After years of turbulence, Chinese property giant Evergrande was hit with a winding-up order by a judge in Hong Kong on Monday, setting up a multibillion-dollar battle between Western creditors and Chinese authorities.
In a dramatic escalation of Evergrande’s plight, the world’s most indebted property company failed to convince Judge Linda Chan that it had a viable restructuring plan – three years after the company first defaulted on its debt.
“Enough is enough,” said Judge Chan, as she ordered Evergrande to liquidate.
The decision wiped a fifth off its share price in Hong Kong before trading was halted, meaning Evergrande – which was founded by Hui Ka Yan in 1996 – is now worth $275m (£216m) but has $328bn of debt.
Given the scale of its borrowings, it is unclear what happens next.
The one certainty is that there will be an almighty battle between Western financiers and Chinese policymakers.
Despite Evergrande’s liquidation being decided by a court in Hong Kong, the vast bulk of the company’s assets are held in mainland China.
This means Western investors who lent it billions of dollars must now proceed through the Chinese courts, pitting them against Beijing policymakers, retail investors, and small suppliers.
In theory, the latter two will rank lower than overseas investors when it comes to sharing payouts.
An ad hoc creditor group of offshore bondholders, advised by Moelis & Company and Kirkland & Ellis, has already been leading efforts to recoup cash but now they face a new challenge.
Will local authorities stiff them, further undermining China’s status as an international market? Or will they be minded to preserve China’s attractiveness to Wall Street and the City of London and pay investors back?
“If there’s a choice that needs to be made, I’m sure the Chinese Government will protect the domestic retail investor versus the foreign one,” said Natixis’ Hong Kong senior economist Gary Ng.
Evergrande has around 1,000 projects across mainland China, although Duncan Wrigley, chief China economist at Capital Economics, warns that investors will struggle to get their money back.
“Even if the mainland courts accept this, it is going to run into political and social issues,” he says.
“I don’t think local governments are going to be amenable to just selling them off and getting the money over as quickly as possible.”
For Western investors, the liquidation of Evergrande marks the end of a slow-motion car crash that started several years ago.
Before China’s property crisis, when the so-called Golden Era was in full swing, Evergrande raised money by issuing IOUs in dollars rather than renminbi to lure international investors.
Western fund managers like Ashmore, Amundi and Legal & General, as well as banks such as HSBC and UBS, lapped up so-called “Kungfu bonds”, with Evergrande holding around $19bn worth of IOUs at its peak.
However, as the company unravelled and ultimately defaulted, these bonds fell from being worth 95 cents in the dollar to just 20.
They are now trading at around just 1.5 cents in the dollar, attracting the attention of vulture funds who buy cheap debt to squeeze a few more pennies from insolvency.
In recent years, Evergrande’s debt has been acquired by funds such as Saba Capital Management, led by US hedge fund boss Boaz Weinstein, who made millions of dollars from the infamous “London Whale” trade.
It is unclear which investors sit in the bondholder group led by Moelis and Kirkland while Saba declined to comment.
However, one bond investor says: “At those prices, they will be purely distressed guys.
“These are teams where there are as many lawyers as there are portfolio managers because the key thing is trying to predict how courts will play it.”
Predicting how mainland courts in China will rule on commercial disputes is an unenviable task.
And in this case, China may be hesitant to follow through with Evergrande’s liquidation order for a range of complex political reasons.
Firstly, the Hong Kong court order was made on the same day that new rules designed to increase mutual recognition of judgements in courts between Hong Kong and China came into force.
How China responds to Evergrande will set a major precedent.
Secondly, the vast majority of Evergrande’s assets are in mainland China.
Local government financing has long been intertwined with property development and if Evergrande’s assets are rapidly sold, there could be a ripple effect of unintended consequences.
The third factor is that President Xi Jinping’s economic priorities have changed.
He now cares less about the message he sends to international investors as he tries to move the economy away from investment and property, says William Hurst, Chong Hua Professor of Chinese Development at the University of Cambridge.
Instead, he says the President is focusing on consumption and higher-value production.
“In the past, the Chinese government has frequently erred on the side of better protections for large foreign investors,” he says. “But certainly the Chinese government currently does favour the domestic economy over going back to the export-driven, foreign direct investment dependent model that was there for so many years.”
But Xi Jinping is being pulled in two directions.
“There’s a bit of schizophrenia,” Hurst adds. “On the one hand, there is huge domestic emphasis and a trepidation about too much international integration.
“On the other, there is an overriding imperative to try to bring global business back to China.”
The bond investor adds: “Xi is paranoid about a subprime crisis, which leaves him in a tough spot.
“The longer-term repercussions of this is that international investors are going to get less involved but he’s a bit less worried about that. He doesn’t necessarily mind. A bit less capital in there, keeping it cooler – he doesn’t feel that’s the end of the world.”
Still, as the saga moves to the next phase, the outcome for international investors may be more nuanced.
They could take a small haircut on their investment in return for the guarantee of at least some return on their cash.
“There’s still uncertainty about whether the offshore investors will be high enough in the repayment rankings to actually recover some of their assets and whether that will be enforced in China,” says Ng.
Undoubtedly, this will spark unease for investors around the world and all eyes will be on Beijing as Evergrande limbers up for the next stage of its crisis.
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