China Signals Coming Crackdown On $3tn Trust Industry

REPORTS THAT THE leading companies in the $3 trillion trust industry are being audited suggest a coming crackdown on a critical part of China’s financial sector: a hybrid of commercial and investment banking, private equity and wealth management.

Bloomberg reports that for the past month, the National Audit Office has been going over the books of at least 20 trust firms, including the top five.

The concern is the risks the sector poses to financial stability. No other set of financial firms invests in such a broad class of assets, from property to stocks, bonds and commodities. They are also a key intermediary in China’s shadow banking system, a conduit for deposits into risky investments via products often designed to dodge capital or investment regulations.

Auditors appear to be focusing on trust firms’ loans to property developers, suggesting renewed concern on the part of authorities that the problems of the beleaguered property sector could spill over into the broader financial system.

So far this year, trust firms defaulted on $8.6 billion of investment products linked to property developers, according to industry data tracker Use Trust — the knock-on effect of developer defaults and frozen construction across the country.

Trust firms, including Minmetals Trust and Zhongrong Trust, have bought stakes in at least ten troubled real estate projects this year, betting that unfinished homes will eventually yield cash to pay off some of the $230 billion in property-backed funds they have sold to investors.

It is unclear how long the audit inspections will last, whether more firms will be reviewed, or what regulatory actions will follow.

Improving trust firms’ transparency and risk management seems the very minimum to expect. However, that in itself will be insufficient without other changes. Municipal finance needs reforming so that local authorities are not so dependent on land deals to raise revenue and mainstream financial institutions need to offer new retail savings and investment products that can be an alternative to those provided by the shadow banking system.

As Beijing has shown with its rectification of the platform tech companies, it is willing to bear the costs of disrupting even a large domestic industry once it believes that the cost of not doing will be even higher.

World Bank Lowers China Growth Forecast

THE WORLD BANK has cut back its forecast for China’s economic growth this year by 0.8 of a percentage point to 4.3%.

The revision to its forecast in January comes in the latest update to its Global Economic Prospects report.

The Bank forecasts 5.2% growth next year and 5.1% in 2024. Its revision for 2023 is only a 0.1 of a percentage point reduction.

The World Bank is usually among the more optimistic forecasters of China’s GDP growth. A projection for this year so below the official target of 5.5% growth underlines the severity of the economic headwinds China faces; not that many expect the official target to be hit.

The Bank expects the global economy to slow to 2.9% growth this year and not rebound next.

Following more than two years of pandemic, spillovers from the Russian Federation’s invasion of Ukraine …. is leading to high commodity prices, adding to supply disruptions, increasing food insecurity and poverty, exacerbating inflation, contributing to tighter financial conditions, magnifying financial vulnerability, and heightening policy uncertainty… Moreover, the outlook is subject to various downside risks, including intensifying geopolitical tensions, growing stagflationary headwinds, rising financial instability, continuing supply strains, and worsening food insecurity.

On China, the Bank says that strict lockdowns to control Covid-19 outbreaks have been the main reason for slowing growth. Consumer spending has been particularly subdued, and trade and manufacturing investment have lost momentum, exacerbated by supply disruptions and the negative impact of the war in Ukraine.

The pandemic has also reversed the recovery of the real estate investment seen at the start of the year.

In response, authorities have already relaxed some property and financial regulations and eased fiscal and monetary policy. However, the Bank expects more stimulus measures to mitigate the impact of the lingering pandemic and worsening terms of trade.

The Bank is uncertain about the size, composition and effectiveness of policy stimulus, noting that increased investment in the stock of public infrastructure — the tried and trusted measure authorities are most likely to turn to — faces diminishing returns.

The outlook is subject to significant risks.

Repeated COVID-19 outbreaks and strict lockdowns across major cities would curtail the recovery of consumption and services activity, disrupt supply chains, and weigh on investor confidence. In addition, renewed stress in the housing sector would further reduce real estate investment and government revenues, affect the solvency of developers and local government financing vehicles, and weigh on house prices and consumer spending.

It is Covid-19 that hangs heaviest over the outlook. The Bank estimates that a resurgence could reduce China’s growth by a further 0.5 of a percentage point in 2022 and 0.3 of a percentage point in 2023.

Policy Shift Will Favour China’s Tech Platform And Real Estate Firms

THERE IS LITTLE doubt that China’s economic managers are ruffled. The combination of economic headwinds from the war in Ukraine to Covid’s resurgence with its large-scale lockdowns and the uncertainty over the global economy caused by inflation, supply chain chaos and tightening monetary policy are as disruptive as they were unanticipated.

