China struggles to contain its corporate bond morass.
Maybe the US government refused to pay China’s Dagong Global Credit Rating for an AA or AAA rating. And in January 2018, Dagong let the US know how things worked in China: It downgraded US Treasury debt from A- to BBB+ though there is near-zero credit risk since the Fed can always print the US government out of trouble.
At about the same time, Dagong gave Sunshine Kaidi New Energy Group, a privately-held Chinese company, an AA rating though there were already reports about the difficulties the company had with its debt. In June, the company defaulted on 18 billion yuan ($2.6 billion) in bonds. In July, the Shenzhen Stock Exchange warned that a publicly traded subsidiary – Kaidi Ecological and Environmental Technology Co. – may be delisted after its auditor refused to sign off on its financial statements.
Since the default, Dagong slashed Kaidi New Energy’s rating four times to C.
Despite the government’s struggle to contain the growing corporate-debt meltdown in China, Dagong upgraded about a fifth of its clients’ credit ratings since the start of 2017, according to the South China Morning Post.
It’s a broader problem. Dagong isn’t the only credit rating agency in China. There is a whole industry, of which Dagong has about a 20% market share, though the three major US rating agencies – Standard & Poor’s, Moody’s, and Fitch – have been locked out of the market. Of the 1,744 Chinese companies that have issued bonds, 97% were rated AA or higher by Chinese rating agencies, with 27% (464 companies) being AAA-rated. In the US, only a handful of companies are still AAA-rated.
And now two Chinese regulators have disclosed why rating agencies issue these AA and AAA ratings even as corporate debt meltdown becomes difficult to contain: Dagong had effectively sold high credit ratings to bond issuers.
And as punishment, the regulators decided to suspend Dagong’s credit rating services in China for one year, according to the South China Morning Post:
NAFMII, an agency under the People’s Bank of China, said in a statement on Friday that Dagong had been found to have “directly provided consulting services to rated companies,” which is prohibited, and “charged high fees” that compromised its independence between November 2017 and March 2018.
In also said Dagong had provided false statements and untrue information to the watchdog during its investigation, adding that its actions had a “very negative” impact on the market.
The Chinese Securities Regulatory Commission said in a separate statement cited by the SCMP that a site inspection had found serious problems at Dagong, including:
- “Chaotic internal governance”
- “Charging consulting fees from those being rated”
- “Hiring executives without professional qualifications”
- “Loss of original documents for some rating services.”
Dagong released its own statement, apologizing for its actions.
Investors in China’s corporate bond market have to navigate the Wild West of bond markets where debt creation is opaque, where companies, often with inscrutable ownership structures, have loaded up on enormous piles of debt to fund acquisitions, overcapacity, and foreign adventures, but where outright defaults are rare only because the government, via its state-owned megabanks, keeps bailing out troubled borrowers. This includes measures like telling those state-owned banks to convert some defaulting debt into equity.
No investor can trust anything Chinese companies – or Chinese rating agencies for that matter – disclose about their debts, and the only hope is the history of corporate bailouts by the Chinese government. But Chinese authorities are trying to wean investors ever so gradually off these assurances and have allowed a few bond defaults here and there to proceed to the great astonishment of befuddled investors.
The punishment handed to Dagong – effectively not being able to do business for one year – shows that the government is getting more serious about trying to tamp down on the corporate bond morass and bring some glimmers of sunshine to its opacity. But categorically allowing corporate debt to default, and allowing market participants to restructure this debt on the backs of shareholders and creditors, would accomplish a heck of a lot more in that department.
Emerging Markets turmoil: The price of cheap debt & misallocation of capital. Read… “Asia Will Be the Next Source of Downside Systemic Risk for Financial Markets”
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
“The punishment handed to Dagong – effectively not being able to do business for one year –…”
Hmmm… Maybe that explains the recent flare of Chinese scams like the “Critical Alert from Microsoft” scam you published yesterday. The workers at Dagong need to bring the bacon home. Before they are allowed to resume their main line of business scamming bondholders maybe they are diversifying into scamming folks online.
As if Wall Street is any more honest.
Well at least they serve interests of our honorable elites!!!
There is no doubt that policies of the last 40 years benefited America… Just not the American people who work wages.
all credit rating agencies have conflicts of interest ( The “issuer pays” business model ), or they are monopoly, cartels or oligopoly produced by regulation.
Yes : We taught them everything we know.
‘Not being able to do business for a year’
That sounds like the slap on the wrist you give to an individual broker, realtor or lawyer.
Does The Gong also have to complete a course called ‘Know Your Client’
A major accounting firm, unlike an individual accountant, can’t just take a year off and then come back.
