The Legal Treatment of China’s Corporate Debt
Problems: Case Studies of Trust Products andCorporate Bonds
Eiichi Sekine
Chief Representative, Beijing Representative OfficeNomura Institute of Capital Markets Research

I.

Failure to repay trust products

1. Failure to repay trust product invested in private coal-mining company inShanxi Province
1) Origination of trust products and sale via banks
Earlier this year corporate debt problems in China attracted the attention of market
participants around the world. The cases in question were reminiscent of the collapseof Guangdong International Trust and Investment Corporation (GITIC), the financial
arm of the province of Guangdong, in October 1998.
The first case was a failure to repay a trust product. In February 2011, China Credit
Trust, one of China’s largest trust companies, originated a collective trust product(“Credit Equals Gold #1”) that was privately placed with qualified institutional
investors (Figure 1). The proceeds of the issue were lent to Zhenfu Energy Group, aprivate coal-mining company in Shanxi Province. The amount raised was RMB3.03
billion and the maturity was three years.
Figure 1: China: case of China Credit Trust’s trust product
ICBC(selling agent)

China Credit Trust(product origination)

Shanxi provincial
government(regulation)
Granting mining licenses
Maintaining local financial stability

Off bank's balance sheet

Private placement(700-plus
investors)

RMB3bn(senior debt)

Investment

Inability to repay

Assumption of
responsibility forrepaying principal

Source:1

Zhenfu Energy Group(private coal-mining
company)

Trust product("Credit Equals Gold #1")
Inability to repay

Third party(who?)How to recover
the funds?

Nomura Institute of Capital Markets Research, from China Credit Trust data andChina Securities Journal, 28 January 2014

Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

The RMB30 million subordinated portion was kept by the group’s owner, while theremaining RMB3.0 billion senior portion (with an expected rate of return of 9.5–
11%)1 was sold to investors via Industrial and Commercial Bank of China (ICBC).
This kind of cooperation between trust companies and banks where banks market trust
products is called in Chinese yinxin hezuo.

2) Repayment problem and outcome
The group used the money to develop its mining business. However, as a result of
falling coal prices, problems with local residents, and its failure to obtain a mining
license, the group found itself unable to repay its debts by the redemption deadline of
31 January 2014. This became public knowledge on 20 December 2013. As a result,according to a report in the Shanghai Securities News on 24 January 2014, the selling
agent, Industrial and Commercial Bank of China (Shanghai Branch), announced on 23
January 2014 (1) that it would honor its responsibilities towards investors and (2) that
it would publish a bailout plan by 28 January.
Subsequently, on 27 January, according to a 28 January 2014 report by China
Securities Journal, China Credit Trust offered just over 700 investors the option ofeither (1) accepting repayment of only the principal by a third party and foregoing any
payment of interest or (2) extending the maturity of the trust product (with noguarantee of (re)payment of either principal or interest) in what amounted to anagreement to repay the RMB3.0 billion of principal. We see this as an attempt toresolve the issue before the Chinese New Year holiday, which, as it happens, was due
to begin on the mainland on 31 January. However, no one knows who assumed
responsibility for repaying the principal or where the money came from.

2. Legal status of trust products
1) Regulations governing the trust business and trust companies
The trust business and trust companies are subject to the law.
First of all, as part of the process of restructuring trust companies and learning
lessons from the collapse of GITIC (see above), the Standing Committee of the
National People’s Congress (China’s parliament) passed and promulgated the Trust
Law on 28 April 2001 with effect from 1 October 2001.2
The Trust Law consists of a total of 74 articles: Chapter I, General Provisions(Articles 1–5); Chapter II, Creation of a Trust (Articles 6–13); Chapter III, Trust
Property (Articles 14–18); Chapter IV, Parties Concerned in a Trust (Section 1, Settler,
Articles 19–23; Section 2, Trustee, Articles 24–42; Section 3, Beneficiary, Articles
43–49); Chapter V, Modification and Termination of Trust (Articles 50–58); Chapter
1

