As Mystery Of China's Multi-Billionaire Default Deepens, A New "Bond Scare" Emerges

Tyler Durden's picture

Last week, in a largely "under the radar" event, one of China's wealthiest billionaires (if only on paper), Wu Ruilin, chairman of the Guangdong based telecom company Cosun Group, and whose personal fortune of 98.2 billion yuan ($14 billion) makes him wealthier than Baidu founder Robin Li who is ranked 8th on the Hurun Rich List 2016, shocked Chinese bond market watchers when he defaulted on a paltry 100 million yuan ($14 million) in bonds sold to retail investors through an Alibaba-backed online wealth management platform, citing "tight cash flow."

Needless to say, many were stunned that a billionaire for whom $14 million is pocket change, blamed "tight cash flow" for defaulting on mom and pop investors. In any case, as South China Morning Post reported, despite the founder's personal fortune, according to a notice put up by the Guangdong Equity Exchange on Tuesday, two subsidiaries of Cosun Group are each defaulting on seven batches of privately raised bonds they issued in 2014. According to the notice, “the issuer had sent over a notice on December 15, claiming not to be able to make the payments on the bonds on time, due to short-term capital crunch."

To be sure, yet another default in a Chinese landscape suddenly littered with bankrupting debt dominoes would have been the end of it, however this morning Reuters added to the mystery when it said that the fate of the defaulted $45 million Chinese corporate bond sold through an Alibaba-backed online wealth management platform was thrown into doubt on Monday, after a bank said letters of guarantee for the bonds were counterfeit.

Quoted by Reuters, China Guangfa Bank Co Ltd (CGB) said guarantee documents, official seals and personal seals presented by the insurer of the bonds "are all fake" and that it has reported the matter to the police.

The dispute highlights challenges in China's loosely regulated online finance industry, where retail investors often buy high-yielding bonds and other assets, expecting them to be "risk-free" due to guarantees provided by various parties.

As first reported last Wednesday, at the center of the latest dispute are up to 312 million yuan ($45 million) worth of high-yielding bonds issued by southern Chinese phone maker Cosun Group that defaulted this month. The bonds were sold through Zhao Cai Bao, an online platform run by Ant Financial Services Group, the payment affiliate of e-commerce firm Alibaba Group Holding Ltd.

Ant Financial has asked Zheshang Property and Casualty Insurance Co Ltd, which wrote insurance on the bonds, to repay investors. On Sunday, Zheshang Insurance published two documents on its website that it said were from CGB carrying the bank's official seals, and that guaranteed Zheshang Insurance policies for the Consun bonds. The letters were issued at CGB's Huizhou branch in December 2014, when the Cosun bonds were sold, Zheshang Insurance said.

And yet, suggesting there is a massive landmine hiding just below the surface of China's bond market, far worse than merely the consequences rising interest rates, on Monday, CGB said the documents were fake and that it had reported the incident to police as "suspected financial fraud."

While material misrepresentation of facts in Chinese finance is hardly new, the recent alleged violations usher in a whole new breed of fraud, one which is far less nuanced and far more simpllistic and includes outright forgeries of documents that backstop tens if not hundreds of billions in debt. The Cosun dispute follows similar instances of financial fraud this year including forged bond agreements that led to brokerage Sealand Securities sharing potential losses of up to $2.4 billion. In May, the government advised banks to be vigilant after several cases of bill fraud.

Ant Financial on Tuesday said Zheshang Insurance "hasn't any reason to refuse repayment" which it was obliged to do "within three days" of default.

Making matters worse, the fraud has taken place in the context of a bond default that, according to an Ant Financial spokeswoman cited by Reuters, was a "a one in billions incident" on the platform.

Incidentally, Cosun's bond issuance totals 1 billion yuan, according to Zheshang Insurance. The insurer's total registered capital is 1.5 billion yuan.

Should more such "one in billions incidents" emerge, Chinese bond investors - already freaked out by the recent record plunge in Chinese govt bond futures, soaring overnight funding rates, and fears over Fed rate hikes - will rush for the exits just as China's housing bubble is also popping as reported yesterday, leading to a rerun of the US 2006/2007 dual bursting of the housing/credit bubbles, only this time instead of an $8 trillion financial system, the world will have to backstop China... whose banking system at last check had over $30 trillion in liabilities.

Incidentally, we wonder if now that China's bond insurers are also under the spotlight, if that means China's very own MBIA/Ambac moments is imminent, as billions in bond insurance contracts are deemed "fake" by the insurers who would rather not pay up on what is set to be an avalanche of defaults.