The readout from Friday’s Politburo meeting was a clear recognition that the leadership understands the straitened state of the economy. Thus it is switching the balance of policy priorities from regulation and structural change back to growth.

Evidence of that can be seen in the Politburo’s signalling of an end of the campaign to ‘rectify’ the platform tech companies that started in late 2020, and its declaration that there needs to be liquidity support for beleaguered property development firms.

The English-language version of the readout put less emphasis on continuing regulation of the tech sector than the Chinese version, which, similarly, was clearer that controls on real estate speculation would continue. 

If that was an attempt to send different messages to domestic and international audiences, it strikes this Bystander as cack-handed.

Many international investors have recently turned bearish about China and moved capital out, believing the economy is in worse shape than even the official figures suggest, exacerbated by adherence to the zero-Covid policy.

However, they will judge the concrete support for the ‘healthy’ development of the platform tech and real estate sectors on its merits rather than its promise. That support will come sooner rather than later.

The government wants both sectors to thrive, especially now, but in a way that serves central policy objectives more directly than before. 

And The Greatest Of These Is Stability

THE PECKING ORDER of the priorities laid out by the Financial Stability and Development Committee (FSDC), China’s top financial policy committee, on March 16 is probably stability, economic stimulus and greater clarity on the regulation of the platform internet companies.

The readout from the meeting, chaired by Vice Premier Liu, also represents a short-term order of business in response to some unexpectedly gusty economic headwinds rather than a long-term change of policy course — an effort to stabilise financial markets and bolster investor confidence.

There is nothing in the reports of the FSDC’s deliberations to suggest private companies will not have to align themselves with government policy objectives or that current policy objectives have changed materially.

On the contrary, financial institutions were told to ‘consider the big picture’ and firmly support the development of the real economy, while regulators were told to complete the ‘rectification’ of the platform internet companies soon and with transparency, not to ease off them.

Nonetheless, investors in Chinese financial markets chose to see only light at the end of the tunnel, not the darkness surrounding them of late. The CSI 300 Index of mainland shares climbed 4.3%, while the Hang Seng China Enterprises Index jumped 13% in Hong Kong, recouping nearly half of its loss this year.

The China Banking and Insurance Regulatory Commission encouraged bank subsidiaries, asset managers and insurance companies to increase their investment in equities. The People’s Bank of China said the risks in the real estate market must be dealt with ‘under the principle of steady progress’. The finance ministry let it be known that there would be no further expansion of the property tax trial this year, regardless that President Xi Jinping in a speech last October indicated that a national property tax would be a centrepiece of ‘common prosperity’ .

Going even slower on deleveraging the real estate sector and introducing a property tax is a sign of how worried authorities remain about the housing market’s slump, the intractability of developers’ debt and their potential knock-on effects for the broader economy.

Despite regulators relaxing M&A funding rules and being more permissive towards developers taking on new debt, reversing the squeeze on financing for property developers, potential buyers have remained cautious. It has only really been state-owned banks buying up their clients’ distressed deals.

Reuters news agency has reported that in Shanghai, authorities told local state-owned enterprises (SOEs) to buy new bonds being sold by Greenland, a developer at risk of defaulting on a $500 million offshore bond in December. Reuters says this is the first known example of SOEs being ordered to participate this way in a bailout.

The war in Ukraine poses further challenges to an economy also dealing with an uncertain global economy, the effects of the most menacing surge in new Covid cases since the pandemic’s earliest days at the start of 2020, and the unexpected outflow of capital when other emerging markets are attracting it.

At the Two Meetings earlier this month, authorities made it clear that some long-term economic reforms would be put off for now in order to focus on growth this year. Even before then, at the Central Economic Work Conference at the end of last year, stability was the watchword.

Stability will matter more than ever in the Party Congress in the autumn. Investors should remember that their sentiment is also expected to fall in with that cause.

World Bank Trims China Growth Forecast, Frets About Real Estate

THE WORLD BANK has trimmed half a percentage point off its estimate for China’s GDP growth last year and three-tenths of a percentage point off its forecast for this year and remains concerned about the risk of a prolonged downturn in the property market.

In the latest edition of its Global Economic Prospects, the Bank estimates China’s economy grew by 8.0% last year, down from the 8.5% forecast in June 2021. It forecasts 5.1% for 2022, down 5.4%, reflecting the lingering effects of the pandemic and additional regulatory tightening. It is holding its 2023 forecast unchanged at 5.2%.

Its forecast for this year is in line with China’s slowing trend growth.

In its commentary, the Bank says that manufacturing activity has been solid despite supply disruptions and electricity shortages, and export growth has accelerated, even as Covid-induced lockdowns and curbs on the property and financial sectors have restrained consumer spending and residential investment.