2

The interest rate set by the People’s Bank of China on ordinary savings accounts is
0.35%, while that on one-year savings deposits is 3.00%. (Both rates have applied since 6
July 2012.)
http://www.pbc.gov.cn/publish/tiaofasi/272/1384/13844/13844_.html
The Legal Treatment of China’s Corporate Debt Problems:Case Studies of Trust Products and Corporate Bonds

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VI, Charitable Trust (Articles 59–73), and Chapter VII, Supplementary Provisions(Article 74).
Second, as part of the process of regulating trust companies, the industry’s
regulator, the China Banking Regulatory Commission (CBRC), promulgated theRules Governing Trust Companies on 23 January 2007 with effect from 1 March
2007.3
These rules consist of a total of 66 articles: Chapter I, General Provisions (Articles1–5); Chapter II, Incorporation, Change and Termination (Articles 6–15); Chapter III,
Business Scope (Articles 16–23); Chapter IV, Business Operations (Articles 24–42);
Chapter V, Supervision and Regulation (Articles 43–57); Chapter VI, Penalties(Articles 58–63); and Chapter VII, Supplementary Provisions (Articles 64–66).

2) Defining “trust” and “trust property”
Next we consider the definitions of “trust” and “trust property.”
First, “trust.” Article 2 of the Trust Law defines “trust” as follows: “For the
purposes of this Law, trust refers to the fact that the settler, based on his faith in thetrustee, entrusts his property rights to the trustee and allows the trustee to, according
to the will of the settler and in the name of the trustee, administer or dispose of suchproperty in the interest of a beneficiary or for any intended purposes.”
Second, regarding the scope of a trust company’s business, Article 16 of the Rules
Governing Trust Companies lists various types of trust business, including thefollowing: (1) the entrusted management of cash, (2) the entrusted management of
movable property, (3) the entrusted management of real estate, and (4) the entrusted
management of securities. In addition, regarding the aforementioned administration or
disposal of trust property, Article 19 of the Rules Governing Trust Companies
stipulates (1) that a trust company may manage, use or dispose of the entrusted
property by means of investment, sale, interbank placement, purchase-and-sellback,leasing and lending, etc. according to entrustment contracts, but (2) that, if the CBRC
otherwise makes a policy on it, such policy shall prevail.

3) Different sources of trust business
Next we consider trust companies’ different sources of business.
First, trust companies have three different sources of business: (1) collective trusts,(2) single trusts, and (3) property management trusts. (1) Collective trusts manage theassets of a number of investors whereas (2) single trusts manage those of a single
investor. In both cases, the trustee manages the entrusted assets (e.g., in the form of aloan trust or as a bond investment). The trust product mentioned earlier (“Credit3

http://www.cbrc.gov.cn/chinese/home/docDOC_ReadView/2007020146C75FE4EC42DAA
9FFADADCB71D8A300.html

3

Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

Equals Gold #1”) was a collective trust. Property management trusts manage
entrusted assets according to the original function of a trust.
As of end-December 2013, the amount of trust assets under management in China
was RMB10,907.1 billion. Of this amount, RMB2,715.5 billion was managed in theform of collective trusts, RMB7,503.0 billion in the form of single trusts, andRMB598.6 billion in the form of property management trusts (Figure 2). The lion’sshare (namely, RMB4,858.1 billion or 47.13%) of the RMB10,308.5 billion in assets
managed as either collective or single trusts as of end-December 2013 was managed
in the form of loan trusts, while the next-largest share (RMB1,908.9 billion or
18.52%) was managed in the form of investments held until maturity.
Figure 2: China: breakdown of trust assets under management (by value)(RMB100mn)
80,00070,00060,00050,00040,00030,00020,00010,000
0
3

