart amid bond rout
FORGED seals, fake letters, and counterfeit documents. They’re all part of China’s recent spate of fraud coming to light in the country’s US$ 3 trillion ( RM14 trillion) corporate debt market amid a rout that has analysts predicting a record number of defaults in 2017.
As it becomes harder for Chinese companies to issue new notes to repay maturing debt, expect more scandals to come – and to worsen the bond market’s already-precipitous downturn.
“We expect to see more of this type of behaviour given the increasingly problematic environment for refinancing in the domestic bond market,” said Charles Macgregor, head of emerging markets at Lucror Analytics in Singapore.
“Unfortunately, these frauds may be difficult to detect, as documentation and seals may appear authentic given collusion between various parties.”
A survey by Ernst & Young last year found that 56 per cent of Chinese executives polled said that unethical behaviour, including misstating financial performance, could be justified to help a company survive a downturn, compared with 36 per cent globally. “When there’s economic uncertainty, when there’s pressure on results, sometimes management can be induced or can sometimes naively get into a situation where they believe that they can act in a way, they rationalise the way, that essentially could be unethical,” said Chris Fordham, Hong Kong-based managing partner with Ernst & Young’s fraud investigation and dispute services in Asia.
“But they rationalise it, that they’re doing it for the good of the business, for the survival of the company.”
Within two weeks in December, two fraud cases emerged that shook the bond market by threatening to undermine confidence in the ability to collect on the enormous amount of credit that’s built up in the nation. China Guangfa Bank Co. said documents and seals in its name had been forged for use on a letter to guarantee bond payments. Separately, Sealand Securities Co. said former employees conducted as much as 16.5 billion yuan ( RM11 billion) of bond trading with a forged official seal, or chop.
The alleged forged stamps at Sealand, which it has said are being investigated by the police, were on so- called entrusted holdings, a widely used tool to boost leverage in China’s debt market. Under such structures, investors legally skirt rules by entrusting their note holdings to a third party and agreeing to buy them back later. That frees up funds on their books that they can use to purchase more bonds.
While China is no stranger to fraud, the scandals hitting the bond market prompted an escalation in counter-party risks, discouraged financial institutions from trading with each other and dried up liquidity.
Chinese firms may have trouble selling notes in 2017 to repay maturing debt, and that could spark more defaults, according to Moody’s Investors Service. At least 117.5 billion yuan of bond sales were canceled or postponed in December, almost quadruple the amount in November, according to data compiled by Bloomberg.
The number of onshore bond defaults in 2017 may exceed last year’s level, according to 75 out of 100 analysts and traders who took part in a Bloomberg survey in December. At least 29 notes defaulted in 2016, compared with seven in 2015.
We expect to see more of this type of behaviour given the increasingly problematic environment for refinancing in the domestic bond market.
S& P said in a Dec 12 report that inadequate risk management and transaction and settlement issues could escalate and hurt market confidence as China’s economy slows and markets experience volatility.
“As the economic slowdown continues, we will see more and more naked swimmers,” said Zhu Ning, deputy director of the National Institute of Financial Research at Tsinghua University in Beijing.
“We won’t see systemic risks in the immediate term, but if the government doesn’t rein in wrongdoing, risks will escalate.”
China’s policy makers vowed to make preventing financial risks a top priority this year and set the tone for tighter monetary policy, mentioning the term “liquidity gate” which has historically been associated with sharp bond market sell- offs.
The previous two times the term was mentioned, in December 2010 and May 2013, bond yields surged by 27 basis points and 128 basis points in the next three months and six months respectively, according to Citigroup. — WP-Bloomberg
Charles Macgregor, head of emerging markets at Lucror Analytics in Singapore