August has rolled around and there’s still no official word if China Huarong Asset Management will release its 2020 financial results.
Investors already living on a knife-edge in the past few months with the bloodshed in the Chinese bond and equity markets, may just suffer a complete meltdown if Huarong fails to deliver its results by 31 August 2021 (as stipulated in its bond terms) and enters a technical default.
Huarong, the biggest of the Big Four state-owned distressed asset management companies that Beijing had established to manage the bad debts of Chinese state-owned banks, has been hit with a spate of news highlighting its precarious financial position.
A default by Huarong will be the clearest indication yet that the Chinese government will no longer backstop state-owned companies that were once considered “too big to fail”.
Without the safety net of government support, the Chinese markets may just go into free-fall.
Analysts still believe the Chinese government will not allow Huarong to fail, though the same cannot be said for other companies.
“A Huarong bankruptcy will have very bad implications because it is directly owned by the Ministry of Finance,” a Western investment banking source said. “If Huarong defaults, people will think the Chinese government will not honour its debt.”
And that could spark a major crisis. As institutional investors mark down the value of Chinese bonds and equities, retail investors will also lose their life savings in a market rout.
Hence, the Chinese government is trying to insulate Huarong from the rest of the market, the source believes, adding though that it will be wary of creating a moral hazard that financial institutions will be bailed out.
The central Chinese government likes to allow near defaults as a warning to investors, and prefers not to be responsible for debt workouts, Andrew Collier, managing director of Orient Capital Research, a Hong Kong firm which conducts research on economy and finance in China, wrote in a 30 April 2021 report for GlobalSource Partners.
Nonetheless, it is unlikely the government will allow Huarong to fail, Collier said.
“A bankruptcy for Huarong would also be embarrassing for the government since it is a large company centrally owned and it was established precisely for the purpose of arranging debt workouts — and yet it would be subject to a debt workout itself.”
Not Out Of The Woods Even With No Default
So far, Huarong has not defaulted on any of its payments.
It also announced plans to exit its non-core businesses in accordance with the regulatory requirements on financial asset management companies.
Huarong said on 2 August 2021 that it will offload its 70% stake in Huarong Consumer Finance, and also negotiate a “debt-to-equity swap and equity transfer” of Huarong Trust.
Although Huarong is expected to survive, it’s not out of the woods, and its bonds and equities will come under continued selling pressure.
Huarong’s stock was kicked out of FTSE Russell indices and dropped from global index compiler MSCI in June 2021.
Trading in the Hong Kong shares of Huarong has been halted since 1 April 2021 after it failed to release its 2020 annual results, which triggered an MSCI rule that a stock will be expelled if its trading suspension lasts 50 consecutive days.
Huarong’s removal from MSCI will lead to portfolio adjustments by global funds managing USD210 billion that track the MSCI gauges. If international institutional investors track MSCI indices, they will have to sell their holdings in Huarong bonds and equities, said the Western investment banking source.
A major root of Huarong’s debt woes dates back several years ago when Lai Xiaomin was chairman of the company.
Prior to 2018, Huarong pursued an aggressive lending and investment strategy, and a large proportion of these investments were in illiquid and non-transparent assets, noted a Moody’s report on April 30.
Headquartered in Beijing, Huarong reported consolidated assets of CNY1.73 trillion (USD267 billion) as of 30 June 2020.
On 18 April 2018, the Central Commission for Discipline Inspection, a Chinese anti-graft agency, announced that Lai was detained because of serious personal misconduct.
Lai was executed on 29 January 2021.
“To let Huarong get into serious financial trouble because of mismanagement and corruption reflects badly on the Chinese government’s supervision and governance of its entities,” said the Western investment banking source.
Beijing will not let Huarong fail. But the same can’t be said of the likes of others such as China Evergrande Group, which is another story in itself.
Toh Han Shih is a chief analyst of Headland Intelligence, a Hong Kong risk consultancy. Based in Hong Kong, he was previously a business reporter focusing on China for more than 10 years.