6

9

12

2010

3

6

9

12

2011

3

6

9

2012

12

3

6

9

12

2013

(Year/month-end)
Collective trusts

Source:Single trusts

Property management trusts

Nomura Institute of Capital Markets Research, from China Trustee Associationdata

3. Regulations governing collective trusts
1) Rules on Trust Schemes of Collective Funds by Trust Companies
Investment schemes (products) based on collective trusts such as theaforementioned “Credit Equals Gold #1” are governed by special rules.
These are the Rules on Trust Schemes of Collective Funds by Trust Companies
promulgated by the CBRC on 23 January 2007 with effect from 1 March 2007.4 A
revised version was subsequently promulgated on 4 February 2009 with immediate
effect. 5 These rules consist of a total of 55 articles: Chapter I, General Provisions(Articles 1–4); Chapter II, Establishment of Trust Schemes (Articles 5–18); Chapter
45

http://www.cbrc.gov.cn/chinese/home/docDOC_ReadView/2007020140E41E8F4749E6F4FF15F12F68C86600.html
http://www.cbrc.gov.cn/chinese/home/docDOC_ReadView/200909155AD71D59AFD82FB
5FFA27E225216B800.html
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III, Custody of Trust Scheme Property (Articles 19–22); Chapter IV, Operation andRisk Management of Trust Schemes (Articles 23–28); Chapter V, Alteration,
Termination and Liquidation of Trust Schemes (Articles 29–33); Chapter VI,
Information Disclosure and Supervision (Articles 34–40), Chapter VII, Beneficiaries’
Meeting (Articles 41–46); Chapter VIII, Penalties (Articles 47–51); and Chapter IX,
Supplementary Provisions (Articles 52–55). The main points of the rules are as
follows (Figure 3).
First of all, the rules define “trust schemes” as “entrusted fund management
activities where a trust company acts as a trustee, in line with the clients’ will, tomanage, use or dispose of the funds entrusted by two or more clients in a collective
manner with a view to benefiting the beneficiaries.”

Figure 3: China: main rules governing collective trusts
Rules on Trust Schemes of Collective Funds b y Trust Companies(revised version promulgated with immediate effect on 4 February 2009)

Name of law
Definition of collective
trust plan

Article 2・ Entrusted fund management activities where a trust company acts as a trustee, inline with the clients' will, to manage, use or dispose of the funds entrusted by two
or more clients in a collective manner with a view to benefiting the beneficiaries.

Definition of settler
Definition of qualified
investor

Article 5(1)Article 6

Requirements forestablishment of trust
plan
Product design

Article 5(3)・ The settler must be a qualified investor.
・ One of the following types of investor:① A natural person, corporation, or other organization investing at least RMB1
million in a single trust plan.
② A natural person (individual or household) with financial assets of more than
RMB1 million at the time of purchase. He/She must be able to provide proof of
their financial assets.
③ An individual with an annual income of more than RMB200,000 for the past three
years or a couple with a joint annual income of more than RMB700,000 for the
past three years. He/She/They must be able to provide proof of their income.
・ No more than 50 natural persons per trust plan.
・ However, this numerical restriction does not apply if the amount entrusted per
natural person investor or qualified institutional investor is at least RMB3 million.
・ A trust period of at least one year.
・ The entrusted money must have a clear investment strategy and comply withgovernment industrial policy and any related rules.
・ The trust company may not guarantee the plan against losses or guarantee any
minimum return.
・ The trust plan may not be used as a third-party guarantee.
・ Any loans to third parties may not exceed 30% of the value of the trust plan's
assets on an actual return basis. However, any rules issued by the CBRC takeprecedence.
・ The trust money may not be invested, either directly or indirectly, by either
shareholders or affiliates of the trust company. However, this does not apply if alla trust plan's money originates from the trust company's shareholders oraffiliates.
・ Where a trust company manages the entrusted property in line with the trust
scheme documents, the risks arising from the management shall be covered by
the entrusted property.
・ A trust company that infringes an entrustment contract or causes a loss to thetrust property as a result of not taking due care must make good the loss using its
own assets. If the trust company is unable to make good the entire loss, theinvestors must bear the residual loss.

Article 5(4)Article 5(5)Rules governing product Article 8(1)designArticle 27(1)Article 27(2)Article 27(3)Risks and losses to trust Article 14
property

Source:5

Nomura Institute of Capital Markets Research, from CBRC data

Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

Second, only “qualified investors” may invest in collective trust schemes. As a rule,
only investors with a minimum of RMB1 million to invest per scheme are considered.
Third, trust companies are forbidden from guaranteeing entrusted funds against
losses or guaranteeing minimum returns.