This discipline is either a corporate death sentence or a fiction.
I’m sure when it reopens, they will have been reeducated and the former leadership disappaered.
Darn those burdensome government regulations interfering with corporate profits!
(/snark)
Seriously, this is why we need strong financial industry regulations. Without them, trust is non-existent and markets suffer
In China the authority of the Central Financial and Economic Affairs Commission is absolute, so much it’s always been chaired by either the Premier or the General Secretary of the Communist Party, like it is today.
The Commission does not answer to anybody and can do whatever its 26 members decide to do. All the decisions taken by the Commission are law and Chinese law can impose extremely stiff penalties, from long prison sentences to the firing squad. Appealing against such sentences is extremely hard if not impossible.
In short regulations do not go much stronger than this.
Yet look at the opaque financial reporting by Chinese firms, the shadow banking system, the inexistant collaterals and the financial scandals papered over with State funds. The death and life authority of the Commission looks like a complete joke.
The same is true for any other country in the world: strong financial legislation is already in place everywhere, often supported by stiff financial penalties and jail sentences.
Yet it makes no difference.
The reason is very simple: non-enforcement of ordinances.
Now, every single regulator will cry the reason for this is “lack of funds and resources”, and we can all agree this is a complete joke.
If law enforcement lacked “funds and resources” they wouldn’t go after small fries such as how tall is the grass in a private garden and surely wouldn’t rebuke you for laughing out loud in public.
Very much like Italy leaving her roads to rot and then spending over €50 million per km of useless high speed railways it’s all a matter of choices.
Regulators choose not to intervene and politicians (and their voters) seem to be fine with little more than rhetorics emptier that the Commission’s I started my post with.
“The reason is very simple: non-enforcement of ordinances.”
Simpler reason still – corruption. Who watches the watchmen? Who watches the watchmen’s watchers? Etc…
China maintains the death penalty including for corruption, but appears to have armies of corrupt well-connected bureaucrats. These channel their gains abroad where they masquerade as “investors”, enjoying the blessings and protection of the western legal apparatus – not unlike their local peers. The chance of striking it rich once and forever is irresistible.
“No investor can trust anything Chinese companies”
If despite this investors want to invest let them invest and get screwed. That is how it should be.
“the only hope is the history of corporate bailouts by the Chinese government.”
Means investment is not based on ratings. It is based on central bank put! But then in what way is it different in Europe and the US. Everyone is riding the central bankers’ put everywhere.
I always find it interesting that investors trust any of the numbers that come out of China-as if they can discern what is real or false.
A good example are all the stories that were kicking around a couple of months back (seems so long ago now) about how the Petro-Yuan was going to dominate the currency markets of the future…just a matter of time before the Greenback went the way of the Dodo, all eyes bowing to the Great Wall. Well, two months later and the Chinese currency is down what 7%-8%? with many “experts” predicting its going to go lower. Anyone who bought the Petro-Yuan Masters of the Universe stuff….well a 7-8 % return, if you shorted the currency, is a pretty good rate of return for two months spec.
…..So Why did China’s Yuan fall the last 8 weeks?, Well pick your reason, Chinese is intentionally devaluating, money is fleeing the country, speculators are being punished by the government, temporary head fake before Petro-Yuan goes to Mount Olympus….etc, etc…. Good luck figuring anything out anything past, current or future, from what is comes out of China….
Impossible!! One of the contributors to this blog i.e. Mr Deep Throat IPO himself has stated that the Chinese government is ALWAYS in control. After all both Amazon and Walmart are CCP apparatus!! Everyone here also knows FOR SURE that Chinese people ALWAYS follow directives from the center.
ROFL!!!
There is a good documentary, I believe it is called “Mao: The real story”. One of the interviewees, a daughter of a high level official at the time said: “During the Cultural revolution China was speaking in one voice; after the revolution, every Chinese had a mind of his/her own.
American rating agencies are honest?
What caused Bear Sterns, Lehman etc. to fail?
Everyone lies and ours or Chinese don’t trust anyone..
I’m awestruck to see Chinese auditors refusing to sign-off on clients’ accounts.
Elsewhere in the world we find:
https://www.theguardian.com/business/2018/jun/12/senior-pwc-auditor-of-bhs-accounts-faces-15-year-ban-and-hefty-fine
Richard Murphy’s comments:
http://www.taxresearch.org.uk/Blog/2018/08/16/the-pwc-bhs-audit-failure-reveals-a-system-rotten-to-its-very-core/
A generic definition of fraud (found online, but still business law 101 generic):
**************************
To state a cause of action for fraud, a person must allege and prove:
(1) Misrepresentation;
(2) Knowledge of the falsity;
(3) Intent to defraud, i.e. to induce reliance;
(4) Justifiable reliance; and
(5) Resulting damage.