* * *

Finally, for those interested in what Bloomberg last week dubbed the "latest China Finance Scare", namely outright forgeries in various debt products, mostly focusing on Entrusted Bonds, here is a useful primer courtesy of BBG:

There’s another Chinese financial practice that’s prompting high-decibel warnings. So-called entrusted bond holdings are a way for financial institutions to skirt rules on using borrowed money to invest in bonds. How? By getting a third party to buy the bonds and agreeing to purchase them at a later date. What could possibly go wrong? How about the worst rout in China’s bond market in a decade. That’s left regulators concerned about the prospect of investors failing to make good on such arrangements, estimated to involve at least $144 billion of bonds.

1. Why entrust us with this news only now?

Concerns about entrusted bond holdings have worsened the tumble in the debt market. Last week, Caixin cited market rumors when it reported a brokerage called Sealand Securities Co. had refused to take over bonds held by a counterparty. That got investors worried. Oversea-Chinese Banking Corp. then said in a note, citing media reports it didn’t identify, that the entrusted holding agreement may have been tied to alleged fraud by ex-staff. Sealand cleared the air when it said it would in fact fulfill the bond contracts that had been stamped with a forged seal. The whole incident was enough to frighten an already jittery market.

2. So why do investors use entrusted holding agreements?

Brokerages and other institutional investors ask counterparties to buy bonds from them when they need to circumvent internal rules on note holdings and leverage, according to Xu Hanfei, a bond analyst at Guotai Junan Securities Co. Or they can simply have third parties buy the notes directly from the market. The practice boosts leverage by effectively giving the financial institutions loans: As brokerages and institutional investors don’t carry the bonds on their books, they can use the funds freed up on paper to purchase more bonds, which can then be rolled into more such agreements. “Non-bank financial institutions, which emphasize returns, have more motivation to amplify leverage through entrusted holdings,” said Li Liuyang, a market analyst at Bank of Tokyo-Mitsubishi UFJ in Shanghai.

3. How widespread is the practice?

Outstanding entrusted holdings are "in the trillions of yuan," according to Guotai Junan’s Xu. That estimate is based on the bond holdings of the brokerages and smaller banks that are major participants in such transactions. That means the amount of money tied up in such deals is at least 5 percent of the 21 trillion yuan ($3 trillion) of outstanding corporate notes in China, according to data compiled by Bloomberg.

4. What broader risks does it pose to China’s financial markets?

A default in an entrusted holding could turn what otherwise might have been a problem with one company’s liquidity into a broader credit event, given that multiple parties may be involved, according to Li at Bank of Tokyo-Mitsubishi UFJ. Li says “everyone is worried about similar situations in their transactions with non-bank financial institutions.” OCBC said that things had got so bad that banks were reluctant to lend to non-bank institutions amid a breakdown in trust between investors.

5. What are regulators doing about it?

Authorities including the central bank and the China Securities Regulatory Commission are investigating some financial institutions’ entrusted bond holdings after the Sealand incident, people familiar with the matter said Tuesday. The holdings run contrary to the central bank’s push to trim investments made on borrowed money, according to China Merchants Bank Co. “It’s just a question of when Chinese regulators will clean up entrusted bond holdings,” said Liu Dongliang, a senior analyst at the bank. Tommy Xie, an economist in Singapore at OCBC, says China’s market rout may prompt regulators to strengthen rules on entrusted holdings. He describes them as "a common practice in the grey area of the bond market.”

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knukles's picture

Counterfeit Guarantors?
Like 2008 MBS Era or Tea Pot Dome?

Moe Hamhead's picture

Or the Clinton Foundation.

knukles's picture

Gives Whole New Meaning to "No Tickie No Laundry"

NoDebt's picture

As I've commented many times on ZH, China is the greatest fraud of the 21st century.  Everything is fake, all numbers are falsified, every set of books is cooked.  All of it.  ALL. OF.  IT.  

Do I give a shit about their internal financial malfeasance?  No, I do not.

But when the entire globe is relying on China to be the growth engine of the world, finding out everything there is bullshit can be somewhat disconcerting.

 

SoDamnMad's picture

"Regulators are going to strengthen the rules..."

Guys, the horses are long gone from the corral through the bad gate...and are in Vancouver and everywhere else with the money.

Giant Meteor's picture

Building life size replica of the Titanic, leading indicator. I mean what the fuck, they get bored with building ghost cities?

MASTER OF UNIVERSE's picture

I tweaked the timing on all the growth engines of the world March 10th 2008, NoDebt. Moreover, you know that none of the 'world's growth engines' have fired on all cylinders since March 9th 2008. The world is not 'relying on China's 'growth engine' because everyone in the world knows they don't have one. Furthermore, America has no 'growth engine' either and has not had a 'growth engine' since March 10th 2008. Count the business quarters since the last time America had any growth, NoDebt. Clearly, I must be the only person in the world that knows there is no growth occuring anywhere on the planet Earth aside from the Oligopoly Rothschild Bank. Do you honestly think that you will ever see 'growth' in the Economy ever again? If the answer is 'yes' you need to add up the business quarters where there has been no appreciable gains or increases in growth so that you can see the futility in that argument.