For now, macroeconomic policy measures have forestalled a sharper economic slowdown and mitigated financial stress. The People’s Bank of China has reduced reserve requirements, lowered its one-year loan prime rate and implemented significant short-term liquidity injections. The government has accelerated infrastructure investment, supported homeowners and creditworthy developers, and accelerated local government bond issuance.

However, looking ahead into this year, the Bank expects the effects of the pandemic and tighter sector-specific regulations to linger, with policy support only partly offsetting that. It also remains concerned about the possibility of a marked and prolonged downturn in the property sector—and its potential effects on house prices, consumer spending, and local government financing. It describes this as ‘a notable downside risk’ to its forecasts.

In China, financial stress could trigger a disorderly deleveraging of the property sector. Property developers such as China Evergrande have collectively accumulated financial liabilities approaching 30 percent of GDP. Moreover, corporate bonds issued by property developers accounting for a third of the sector’s liabilities have recently been trading at distressed prices. A turbulent deleveraging episode could cause a prolonged downturn in the real estate sector, with significant economy-wide spillovers through lower house prices, reduced household wealth, and plummeting local government revenues. The banking sector—local banks in particular—would be significantly impaired, raising borrowing costs for corporations and households.

Should that come about, the impact would be felt well beyond China. The financial stress would quickly reverberate across the region’s emerging markets and developing economies. The knock-on effect would be the risk of capital inflows suddenly drying up, triggering currency crises, especially in any country dependent on short-term inflows to finance its current account deficit.

Evergrande Worries The US Fed After All

THE US FEDERAL RESERVE’S latest semi-annual financial stability report comes with an uncommon warning about China’s financial stresses, not the sort of thing it typically comments on.

Its concern is that the stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States:

In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.

Was it just two months ago that Fed Chair Jerome Powell said that the risks from Evergrande’s troubles seemed very particular to China?

China’s Property Tax Edges Closer But Is Still Distant

IT HAS BEEN a decade since a property tax was piloted in Shanghai and Chongqing. However, on October 23, the National People’s Congress announced that these pilots would be extended to other cities in a five-year test, although details have not been made public.

The decade-long gap is indicative of how much resistance there has been to bringing in a property tax nationally in the meanwhile.

Unaffordable home prices are a significant grievance among the urban middle class, especially for younger members struggling to get on the property ladder. Yet, it is also the primary means of accumulating wealth, particularly for the subset of the middle class who are officials. According to the rating agency Moody’s, property accounts for about 70% to 80% of household wealth in China.

The current five-year plan (2021-25) promises the introduction of a property tax within its term. However, when President Xi Jinping called for a property tax earlier this month, albeit couched in terms of curbing property speculation and limiting excessively high incomes under his ‘common prosperity’ rubric, there was scepticism about whether this latest attempt to introduce it more widely would be any more successful than previous efforts.

A property tax would be instrumental in reforming China’s fiscal model in a way that would support more balanced development and reduce local authorities dependence on land sales to raise revenue — and the associated opportunities for pocket lining by local officials. More than 20% of provincial and municipal government revenue comes from land sales to developers, totalling some $1.3 trillion last year.

A property tax would have to replace that and more. The limited schemes being tested in Shanghai and Chongqing accounted for an estimated 5% of local tax revenue at most last year. Sticking our fiscal finger in the air, we reckon that a national property tax, like property taxes in most countries, would have to extend far beyond the superwealthy to raise the revenue that would be needed.

The political obstacles to a property tax remain high, although arguably the least high of any point in the past decade. For many, officials in particular, it will not be so much the taxes to be handed over to the central government as the disclosures of properties for tax assessment.

There is also the significant risk that, if mismanaged, it would exacerbate the slowdown in the property market triggered by the Evergrande crisis.

There is some headroom for growth to slow and still meet official targets of around 6% growth. Yet, a prolonged or significant slowing of the economy beyond that could cause politically troubling social instability.

The expanded trials of property tax will likely start small and be implemented gradually. Wealthy Zhejiang province has been floated as a possible candidate. Other reports speak of up to 10 cities being selected. First-tier and core second-tier cities would be the most likely to be chosen. What the tax rate would be, what it would be applied to and when it would start has still probably to be argued out. Similarly, what, and more importantly, who gets an exemption or preferential rate.

If Xi throws his weight behind pushing through a property tax, it will be a litmus test of how powerful he is. However, as he has given himself five years for the expanded pilots, we may well know the answer to that by other means by then.

Evergrande, Still Breathing Hard, Resumes Construction

BELEAGUERED PROPERTY DEVELOPER Evergrande dodged its October 23 debt default deadline, making an $83.5 million payment to its international bondholders due on September 23, just before the 30-day grace period expired.

