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This Bond Shows China Investors Don't Put Premium on Accounting

  • Chinese textile company bonds rebound despite ownership query
  • Buyers from China probably ’considered such risks’ already

Transparent accounting may be one of the topmost concerns of bond investors in developed markets. When it comes to China, well, things aren’t so straightforward.

Take the case of a Chinese textile company that has faced questions on its ownership, troubling foreign observers. When discrepancies arose after Shandong Ruyi Science and Technology Group Co. sold a five-year dollar bond in June, the securities predictably tumbled. But not for long, and they’re now trading a stone’s throw from where they issued. Here’s the sequence of events:

  • Shandong Ruyi in an offering circular for its $200 million of notes indicated it had a link with a state-owned enterprise, which are sometimes assumed to have the government’s backstop. The document said Yinchuan Tonglian Capital Investment Operation Co., a local government financing vehicle, as its No. 2 shareholder as of the end of last year, with a 26 percent stake.
  • When that LGFV, Yinchuan Tonglian, the following month distributed an offering circular for its own dollar bond sale, it said it had no equity interest in Shandong Ruyi as of end-2016.
  • (Yinchuan Tonglian told Bloomberg in a written response to questions that it had transferred the stake in July 2016 to Ningxia Ruyi Ecological Textile Co., an entity 99.5 percent owned by Shandong Ruyi.)
  • Shandong Ruyi’s bonds dropped to as low as 88.6 cents on the dollar on July 18.
  • Days later, the securities rebounded to 92.4 cents, after Shandong Ruyi claimed in a statement that Yinchuan Tonglian remains the "legal owner" of the 26 percent stake, without presenting further documentation. They traded Wednesday at 93.3 cents. Shandong Ruyi declined to comment on questions on the ownership discrepancy in July, and calls this week went unanswered.

“After some initial jolt, its secondary performance shows investors remain unfazed,” Sean Chang, Hong Kong-based head of Asian debt at Barings Asset Management Ltd., said in an interview. The episode serves as a reminder to global investors such as Barings that “corporate governance is one of the main risk concerns” when it comes to buying into Chinese private-sector companies. 

While a detailed breakdown of ownership of the Shandong Ruyi securities hasn’t been published, Chinese bonds issued in Asia are typically taken up mostly by Chinese buyers, who have long had to grapple with opaque accounting standards. 

Any case of presenting inaccurate information on a bond offering circular to investors could open both the issuer and underwriters to lawsuits, according to capital-market lawyers, though there’s been no sign of any such move with the Shandong Ruyi bond. Standard Chartered Plc, the bank that served as sole global coordinator on the bond deal, declined to comment on the matter when contacted by Bloomberg.

Buy Recommendations

Analysts at Standard Chartered, in a July 19 note, said investors should focus on Shandong Ruyi’s operations and business plans, rather than dwelling on the question of ownership. Shandong Ruyi has been part of the wave of foreign acquisitions out of China, snapping up French and British luxury brands. Deutsche Bank AG analysts the next day recommended buying the bonds on valuation grounds, while noting that the "company needs to improve on disclosure standard."

An older bond, due in 2019, sold by Shandong Ruyi is priced even more strongly in secondary trading, at 98.8 cents on the dollar as of 10:48am in Hong Kong, according to Bloomberg-compiled prices.

A record pace of Asian dollar-bond issuance this year has spurred worries in some quarters that "drive-by" deals leave little time for investors to do much analysis. Read more about that here. 

“Weaker covenants, a developing legal framework and poor corporate governance have always been the key risks faced by investors in the Asian corporate-bond market," said Jenny Zeng, a Hong Kong-based portfolio manager & head of credit research for Asian fixed income at AllianceBernstein. It’s up to investors to find spots where potential returns can sufficiently compensate for such risks, she said.

To Zeng’s point, recent history had a more striking example of what European or American investors would find alien. In one of the most high-profile cases, China National Bluestar, a subsidiary of state-owned China National Chemical Corp., had to cancel its debut international bond even after it had priced, after discovering the shares in a company guaranteeing the bonds had already been pledged as collateral for another loan. Yet just weeks later it was able to come back to the market and sell the dollar notes, amazing veteran observers.

“Corporate governance and weakness in disclosures are always concerns in private companies -- especially in emerging markets,” said Ivan Chung, head of greater China credit research at Moody’s Investor Service. “If offshore Chinese issuers have already issued bonds onshore, Chinese investors probably have had exposures and knowledge of these issuers, and have considered such risks in the bond pricing.”

— With assistance by Allen Yan

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