2) Attitude of collective trusts to risks and losses to trust property
The rules also define risks and losses to the trust property of collective trust
schemes.
First of all, where a trust company manages the entrusted property in line with thetrust scheme documents, the risks arising from the management shall be covered by
the entrusted property.
Although the rules do not explicitly define “risk,” we assume that this would inpractice mean extending the trust period. In such cases, a beneficiaries’ meeting has tobe convened. Alternatives would be for the scheme concerned to be taken over byanother scheme or, where the priority was to recover funds or distribute income at theend of the trust period, to proceed against the investment collateral.
Second, a trust company that infringes an entrustment contract or causes a loss tothe trust property as a result of not taking due care must make good the loss using its
own assets. If the trust company is unable to make good the entire loss, the investors
must bear the residual loss.
This applies if the trust company infringes any regulations or fails to exercise due
diligence. However, in such cases, investors bear joint responsibility for making good
any losses.

3) The case of “Credit Equals Gold #1”
It is not clear which of the above applied in the case of “Credit Equals Gold #1.”
However, the fact that investors were given the choice of either having the scheme
taken over by a third party or having the trust period extended suggests to us that it
was probably the former rule that was applied.
As far as the identity of the third party is concerned, some take the view that it was(1) China Credit Trust, Industrial and Commercial Bank of China, or the Shanxi
provincial government, while others take the view that it was (2) China Huarong
Asset Management, a bad debt manager affiliated to ICBC. However, ICBC, theShanxi provincial government, and Huarong all deny any involvement. Whatever thetruth of the matter, the assets underlying the loan to Zhenfu Energy Group still exist,
and investors will want to know how they are going to be managed and recovered.

The Legal Treatment of China’s Corporate Debt Problems:Case Studies of Trust Products and Corporate Bonds

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II. Corporate bond defaults
1. What are “corporate bonds” (gongsizhai) in China?
In March of this year corporate debt problems in China attracted the attention ofmarket participants around the world because of the first default on a corporate bondon the mainland. Before we look at this case in more detail, it may be appropriate toconsider the types of fixed-income products available in China and the organizations
responsible for regulating them. This is because the regulator and the market varyfrom product to product.
The first type of fixed-income product is “enterprise bonds,” which are regulatedby the National Development and Reform Commission (NDRC). Although thesebonds are listed on a stock exchange, they can also be listed on the interbank bondmarket.
The second type of fixed-income product is the commercial paper and mediumterm notes registered with China’s National Association of Financial Market
Institutional Investors (NAFMII), which is regulated by the People’s Bank of China(PBOC). Commercial paper and medium-term notes are issued on the interbank bondmarket.
The third type of fixed-income product is the corporate bonds regulated by the
China Securities Regulatory Commission (CSRC). As these bonds are listed on astock exchange, they have the status of publicly listed corporate bonds.
Because each type of fixed-income product is issued on a different market, theyeach attract different types of investors. The main investors on the interbank bondmarket are commercial banks and other financial institutions (institutional investors).
Stock exchanges, on the other hand, attract both institutional investors, especiallysecurities companies and fund management companies (investment trusts), andindividual investors.

2. Default of Shanghai solar cell/panel manufacturer on corporate bond
1) Overview
On 7 March 2012, the solar cell/panel manufacturer Shanghai Chaori Solar Energy
Science & Technology Co., Ltd. (“Chaori Solar”) issued a corporate bond, which waslisted on the Shenzhen Stock Exchange on 20 April of the same year. The bond isreferred to as the “Chaori-11 bond.” The CSRC approved the issue on 20 October
2011.
The issue amount was RMB1 billion; the maturity was five years; and the coupon
was 8.98%. Under the terms of the bond indenture, the issuer was due to pay intereston the bond on 7 March, starting in 2013, and had an option to vary the coupon or buy
the bond back from investors from March 2015 (i.e., three years after the bond wasissued). China Securities is the sponsor, lead manager, and “bond trustee” (i.e., bondmanager).
7

Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

2) Background to partial default on interest rate payment
The credit rating company was Pengyuan Credit Rating, which initially rated boththe issuer and the bond AA. Pengyuan subsequently lowered its rating on both theissuer and the bond to CCC (non-investment grade) on 18 May 2013 after Chaori
Solar made a loss for two consecutive years (2011 and 2012). Also, trading in thebond was suspended from 8 July 2013.
Chaori Solar faced a liquidity crisis at the end of 2012. The bond trustee, China
Securities, called on Chaori Solar to increase its collateral. Once Chaori Solar did this,
China Securities announced the fact on 18 January 2013.
However, on 5 March 2014, two days before Chaori Solar was due to make apayment of RMB89.8 million in interest, Chaori announced that it would only be able
to pay RMB4 million in interest.

