China Sets Guidelines on Debt-Relief Program for Struggling Corporations

(Beijing) – As Chinese banks set up their own distressed-asset managers, the regulator has laid out detailed guidelines in a bid to inject discipline into the government-endorsed debt-relief program.

While unprofitable state-owned or private enterprises struggle to repay their debts, the government proposed early last year that creditors could offer to take equity stakes for debt to avoid pushing debtors into default. Prior to this new rule, Chinese banks were not allowed to hold equity in any non-banking institutions.

This so-called debt-for-equity swap program is the government’s latest market-based tool to tackle the country’s ballooning debt. But market-watchers said that without clearly defined rules, banks were not keen to swap stakes for bad loans. Meanwhile, other debt-restructuring practices, such as securitizing bad loans, continue to help China clean up trillions of yuan in sour debts in and outside the formal banking system.

In the latest guidelines issued Tuesday by the China Banking Regulatory Commission (CBRC), a bank can create a subsidiary to absorb toxic assets and segregate them from the rest of the institution. The unit would convert the bad loans into equity stakes in the debtors, usually at a price and time agreed between them.

That unit must have a registered capital of at least 10 billion yuan ($1.49 billion), the guidelines added. The bank must also have at least a 50% stake in the unit, should be the unit’s largest shareholder, and cannot sell down its stake within five years, the guidelines said.

The unit also must not accept guarantee or repurchase commitment from debtors. Meanwhile, the unit must not use funding offered by debtors to purchase its own debts, the guideline said.

David Yin, a banking analyst at Moody’s Investors Service, said, “These requirements, if strictly implemented, could help improve the transparency of (swap) transactions.”

Since the program kicked off in early 2016, 65 agreements were signed that let creditors swap their stakes for debt. However, only 10 debt-for-equity swaps were completed, addressing 73.45 billion yuan worth of loans, according to data compiled by financial service provider Wind.

CBRC reiterated in the draft that zombie companies, which are largely non-operational due to excess capacity, cannot roll over their debts via swapping equity with creditors.

Contact reporter Leng Cheng (chengleng@caixin.com)