That was the first of five coupon payments it has missed on their due dates, totalling a combined $275 million.

It is unclear where Evergrande got the $83.5 million from, but it has bought another week of breathing room, although the company will still be breathing hard under the weight of its more than $300 billion in liabilities.

One place the funds for the coupon payment did not come from was the hoped-for sale of control of its core property business, Evergrande Property Services. Talks to sell a 51% stake of Evergrande Property Services to Hong Kong-listed Chinese property developer Hopson Development fell through.

Trading of shares in Evergrande Property Services resumed on Thursday on the Hong Kong stock exchange, having been suspended since October 4 pending a possible general offer for its shares. Evergrande said the day before that there had been no material progress in asset sales. The last significant disposal was a 20% stake in Shengjing Bank to an agency of Shenyang city’s government.

However, the company has restarted work on up to 10 projects in six cities, including Shenzhen. On August 31, it had acknowledged that delays in paying suppliers and contractors had forced the suspension of some projects. However, its statement on Sunday on WeChat announcing the resumptions did not disclose on how many of its 1,300 developments across China it had halted work.

Last week, People’s Bank of China Deputy Governor Pan Gongsheng reiterated that the risks from Evergrande are controllable, property sector financing is returning to normal, and that the bank will protect households and suppliers.

Not many investors in financial markets share the central bank’s sanguinity. First, there is the ever-present risk of default. Each grace period is starting to feel like a round of Squid Game for Evergrande.

Second, the speed and depth of the slowdown of China’s property market that the crisis has triggered are raising concerns about the extent to which they will weigh on GDP and whether authorities can balance reducing the cost of living by making housing more affordable with managing decelerating growth.

Contagion Fears Will Intensify As China’s Property Debt Woes Widen

A THIRD WEEK; a third round of missed bond payments by beleaguered property group Evergrande.

Reports say the group missed coupon payments totalling $148 million due today. That follows two sets of payments missed in September. The clock is ticking down on the 30-day grace period on the first of them before a default must be declared.

The developer has more than $300 billion in liabilities.

The fear is of the debt crisis spreading to other developers. A total of $92.3 billion of bonds issued by Chinese developers fall due over the next twelve months. Developers with weak credit ratings are already finding refinancing their debt next to impossible.

Fantasia Holdings, a mid-sized developer based in Shenzhen, has already defaulted on $206 million in payments due. Sinic Holdings, which develops residential and commercial property across China, told the Hong Kong Stock Exchange on October 11 that it would likely default on a bond payment due on the 18th of this month. Beijing-based Modern Land is asking its bondholders to extend payment-due deadlines by three months.

If the sector’s liquidity problems do not improve, further defaults seem inevitable. The question would then become how much contagion there would be in the rest of the economy, of which real estate accounts for a quarter.

Managing a soft landing for the sector’s most troubled companies without making an overt bailout remains a high priority for authorities. More measures at the municipal and provincial level to support developers, such as Harbin’s release of presale funds held in government escrow accounts to ease cash flows, are likely.

China’s Property Sector Teeters

THE DOMINOES in China’s property market are teetering, even if the first has yet to fall.

Fantasia Holdings, a mid-sized developer based in Shenzhen that the rating agency S&P downgraded to triple C last week, suspended trading in its shares on the Hong Kong exchange on Tuesday after announcing that it had defaulted on a $206 million bond the day before.

It has a further $1.9 billion of offshore bond payments a d $992 million of onshore bond payments due by year’s end. Last month, the company had told investors that it did not have a liquidity issue.

Stress is clearing rising in China’s property sector and the high-yield bonds that underpin it. Fantasia joins beleaguered Evergrande in suspending its shares. In addition, rating agency Fitch has cut its grading of another developer, Shanghai-based Sinic Holdings, to C from triple C. There is only one further cut left, to D for default.

Evergrande, which is selling assets where it can to prevent being dragged under by total liabilities of more than $300 billion, is expected to announce that it has sold 51% of its property service business, which is listed in Hong Kong, to Hopson Development for $5 billion. Evergrande missed an interest payment on an offshore bond on September 23, triggering a 30-day grace period before a formal default.

Evergrande has said nothing formally beyond an exchange filing that it was suspending trading in advance of a ‘possible general offer’ for its Hong Kong-listed shares. Any such offer could be imminent or could not come for some time, with Evergrande’s shares, which had fallen 80% this year, remaining suspended in the interim.

Beijing has also been officially silent on the sector’s problems, even if authorities are orchestrating as soft a landing as they can behind the scenes. Spoiler alert: it will still be pretty bumpy, especially for bondholders.