3. Legal status of Chinese corporate bonds
1) Regulations governing corporate bonds
The following are the main regulations governing Chinese corporate bonds.
First of all, China’s Securities Law, the most recent amendments to which were
promulgated on 27 October 2005 with effect from 1 January 2006,6 governs the issue
and listing of corporate bonds. 7 As happened in the case of the Chaori-11 bond,
Article 60(5) stipulates that the stock exchange on which a corporate bond is tradedmust suspend trading in the bond if its issuer makes a loss for two years in succession.
Since April 1998, Chinese stock exchanges prefix the letters “ST” (special
treatment) to the names of such listed companies. Furthermore, since May 2003,“*ST” is prefixed to the names of such listed companies if the risk of a delisting is
considered particularly high. This has been the case with the Chaori-11 bond since
May 2013.
Second, on 14 August 2007, the CSRC promulgated Provisional Measures for theIssuance of Corporate Bonds 8 as detailed rules for the implementation of the
Securities Law with immediate effect. These measures consist of a total of 32 articles:
Chapter I, General Provisions (Articles 1–6); Chapter II, Terms of Issue (Articles 7–11); Chapter III, Issue Procedures (Articles 12–22); Chapter IV, Bondholders’ Rights(Articles 23–27); Chapter V, Supervision and Regulation (Articles 28–31); andChapter VI, Supplementary Provisions (Article 32).

678

http://www.csrc.gov.cn/pub/newsite/flb/flfg/flxzsf/201312/t20131205_239325.htm
For further details of the Securities Law’s rules governing the issuance of securities in
China, see Nomura Institute of Capital Markets Research, “Chuugoku Shouken Shijou
Taizen” (Compendium of Chinese Securities Markets), Nihon Keizai Shimbunsha, 2007.
http://www.csrc.gov.cn/pub/zjhpublic/zjh/200804/t20080418_14512.htm
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The following provisions are important with regard to Chaori Solar’s default on theinterest payment on its bond. First of all, Article 25 stipulates that the bond trustee
must constantly monitor the credit status of the issuer and the guarantor, and, in theevent that anything occurs that might materially affect the interest of the bondholders,convene a meeting of the creditors (i.e., bondholders). Second, Article 27 stipulates
that one particular case where such a meeting must be convened is when an issuer isunable to service its debt according to schedule. Chaori Solar’s default on payment ofinterest on its bond would seem to us a prime example of the need to convene such ameeting to determine what to do next.

2) Bond trustee’s response to interest payment default
In its public notice of 5 March 2014,9 the bond trustee, China Securities, explained,
first, that, in accordance with the bond’s issue prospectus and deed of trust (i.e.,
indenture), it would give notice within five days of 7 March 2014, the date on which
the issuer was due to pay interest, (namely, on 11 March 2014) of a creditors’ meeting
and would convene such a meeting in good time.
Second, it gave notice that the meeting would discuss matters within the bondtrustee’s competence: namely, any proposals for safeguarding the creditors’ legal
interests (e.g., by suing the issuer), taking any reasonable and practicable legal action,or proceeding against the collateral.
In addition, Article 25 stipulates that, if an issuer is unable to make repayments, thebond trustee is obliged to (1) either call on the issuer to increase its collateral or torequest that the assets be protected by organs of the law in accordance with the law,and to (2) institute legal proceedings against the issuer, such as liquidation,
compromise, restructuring, or bankruptcy, if requested to do so by the bondholders.