JohnGaltUk's picture

The UK even added prostitution and illegal drugs to its GDP figures. How the hell do you quantify that!!!

Milton Keynes's picture

Nigeria had this problem and now no Line of Credit from Nigeria is any good. They have to pay cash and deliver funds prior...

 

 

wisehiney's picture

This would be a good time to flee to the safety of treasury bonds.

GRDguy's picture

Sure, the counterfeiters of last resort.

Davidduke2000's picture

The Chinese Billionaire deserve what they get running away with their money to the US and UK where disaster was waiting for them. 

DownWithYogaPants's picture

Voting with your feet is the most powerful form of fight against big government that exists.  Please rethink your position sir.  It is in error.

Able Ape's picture

If it's not gold or silver, it's some shade of counterfeit - if it's not part of the Periodic Table, it's some sort of scam...How can it NOT be?...

Pure Evil's picture

Paper's only good for two things.

Ass wiping and tissues to clean up the tazs after masterbating at an NFL game.

Vinividivinci's picture

Faking, forging and fooling...
Three things that the chinese are pros at.

Justin Case's picture

I always thought it was a different race of people that held that title.

Vinividivinci's picture

hummmm, I wonder what "peoples" you're hinting at...
does it rhyme with Manichevitz or Mohamad ?

Argos's picture

Gooks are Korean, not Chinese.

Dr. Bonzo's picture

Gooks are Korean, not Chinese.

You mean, the genesis of the word gook is from Korean. Heavily used by GIs during the Vietnam War. Or you gonna give them a lecture too? Asian racial slurs are many and varied. Gook, slope, slant, buckethead, fishhead, chink, dink.... yawn.... oh, that wasn't a racial slur. That was me being utterly bored with pedants. Myself included when someone forces my hand.

indygo55's picture

Heyyyyy,,,,, I thought Gooks were Vietnamese.

Justin Case's picture

Things are unwinding. Slowly at first, like a leak in a dam. Then without warning the dam lets go en masse. He's not much unlike the banks.

onewayticket2's picture

Thanks ZH for bringing this to light.....certainly one to watch very closely....

jamesmmu's picture

Geo-Political and Economic Risks Create Uncertain Role for China in 2017

http://investmentwatchblog.com/geo-political-and-economic-risks-create-u...

DarkPurpleHaze's picture

Just imagine what'll happen as US interest rates continue to  slowly and incrementally creep up and the USD strengthens while at the same time Trump is tweeting and tweaking China about trade tariffs and anything else he dares put on the table.

This is just the beginning.

JackMeOff's picture

And another card falls in the global great house of cards...  Look to 2017 this pace picking up as Europe is next.

whatswhat1@yahoo.com's picture

About to change the name of the China to WE SO SOWWI.

whatswhat1@yahoo.com's picture

next up for the sheep...

Lose Weight Fast
goal and solution in same sentence

hedgiex's picture

Since when had the bond and securities markets in China ever protected non state investors. It is because of these past  dumps on the households that the present small savers are furiously exploiting loopholes to remit monies abroad. Trust in their regulated markets is best built in stress times and it looks like that this can be undermined as the Ponzi got to be maintained otherwise a collapse resulting in unemployment is unacceptable. Unemployments leads to social unrests. 

The shadow banking system did not spring out of free market forces. It exists because of "wilful blindness' as China's vested interests are inextricably linked to it. All the games played by approved local instituions are not worthy of analysis on the assumption of regulations that stick to the doctrine of "property rights'. All the plays in the financial economy has a put to the Central Bank, which is non-independent. It will serve to protect the vested interests not YOU. 

However, it is a great market to play now that the credibility of the CB is waning together with the Ponzi being more widely known...just hold no silly notions of Trust or Property Rights while you trade and not invest. 

PumpherDumper's picture

hedgiex is correct.  It is why there is a mass rush into anything other than the yuan in an attempt to preserve wealth.  It is why Bitcoin is moving up...and we ain't seen nothin' yet.

are we there yet's picture

When China heavily undervalues their currency and then when corrupt officials move money out of China to the west, they are effectively giving free value to the west and stiffing china in a magnified way.

Yen Cross's picture

 Awe, $30T stated debt.

 I'm short the Chinese Navy.

whatamaroon's picture

Not only that but they are fucking thieves.

Kina's picture

Seems some more State bullets to back of head coming

pc_babe's picture

.
.
Another Chinese ponzi scheme ... I leally, LEALLY suprised.
.
.
Bernie Madoff ... copy/paste

Archive_file's picture

Free John Corzine.

Econogeek's picture

Fantastic article, many thanks ZH.

pashley1411's picture

Beijing is on top of this debt pile.   Crash the value of the renimbi to ash, so debts instruments valued in renimbi go to nothing.

That's why Chineese investors value anything foreign,, real estate, bitcoin, and gold, to get them out of that failing currency.