Mispricing Asian risk

Chinese assets and loans are too expensive and often don’t take into account the added risk in the country, delegates heard at the Private Debt Investor Asia Briefing 2013 in Hong Kong last month.

“Chinese assets in general, and loans in particular, are mispriced for risk. Part of that is the dominance of the local banks who don’t price for risk at all as far as I can see. So it is quite hard to do business onshore in China, especially with the state-owned enterprises,” Jake Williams, deputy group chief risk officer at Standard Chartered Bank, said on a China-focused panel at the event. 
Williams warned there’s still a premium charged, but returns aren’t commensurate with the risks involved. It’s been a problem for private equity for many years, but it’s increasingly an obstacle for would-be debt investors too. 

Moreover, while the enforcement situation has improved to some extent in China (particularly on the equity side), debt investors are not well-protected when investing as contracts remain difficult to enforce in bankruptcy situations, panelists agreed. This has long been a barrier to entry, but there’s reason for optimism. 

“There are certainly areas where it has improved – Shanghai in particular – where you’ve got young judges, many of whom can speak good English and are keen to do the right thing and adopt the principles that are annunciated in the Enterprise Bankruptcy Law,” Neil McDonald, partner at Hogan Lovells, explained.

However, while judges are more open-minded, there are many stakeholders in distressed situations in China and inevitably the local government will be a large one.

“You end up with courts in the better jurisdictions who may be willing to try to do something a little bit better, but are frankly and bluntly told, sorry, you can’t do this – you need to toe the party line, literally. Access to justice in the more remote areas, where we are doing deals more and more, remains very problematic.”

Anthony Holmes, principal at LVF Capital, went one step further, saying the firm doesn’t even enter enforcement processes in China. “Our approach has been never to attempt to enforce by the courts. If you end up in that situation we think you’re in a lose-lose position,” he said.

Standard Chartered’s Williams agreed, saying, “We don’t frankly trust the courts system.”

While returns in the US significantly outstrip those in China, the level of risk is also lower too. McDonald said, “A lot of the clients that I work for, particularly the East Coast bond market in the US, just don’t get that risk.”

On the following panel, Sarit Chopra, managing director of mezzanine and alternative solutions at Standard Chartered, echoed this sentiment with regard to India.

“There is a huge opportunity that is developing in India, but the issue that we come across is the way the risk-reward [metric] is being priced in India – it is very difficult to get around. There are a lot of Indian local funds, which are essentially just trapped INR funding that don’t have the perspective of the region, and seem to be driving yields down.”

The number of non-performing loans in India is growing as local banks reduce their lending to businesses and growth rates stress businesses with heavy debt loads.

For private debt investors in Asia then, there’s undoubted opportunity – panelists and delegates alike all agreed on this. But for managers, and more importantly investors, to transact, there needs to be further improvement in terms of the bankruptcy regimes to aid recovery, and a re-pricing of risk to bring the region into line with Western interpretations of the risk-reward metric.