Debt-Equity Swap Agreements Exceed 1.3 Trillion Yuan a Year After Deleveraging Launch

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A year following the launch of debt-equity swaps by the central government as a key vehicle for deleveraging of China’s state-owned enterprises, the total scale of related agreements has risen to over 1.3 trillion yuan (USD$200 billion).

The current round of debt-equity swap deleveraging kicked off in earnest in October 2016, with the release of the “Opinions Concerning Actively and Appropriately Reducing Enterprise Leverage Rates” (关于积极稳妥降低企业杠杆率的意见) by China’s State Council, and the attached “Guidance Opinions on the Marketization of Bank Debt-Equity Swaps.”

A year following the launch of the current deleveraging campaign, the latest data from the National Development and Reform Commission indicates that financial institutions have entered debt-equity swap framework agreements worth over 1.3 trillion yuan with a total of 77 enterprises as of 22 September.

The heavily indebted state-owned enterprise sector has been a key focal point for Beijing’s concerted deleveraging campaign, with Shen Ying, chief accountant for the State-owned Assets Supervision and Administration Commission revealing on 12 October that 14 financial institutions have already entered debt-equity swap agreements worth over 44 billion yuan with central SOE’s.

The large-scale state-owned commercial banks are key players with respect to debt-equity swaps, with investment vehicles established by the Agricultural Bank of China, China Construction Bank and the Industrial and Commercial Bank of China since August of this year already assuming a leading role.

CCB has already entered memoranda of intention of cooperation with 42 enterprises, and executing framework agreements worth over 500 million yuan in total.

According to Guo Tianyong, the chairman of China Banking Sector Research Centre at Beijing’s Central University of Finance and Economics, banks have a strong understanding of corporate debt, which means the vehicles they establish have advantages with respect to commercial negotiations and execution.

Yang Tao (杨涛), vice-head of the China Academy of Social Sciences Institute of Finance and Banking, said to Yicai.com that “overall, the progress of debt-equity swaps has obtained results in accordance with expectations,” and that debt-equity swap vehicles will expand in number as well as diversify.

In addition to the big state-owned banks, other participants will include local asset management vehicles, while the entry of foreign capital will also accelerate.

Yang points out that debt-equity swaps continue to suffer from a number of problems, however, chief amongst whether or not financial institutions can effectively control related risk.

According to Yang the implementation of debt-equity swaps could hamper short-term bank profits, put capital adequacy ratios under pressure, or lead to an abrogation of priority payments to creditors.

Another major problem Yang highlights is the potential for debt-equity swaps to simply serve as a means of rolling over debt, instead of genuinely convert debt into equity.

While commercial banks may execute debt-equity swap agreements with enterprises in name, they often require the repurchase of equity by local government funds over the long-term, converting the swap agreement into a loan.

Other analysts have also pointed out that the central government’s recent decision to allow    investment vehicles to issue bonds in order to fund their swap deals, which could have the effect of simply shifting debt to other parts of the financial system without reducing overall leverage levels.

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