On August 11, 2017, the Dalian Intermediate People's Court approved the proposed bankruptcy restructuring plan of Dongbei Special Steel Group Co. Ltd., a state-owned enterprise ("SOE") which defaulted on debt payments. This is the first case that a Chinese company adopts a debt/equity swap in resolving defaults on its publicly issued bonds.

The major points of the proposed bankruptcy restructuring plan are as follows:

  1. The total amount of restructured debt is RMB 45.6 billion.
  2. Each creditor is entitled to a full repayment of a debt up to RMB 0.5 million.
  3. For any debt over RMB 0.5 million, non-financial creditors and bond holders may choose either to get a lump sum partial repayment in cash or to swap that debt in full for equity, while financial creditors only have the later choice.
  4. Two strategic investors will inject RMB 5.5 billion to the company in exchange for its 53% shareholding.

As reported by Moody's, this case indicates the government's increasingly differentiated support for SOEs. Particularly, the government would only provide direct financial support to defaulted SOEs that are engaged in activities closely aligned with national policy, or if the government is concerned a default could have wider systemic implications. By and large, the debt problems of other SOEs will be resolved through negotiations with creditors, with bankruptcy as a last resort.

More importantly, this case may be a turning point of China's bond markets. In the past, defaulted bonds generally were fully repaid and therefor a risk pricing mechanism for bonds was not well developed. In this case, however, the bond holders had to agree to a deep discount on par value for cash repayment or a debt/equity swap, which breaks the traditional market expectation on the recovery of defaulted bonds and therefore could lead to a revaluation of defaulted bonds, possibly a more significant discount on their par value to reflect the increased risk of loss.

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