It was aided by BlackRock. Goldman Sachs shared this sentiment. Huarong, a sprawling Chinese financial conglomerate, had good reason to trust foreign investors. Even as its executives displayed a dangerous appetite for risky borrowing and lending, investors were confident that Beijing would bail out the state-owned business if things got too dicey. China has always done it this way. Some of the same foreign investors will have to reconsider their positions now. Huarong is in debt to foreign and domestic investors to the tune of more than $40 billion, and it is showing signs of stumbling. According to reports, the Chinese government is preparing a reorganisation that will force both, foreign and domestic bondholders to take substantial losses on their investments.
Beijing has spent centuries bailing out Chinese firms that have gotten themselves into financial trouble, but it has recently pledged to stop doing so. Although regulators have vowed to hold financial institutions accountable for gorging on loans while expecting the government to foot the bill, Huarong is putting the commitment to the test. Huarong is a core part of China’s financial system and, some argue, “too large to fail,” unlike the handful of small banks and state-owned enterprises that have been permitted to fail. Because of its precarious position, China’s leaders are faced with a difficult decision: let it default and sunder investor trust in the government as a lender of last resort, or bail it out and jeopardise efforts to tame the balloo.
Huarong’s future, according to analysts, may be the most telling sign of China’s commitment to financial reform. “The supervisor and stakeholders are sort of playing chicken,” Zhangkai Huang, an associate professor at Beijing’s Tsinghua University, said. “According to the regulator, the financial sector would undergo significant change. “I bet you don’t have the confidence to let this default happen because it will trigger a crisis”, says one of the investors. The false sense of security provided by government bailouts in China, according to Huang, has created an atmosphere similar to that in the United States prior to the 2008 financial crisis, when investors made bets thinking they were safe.
If the government follows through on its proposal to clean up Huarong, it would be the most dramatic announcement yet that China is willing to sacrifice the investors who lend its companies money in the pursuit of change. Although no schedule for a total revamp of the company’s operations has been set, sources familiar with the government’s agenda say China is key to maintaining that both foreign and domestic bondholders are not fully repaid. The aim is to persuade people not to invest in high-risk Chinese companies under the presumption that the government will bail them out.
Huarong was born in the early 1990s, just as China’s state-run economy began to open up. To make themselves more appealing to the global market, state-owned banks had to get rid of debt. Huarong was labelled an “evil bank” because it took some of the most obnoxious loans from these institutions. Huarong, the largest of China’s four “poor banks,” grew its empire by financing companies in oil, insurance, real estate, and other industries. It took advantage of low-cost loans from state-owned banks to invest in high-risk, high-return transactions. It raised capital from foreign investors through its international arm, and it now owes more than $20 billion to them.
Under Lai Xiaomin’s leadership, Huarong’s greedy mentality was brought to light. Lai, Huarong’s former leader, was expelled from the Communist Party in 2018 and executed in January for corruption and abuse of power, a highly unprecedented penalty that analysts believe was intended to send a message. Lai admitted to taking $277 million in bribes, telling state broadcaster that he had $30 million in cash stashed in lockers across his Beijing apartment, which he dubbed his “supermarket”. Chinese authorities are concerned that Lai’s misconduct has become so ingrained in Huarong’s corporate practises that determining the full extent of the company’s damages and collateral damage from a potential default would be impossible.
Huarong made headlines again not long after Lai’s execution when it announced that it would postpone releasing its annual results until March. Last month, it postponed its annual results for the second time, increasing concerns about the company’s financial health and ability to repay investors. If Huarong is unable to refund its investors in whole, it will have repercussions for some of the world’s largest and most well-known investment firms. The bonds recently went into a tailspin as the international stock market struggled with the scenario.
Huarong owes international investors almost $4 billion this year alone. The bonds sold for as little as 60% per dollar after the company postponed reporting its annual results. Its stock was put on hold in Hong Kong. According to Larry Hu, head of Macquarie Group’s China economics desk, it’s already too late for a major reorganisation. He said, “Huarong has indeed grown too large to fail.” “It’s no longer a solution to a dilemma; it’s the problem itself.” China’s business market is likely to be roiled by the government’s new strategy, which has yet to be made public. Last month, the wider market for Chinese companies began to tremble as worried investors considered the possibility of a contagion impact.
Chinese organizations owe almost $500 billion in advances to unfamiliar financial backers. A Huarong default could lead some worldwide bondholders to sell their securities in Chinese state-claimed ventures, and make it harder for Chinese organizations to acquire from unfamiliar financial backers, a basic wellspring of subsidizing. Worries about the organization’s capacity to collect new cash provoked two evaluations office to put Huarong on a “watch” notice — a sort of caution that implies its obligation could be minimized, a move that would make its capacity to acquire much more exorbitant.
Logan Wright, director of China research at consulting firm Rhodium Group, said, “There is no blueprint for this.” According to him, China’s regulators are now faced with the task of keeping a pledge to clean up the financial sector while still avoiding a potential meltdown. You’re pitting Beijing’s latest rhetoric of retaliation against the presumption that they’ll keep the regime stable,” he explained. According to two people familiar with the government’s thinking, the government is likely to inject some capital into whatever reorganised business emerges from Huarong’s difficulties, but it is not willing to infuse sufficient cash to take care of the entirety of the bonds.
As the government works on a proposal to downsize Huarong, the company has tried to reassure investors by stating that it would be able to pay its bills. Huarong Vice President Xu Yongli compared his company to other vital Chinese financial institutions in an interview with state media. “Huarong receives no different government assistance,” he said.
