March 7, 2014 7:58 am

China suffers first corporate bond default

©Reuters

China experienced its first domestic bond default in recent history on Friday after a small Shanghai-based solar power company failed to pay out interest on a security it sold two years ago.

Shanghai Chaori Solar said on Friday it had only managed to pay investors a tiny fraction of the Rmb89.8m ($14.6m) interest they are owed on their investment before a deadline of 3pm, when China’s domestic bond markets closed.

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“We were not able to deliver full interest payment by today but we will still try in the future to make payments [to investors],” Liu Tielong, board secretary for Chaori, told the Financial Times. He acknowledged that Chaori was now officially in default.

China has not seen a single outright default of a domestic corporate bond since it established a nascent bond market in the early 1990s.

The central bank introduced new rules and restrictions on the market in 1997 following a series of technical defaults on bonds issued by companies backed by local governments across the country that forced those governments to bail them out.

On Friday, Mr Liu said he was not aware of any plan from the Shanghai government to bail bond investors out, as it did a year ago when Chaori first threatened to default on its interest payments.

The company’s bonds were suspended from trading last July and equities suspended last month.

Three retailer holders of the Rmb1bn bond told the Financial Times on Friday that the company had paid them about 4.4 per cent of the interest owing to them on Thursday evening and they did not expect to receive any more.

Chaori said it was only able to pay investors Rmb4m of the Rmb89.9m interest they were owed by close of trade on Friday.

Some analysts have suggested Chaori’s default could be China’s “Bear Stearns moment” – an event that prompts investors to reassess the risks of investing in Chinese corporate debt and causes a run on the entire sector ending in a Lehman Brothers-like crash.

But Chinese bond traders said the market appeared calm and well-prepared for the Chaori announcement on Friday.

“There has been no panic in the domestic market because everyone has been expecting a default for some time,” said Ivan Chung, a credit officer at Moody’s in Hong Kong. “We can see that the spread between low quality and high quality bonds has been widening in recent months as the market imposes a risk premium on the poorer quality paper.”

China Securities, the underwriter of Chaori’s bond, is almost entirely owned by the central government so the decision not to bail out the bond has been interpreted by investors as a deliberate signal from Beijing.

Since taking control of the country a year ago, Chinese President Xi Jinping and Premier Li Keqiang have repeatedly pledged to allow market forces to play a greater role in China’s economy.

This bond failure is seen as a key element in their plan to build a more modern and sustainable financial system.

There are likely to be more defaults in the coming months as the leadership tries to gradually convince lenders and investors to better price risk in the domestic debt markets.

For most analysts the only surprise about Friday’s default was the timing.

The ruling Communist Party is half way through its 10-day annual parliamentary political pageant, which is usually a time when nothing is allowed to distract it from going through the motions of a consultative legislative process.

Additional reporting by Emma Dong

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