————————-
So much of what occurs today in monetary, central bank economics everywhere, including the EU/ECB and Chinese economics, meets this definition easily and obviously. To me, the better question is ‘Why’?
WHY is where it gets interesting and where the real analysis begins. Anyone can spot a dirty shirt. Why and how the shirt got dirty tells a better story, especially when influential people try to say the shirt isn’t really dirty, but, perhaps, the new style. If someone understands the small scams, the big ones become obvious. They scale quite well.
It’s not fraud if the people who write the laws say it’s not…and those people are of course of the same ‘class’ as the financiers their laws defend- wealthy and ‘propertied’.
It’s what happens during a country’s decadence phase.
No mystery – why do you think socialist revolutions happen? Because the revolutionaries are ‘jealous’?
Oh no. As you’ll be learning more and more in the coming years of decadence, degeneracy and decline.
Wolf says that there is near zero credit risk to the US because we can print our way out. I call shenanigans. If Treasury has to print their way out, their credit rating gets worse (by logical inference). They have ink and paper in China as well. I think someone at ??? needs to do a strategic hack, and find out what’s buried in those books.
Credit ratings are “Free Speach”. Maybe us-based credit rating bureaus will like this to continue?
Or maybe they like to be regulated, which will happen if they, irresponsibly, misuse Free Speech to interfere with the business of the us government!
Nobody gonna rock that boat which brings the bacon.
Key difference: the US enjoys the exrbitant privilege of owning the far-and-away dominant global reserve currency. No other country is able to force its creditors to subsidize its global-hegemony-supporting deficit spending. My own term for this is “reserve currency colonialism” – it’s a kind of fiat-enforced financial Stockholm syndrome, if you will.
Of course said privilege won’t last forever, but I see no credible alternatives on the horizon, at least near-term.
Well, the FED doesn’t directly mint the currency but we comprehend this to mean they buy US debt. It’s not always to bail out the US government, although the relationship is symbiotic b/c banks feed themselves by helping to grow debt.
Gold bugs don’t seem to understand the importance to banks, of this symbiotic relationship.
As far as China goes, it looks like they’ve lost a good bit of credibility throughout the investment community, for numerous reasons.
LOL at this. I am not a gold bug, but at least I understand their objection i.e. “the symbiotic relationship between banks, the US government and the Fed” only benefits the three PLUS the big corporates. The common man does not benefit. If they are then why do we have such a huge wealth disparity?
Also when it comes to credibility, the US has none in financial terms. Please read your history. Had the US not closed the gold window 1970, God knows where the dollar is right now. In fact foreign countries losing confidence in the US monetary policy was the reason the US had to close the gold window in the first place.
So why hasn’t there been any run on the dollar then? Well in a sense, there has, i.e. the dollar has been losing its value slowly. The only thing preventing a faster depreciation of the dollar is the thousands of Minutemans we have. A Texan would arguably approve that policy ;)
“The common man does not benefit. If they are then why do we have such a huge wealth disparity?”
I’ve struggled with this very question for decades but the answer has eluded me until recently as I’ve become familiarized with the philosophies of the millennial generation it’s become clear common man is evolving regressively at near parabolic rate.
by Hon. Howard Buffett U.S. Congressman from Nebraska
Is there a connection between Human Freedom and A Gold Redeemable Money?
when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.
gold and economic freedom are inseparable,
“why do we have such a huge wealth disparity?”
if you talking about middle class disappearing; than because of fiat money, huge number of regulations, warfare and welfare, …
“why hasn’t there been any run on the dollar then?”
because all other currencies are worse than dollar at the moment
FWIW, my PCAR has been doing well since the death of the trucking industry last month, and despite the repeated warnings not to buy blood in the street..
“…the death of the trucking industry last month”… what are you talking about? Didn’t you even glance at my articles about the trucking industry’s historic boom?
Been posting comments late night after too many beers?
Been posting comments late night after too many beers?
Why not? We must emulate Great, Successful, Leaders like Elon Musk and Donald Trump to become Greater ourselves.
*snigger*
Jail Sentences and Social Credit Demerits for Securities Fraud should help fix those…
American Financial Hypocracy is beyond belief. Their Ratings Agencies in 2008 caused Catastrophy. THEIR Ratings were Fixed by THEIR Masters in Wall Street. Standard & Poor, Fitchess etc WEREN`T Suspended by the SEC.
Those elements of Wall Street which view China as the wild west of deregulated business practices, will get more ammunition. The messenger was shot, strangled and electrocuted. Now lets talk about China’s EPA (soon to arrive at a nations capital near you)