3) Creditors’ meeting held on 26 March 2014
In its public notice of 11 March 2014,10 China Securities notified the bondholders
that a creditors’ meeting would be held in Shanghai on 26 March at 14:00. The noticealso contained four proposals: (1) to authorize the bond trustee (i.e., China Securities)
to bring a civil action against the issuer for default on its interest payment; (2) toauthorize the bond trustee to proceed against the collateral of the Chaori-11 bond by
way of payment of interest; (3) to authorize the bond trustee to institute legal
proceedings (such as liquidation, compromise, restructuring, or bankruptcy11) against
Chaori Solar; and (4) concerning how the creditors’ meeting should be held and a votetaken. Proxy voting is permitted. As it emerged before the meeting due to be held on
9
10
11

9

http://disclosure.szse.cn/m/finalpage/2014-03-05/63638382.PDF
http://disclosure.szse.cn/m/finalpage/2014-03-11/63660439.PDF
For an overview of China’s Enterprise Bankruptcy Law’s rules governing the liquidation
process in bankruptcy cases, see Sekine, Eiichi, “Chuugoku no Chihou Saimu o Dono
You ni Toraerubeki na no ka” (What Should We Make of China’s Local Government
Debt?), Capital Market Quarterly, Autumn 2013 (in Japanese).

Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

26 March that fewer than the number of bondholders needed for any resolution to bevalid (namely, those holding more than 50% of the unredeemed bonds at par value)
had registered, the bond trustee issued a notice on 21 March postponing the meeting.
While it is still unclear whether Chaori Solar’s inability to pay part of the interest is
simply confined to the interest or whether, in future, it could even extend to
repayment of the principal, the above proposals suggest to us that the bond trustee
may have allowed for the possibility that Chaori Solar could eventually be declaredbankrupt. According to a 6 March 2014 report by Xinhua News Agency, Chaori Solar
itself claims that it might be able to make an additional interest rate payment if
negotiations to sell some of its equipment to Greece are successful. Be that as it may,the priority is to see what happens at the creditors’ meeting.

4) The views of market participantsJudging by reports in the Chinese media, market participants have welcomed thedefault on an interest rate payment on a bond issued by a company in a sector withexcessive production capacity such as solar cells/panels as reducing the risk of moral
hazard by issuers and investors. They also appear to think that this is probably thepolicy objective of the financial authorities in China.
As it happens, at a press conference on securities and futures on 6 March 2014, Mr
Ouyang Zehua, a delegate to the National People’s Congress and Director of the
CSRC’s First Supervision Department for Listed Companies, said (1) that Chaori
Solar’s default was the first interest payment default on the market for publicly
offered corporate bonds and (2) that the CSRC was watching the situation very
carefully in case it developed into either an isolated or a systemic risk.12 In addition,
while the move by the bond trustee to take civil action against the issuer should be
welcomed for increasing market discipline, it also suggests to us that the financial
authorities were eager to avert any systemic risk.

III. Background to and outlook for China’s corporate debt
problems
1. Other examples of problems with trust products
The case of China Credit Trust at the beginning of this report has actually not been
the only example of a problem with trust products. A special report on trust products inthe 27 January 2014 edition of Century Weekly describes 11 such cases that occurred in
2013. Six of these involved real estate companies, while two involved resource
producers.
According to data from the China Trustee Association (CTA), the number of new
trusts increased from 8,090 in 2010 to 13,428 in 2011, 16,729 in 2012, and 20,672 in
12

http://www.financialnews.com.cn/yw/jryw/201403/t20140307_51076.html
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2013. Of the RMB10,308.5 billion of assets under management by trust companies asof the end of December 2013, the lion’s share (namely, RMB2,900.5 billion or 28.14%)
was invested in “industrial and commercial companies,” while the next-largest share(RMB2,602.9 billion or 25.25%) was invested in “basic industries,” with RMB951.3
billion (or 12.00%) invested in “financial institutions” and RMB811.9 billion (or10.03%) in “real estate companies” (Figure 4). The private coal-mining companies
involved in these cases probably belong to the category “industrial and commercial
companies.” Similarly, the category “basic industries” probably includes the local
government infrastructure and utility companies financed by local government
financing vehicles (LGFVs).

