Debt market meddling continues troubling trend

Chaori bailout benefits investors, but does little to promote mature habits

Shanghai Chaori Solar Energy Science and Technology Co Ltd announced Wednesday that it will shell out 1.12 billion yuan ($179.64 million) Monday to cover all interest and principal payments on a troubled 1-billion yuan bond issued in 2012. According to statements from the company, all registered bond holders will be repaid in full.

This news finally brings Chaori's bond crisis to an end, allowing the photovoltaic equipment manufacturer to avoid delisting and bankruptcy. As many will remember, Chaori enjoys the ignoble distinction of having been at the center of China's first ever bond default when it announced in March that it would not be able to make a scheduled interest payment to its investors.

Chaori's debt woes quickly garnered much attention, with many speculating on whether authorities would allow the company to go bust. For years, China's financial markets had been free of default thanks to government-led bailouts and restructurings whenever bond issuers encountered repayment trouble. As many have noted, this lack of risk has weakened market discipline by breeding an implicit understanding that authorities will always rescue poorly managed companies.

In the case of Chaori, history seems to be repeating itself once again. Back in October, China Great Wall Asset Management Corp and Shanghai Eternal Sunshine Investment Management Centre came forward to guarantee 880 million yuan worth of unpaid Chaori debt. Of these two entities, China Great Wall, which agreed to guarantee 788 million yuan, is a wholly State-owned institution set up in the 1990s to buy toxic assets from the country's big four State-owned banks.

At the same time, it is reported that Golden Concord Holdings Ltd, an energy group specializing in clean and alternative energy development would lead a consortium of eight enterprises to restructure Chaori, providing the capital needed to clear its remaining debt.

Without behind-the-scenes maneuvering by authorities, it's doubtful whether such a rescue would have materialized. As in past cases, authorities are likely more concerned about maintaining social stability and clamping down on debt-market risk than they are about teaching a lesson in value investment among the more than 2,000 small investors who bought Chaori debt.

Of course, for Chaori bond-holders, last week's news represents a boon for their financial interests. But for the market as a whole though, it marks yet another bad example; one which will only encourage more irrational investment. With authorities as willing as ever to rescue mismanaged firms, investors will surely continue to favor high-yield, high-risk bonds. This will only intensify speculative pressure within the junk-bond market and hold back the long-term healthy development of the country's financial system.

Looking ahead, with China's economy continuing to slow, more credit events will surely come to the fore over the coming years and months. Fortunately, there are some positive signs that local Chinese governments may finally be thinking more seriously about changing their overly supportive ways. In fact, local authorities such as Urumqi, have recent canceled promises to guarantee certain local debts. More local governments should take steps in this direction. They should also caution investors that the days of risk-free debt investment could - and should - soon come to an end.

In the meantime, regulators should also study mature markets in the West for guidance on the orderly management of debt defaults and bankruptcies. Central authorities should also consider raising the threshold for high-yield bond investment to protect vulnerable small investors.