The secretive restructuring of a high-profile Chinese group with ties to Beijing has emerged as a critical legal test for foreign investors holding tens of billions of dollars in bonds issued by companies in China.
Peking University Founder Group traces its origins back to the 1980s as a successful hardware business helmed by the late Wang Xuan, a top computer scientist at the prestigious academic institution. Wang, considered the “father of Chinese character typesetting”, also had close connections to the family of former president Jiang Zemin.
However, the state-backed group ran into severe debt problems after expanding into technology, healthcare, property and finance.
Today, it is the largest defaulter on dollar-denominated debt in China in nearly two decades, according to rating agency S&P, owing about $1.6bn in US dollar notes. It has also defaulted on Rmb36.5bn ($5.6bn) of onshore bonds, according to data from information provider Wind.
China-issued debt backed by keepwell deeds
The result of a Beijing court-ordered restructuring of the group is expected by late April. The company did not respond to requests for comment.
The treatment of foreign bondholders in the restructuring is being closely watched by investors that collectively have taken on $82bn in China-issued debt backed by so-called keepwell deeds.
Foreign investors have historically had little recourse to chase debts in China and keepwell deeds were designed to boost their confidence.
They commit bond issuers’ parent companies to maintain an offshore subsidiary’s financial strength so that it can meet repayments, according to Fitch. The rating agency says they are “essentially a strongly worded letter of comfort” and do not create a direct debt liability for the parent companies of bond issuers.
Out of concern the Beijing court will not recognise these debts, investors in PUFG’s dollar-denominated bonds have launched at least two legal challenges in Hong Kong, according to documents seen by the Financial Times.
An application to liquidate one of PUFG’s subsidiaries ahead of the restructuring deadline was made last week, following an earlier winding up order for which a hearing was scheduled for June.
Investors “feel unsafe and doubtful” over whether they will recover their funds, a person familiar with the proceedings said.
“Will a Chinese parent recognise its contractual obligations under a keepwell deed, which literally gave the impression to offshore bondholders the deeds are equivalent to a guarantee?” the person said, adding that “the Chinese parent actually took the majority of subscription proceeds back to China for its own use”.
Simmons & Simmons, a law firm, said that an earlier bondholder’s claim under the keepwell deed has already been rejected by PUFG’s bankruptcy administrator in China because “the validity and effectiveness” of the arrangements have not been established inside the country.
“The administrator’s decision has cast significant doubts concerning the validity and enforceability of keepwell agreements, at least under [mainland China’s] restructuring process,” the law firm said in a January report.
Investors are also following the case for broader signals of how Beijing will navigate a rising number of defaults among corporates and state-backed groups, which have sent shockwaves through China’s $15tn bond market.
S&P believes Chinese authorities want to use cases like PUFG’s to serve as examples as more entities are allowed to default. “They establish a key template for debt workouts as China improves its restructuring, resolution, and recovery regimes,” analysts said.
But the process is further complicated by questions over what role the Chinese Communist party may be playing behind the scenes. There is a lack of clarity over what impact this might have on foreign bondholders.
According to Cercius Group, a Montreal-headquartered consultancy specialising in elite Chinese politics, PUFG and the powerful Jiang family and its related factions have maintained their ties over several decades.
“The scrutiny that has been placed on Founder Group in recent years by the party is, of course, not solely because the company’s finances are a mess, but also because of the factional affiliations of Founder Group’s successive generations of senior management,” Cercius said.
Additional reporting by Sherry Fei Ju in Beijing