Figure 4: China: breakdown of trust assets under management(by investment sector)
Basicindustries,
25.25%

Other,
14.23%

Industrial andcommercial
companies,
28.14%

Financial
institutions,12.00%

Note:
Source:Real estate,10.03%

Securities(bonds),
6.67%

Securities(equities),
2.94%
Securities(funds),0.74%

Data as of end-December 2013.
Nomura Institute of Capital Markets Research, from CBRC data

The above cases and the amount of assets under management by trust companies
suggest to us that the problems are currently confined to particular parts of the country
or particular sectors of the economy. However, according to a 12 February 2014 reportin the Shanghai Securities News, Shanxi Liansheng Energy, a private coal-mining
company, failed to repay principal and interest on a trust product, originated by Jilin
Province Trust and marketed by China Construction Bank, by the 7 February deadline
and was in arrears. (The trust product had raised RMB289 billion and was expected togenerate a return of 9.8% a year.) Investors, both Chinese and overseas, are following
the situation closely to see whether the problems, which have thus far been confined toparticular parts of the country and sectors of the economy, spread and how the financial
authorities, trust companies, and the banks that market these products react—just incase the problems pose a risk to financial markets.

11 Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

2. Size of corporate bond market and main industries
Since the corporate bond market was established in 2007, annual issuance,
according to data from the CSRC, 13 increased 22.4-fold from RMB11.2 billion in2007 to RMB250.7 billion in 2012 (Figure 5). Similarly, the outstanding amount ofcorporate bonds issued increased 48.5-fold from RMB11.2 billion at the end of 2007
to RMB543.3 billion at the end of 2012.

Figure 5: Annual issuance and outstanding amount of corporate bonds(RMB100mn)
3,000(RMB100mn)
6,000

2,500

5,000

2,000

4,000

1,500

3,000

1,000

2,000

500

1,000

0

0
2007

2008

2009

Annual issuance (lhs)

Source:

2010

2011

2012

(CY)

Outstanding amount (rhs)

Nomura Institute of Capital Markets Research, from China Securities Regulatory
Commission, China Securities and Futures Statistical Yearbook 2013, China
Statistics Press, 2013

Also, according to a different source (data from Shanghai Wind Information),
RMB50.8 billion (or 39.30%) of the RMB129.1 billion in corporate bonds issued in2011 was issued by companies in the raw material sector while RMB44.7 billion (or34.62%) was issued by industrial companies. In 2012, RMB74.6 billion (or 28.6%) of
the RMB260.3 billion in corporate bonds that was issued was issued by industrial
companies while RMB57.6 billion (or 22.11%) was issued by companies in the raw
material sector.
As of 10 March 2013, 26 of the 1,578 companies listed on the Shenzhen Stock
Exchange were prefixed with “*ST,” with manufacturing accounting for 20 of these.
Furthermore, as of the end of February 2014, 192 of these companies had issued
bonds listed on the same exchange. One of these companies was Chaori Solar, which
is classified as a manufacturer. Holders of the Chaori-11 bond had been alerted by theexchange’s delisting warning system of the risk that the bond might be delisted. In
13

China Securities Regulatory Commission, China Securities and Futures Statistical
Yearbook 2013, China Statistics Press, 2013.
The Legal Treatment of China’s Corporate Debt Problems:Case Studies of Trust Products and Corporate Bonds

12

addition, exchange trading in the bond had been suspended. Therefore the default of abond prefixed with “*ST” should not have come as a surprise to any of thebondholders, who should have been prepared for the news.

3. Possible risk scenarios
Chinese companies have recently been able to raise funds via the shadow banking
system, which includes products such as the aforementioned trust products, as well as
in the more traditional form of bank loans or via the capital market. We can envisage
two possible scenarios for the problems that emerged in 2014 in connection with trust
products and corporate bonds.
First of all, trust products. The commercial banks that market these products are
not responsible for their redemption. However, if they did accept some of the
responsibility in order to preserve their reputation, overseas credit rating agencies
would regard the amounts as contingent liabilities on the banks’ balance sheets andpossibly lower their ratings. In particular, if banks listed on overseas exchanges were
subject to a possible re-rating, this could have a knock-on effect on overseas financial
markets (Scenario 1).
Second, if there were defaults on a large number of trust products, even if confined
to particular parts of the country or sectors of the economy, this could have a knockon effect, especially on domestic financial markets, if other companies in the same
sector with corporate bonds were re-rated. This would inevitably affect the confidenceof overseas investors, as well (Scenario 2).
In either case, if there was a knock-on effect on financial markets, the initial
response of the government, including the financial authorities, and especially the
dissemination of news to market participants and proposals for a convincing
resolution, would be crucial.

