Fraud in China a threat to bond market

More scandals, defaults expected as firms struggle to issue new notes and repay debt

BEIJING • Forged seals, fake letters and counterfeit documents.

They are all part of China's recent spate of fraud coming to light in the country's US$3 trillion (S$4.2 trillion) corporate debt market amid a rout that has analysts predicting a record number of defaults this year.

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 Mr Charles Macgregor, head of emerging markets at Lucror Analytics in Singapore.

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 Mr Chris Fordham, 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."

MORE SCANDALS EXPECTED

We expect to see more of this type of behaviour, given the increasingly problematic environment for refinancing in the domestic bond market.

MR CHARLES MACGREGOR, head of emerging markets at Lucror Analytics in Singapore.

Within two weeks last month, 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 is built up in the nation.

China Guangfa Bank said documents and seals in its name had been forged for use on a letter to guarantee bond payments. Separately, Sealand Securities said former employees conducted as much as 16.5 billion yuan (S$3.4 billion) of bond trading with a forged official seal, or chop.

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 this year 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 cancelled or postponed last month, almost quadruple the amount the month before, according to data compiled by Bloomberg.

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.

China's policymakers vowed to make preventing financial risks a top priority this year and set the tone for tighter monetary policy.

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on January 27, 2017, with the headline 'Fraud in China a threat to bond market'. Print Edition | Subscribe