Despite US$290b in the works, China's debt-to-equity swaps underperforming, S&P says

Business | 30 May 2019 8:54 pm

China's debt-for-equity swap program has underperformed in the three years since its launch, Standard & Poor's says.

Even with US$290 billion of swaps in the works, the structure of China's market has worked against swaps, according to an S&P Global Ratings report, titled, Is China's Debt-for-Equity Swap Working? A Reality Check At Year Three.

Beijing wants groups to use such swaps to deleverage, to tackle the US$15.7 trillion in corporate debt racked up in the country.

As most swaps investors are state-owned banks and their asset management arms, big-four asset-management companies, and government-initiated funds, their risk appetite skews more toward fixed-income than equity. The swap program has matured, becoming increasingly market driven. The swaps initially relied on share-repurchase agreements, by which a company agreed to buy back the shares lenders had exchanged for debt.

"Groups are now experimenting with structures that do not rely on repurchases. The upshot is that they aren't on the hook to pay out big sums to investors, which is helpful for companies trying to cut leverage," said S&P Global Ratings country specialist Chang Li.

In most cases, the swapped debt is a normal debt rather than bad debt, which means investors have no incentive to forgo stable fixed returns for uncertain equity gains, especially when it can take a long time to capture any upside.

However, swaps stripped of repurchase agreements require a lot of structuring that only works when conditions are right, for example when the parent is listed. Creditors typically targeted in such swaps also prefer fixed returns over the volatile and unpredictable gains seen from holding equity.

Li added: "We do not expect swaps to have a significant impact on corporate deleveraging. More government reforms are needed -- such as mixed-ownership reform to introduce private capital to state-owned enterprises that, in conjunction with swaps, could fundamentally improve corporate leverage and capital structures."

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