IV. In conclusion
Because of concern about corporate debt, the People’s Bank of China has
published financial indicators for the country’s 5,000 largest companies. Following
the global financial crisis of 2007, the debt-equity ratio (current liabilities + long-term
liabilities/total assets × 100%) of these companies rose from its 2007 pre-crisis levelof 58.3% to 58.9% in 2008 and to 60.2% in 2009 and 2010 (Figure 6). Since then, it
has continued to rise (i.e., deteriorate): to 61.1% in 2011, 61.5% in 2012, and 62.0%
at the end of August 2013.

13 Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1

Figure 6: China: debt-equity ratio of 5,000 largest companies
(%)
68
66
64
62
60
58
56
54
52
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13(CY)

Note: 1. Annual data as of end-December. Data for 2013 as of end-August.
2. Raw data from People’s Bank of China.
Source: Nomura Institute of Capital Markets Research, from CEIC data

This deterioration illustrates the worsening of China’s corporate debt problem.
However, the economic reform program adopted by the Third Plenary Session of the
18th CPC Central Committee in November 2013 confirms a number of policies,
including the creation of a long-term mechanism for preventing and alleviating
industrial overcapacity as well as a system of mixed government/private-sector
ownership to make it easier to restructure state-owned enterprises.14 As it happens, on
4 July 2013 the State Council promulgated Some Opinions on Promoting the Healthy
Development of the Photovoltaic Industry (the Opinions were actually issued on 15July) 15 with a view to dealing with the industry’s overcapacity by concentrating
resources on assisting the development of key competitive companies while leaving
uncompetitive companies to fend for themselves. In response, on 16 September, theMinistry of Industry and Information Technology, which oversees individual
industries, published guidelines,16 which, amongst other things, prohibit new capital
investment intended merely to increase capacity and require companies planning tobuild new production facilities to invest in research and development at the same time.
This was followed on 30 December 2013 (after the Third Plenary Session of the 18th
CPC Central Committee) by the publication by the ministry of a list of 109 bluechip
manufacturing companies that meet the criteria set out in the guidelines.17 As Chaori
Solar was one of the companies on the list (No. 60),18 we need to wait for what isrevealed at the creditors’ meeting to find out whether its interest payment default was

14

15
16
17
18

Sekine, Eiichi, “A Securities Market View of the Third Plenary Session of the 18th CPC
Central Committee,” Nomura Journal of Capital Markets, Spring 2014, Vol.5, No.4.
http://www.gov.cn/zwgk/2013-07/15/content_2447814.htm
http://www.gov.cn/zwgk/2013-09/17/content_2490100.htm
http://www.miit.gov.cn/n11293472/n11293832/n12845605/n13916898/15809356.html
http://www.miit.gov.cn/n11293472/n11293832/n12845605/n13916898/n15809356.files/n1
5808982.pdf
The Legal Treatment of China’s Corporate Debt Problems:Case Studies of Trust Products and Corporate Bonds

14

the result of temporary factors or of structural factors that could affect its ability to
repay the principal.
Another important consideration is that China’s corporate debt problem can only
be resolved if corporate reforms and the financial reforms that should enable them are
pursued in parallel. In our view, a consensus on such a holistic approach is being
formed within the Chinese leadership. Another prerequisite with regard to thefinancial system is reform of the shadow banking system, which has helped Chinesecompanies to raise funds. However, we will address this issue on another occasion.
Yet another prerequisite, if the tacit assumption underlying the corporate debt problem(namely, that the government will always bail out companies in trouble) is to bedispelled, is reform of the system of government approval of investment. For the time
being we will have to take a long-term view of the package of reforms underlying
how the authorities deal with individual cases.

15 Nomura Journal of Capital Markets Summer 2014 Vol.6 No.1