If the government goes ahead with its plan to clean up Huarong,it will be the most dramatic statement yet that in its pursuit of reform,China is willing to sacrifice the investors who lend its companies money.

The timetable for a full overhaul of the company’s operations has not yet been set,but the people familiar with the government’s plans said China is strongly committed to making sure that both foreign and domestic bondholders do not receive full repayment of their principal. The goal is to dissuade people from investing in risky Chinese companies on the assumption that the government will bail them out.

“Huarong has already become too big to fail. It is no longer a fix to the problem,but the problem itself.”

Macquarie Group’s Larry Hu

Huarong was born two decades ago when China’s state-led economy was beginning to open up. Before state-owned banks turned to the global market to raise money,they needed to get rid of debt to make themselves more attractive. Huarong took some of the ugliest loans off these banks,and for this reason was given the title of “bad bank.”

Of the four “bad banks” in China,Huarong became the biggest,expanding its empire by financing companies in energy,insurance,property and beyond. It used its access to cheap loans from state-owned banks to invest in risky deals with higher returns. It used its international arm to raise money from foreign investors,to whom it now owes more than $US20 billion.

Huarong’s appetite for risk was put in stark relief under the leadership of Lai Xiaomin. Lai,the former chairman of Huarong,was stripped of his Communist Party membership in 2018 andexecuted in January for corruption and abuse of power,a highly unusual punishment that experts said was meant to send a message.

Lai confessed to accepting $US277 million in bribes,telling state television that he had kept $US30 million cash in safes around his apartment in Beijing,which he referred to as his “supermarket.”

Not long after Lai was executed,Huarong gripped headlines again when it said that it would delay publishing its annual results in March. It delayed its annual results a second time last month,raising worries about the state of its financial health and its ability to repay investors.

Any situation where Huarong is unable to repay in full its investors would ripple through some of the world’s biggest and most high profile investment firms. As the international financial market grappled with that scenario,the bonds recently went into a tailspin.

This year alone,Huarong owes $US3.4 billion to foreign investors. After it delayed releasing its annual results,the bonds sold for as little as 60 cents for every dollar. In Hong Kong,its stock was suspended.

It is already very late for a big corporate reorganisation,said Larry Hu,head of the China economics desk at Macquarie Group. “Huarong has already become too big to fail,” he said. “It is no longer a fix to the problem,but the problem itself.”

The government’s latest plan,which has not yet been reported,is likely to roil China’s corporate market. Last month,the broader market for Chinese companies started to wobble as anxious investors began to consider a possible contagion effect.

Chinese companies owe nearly $US500 billion in loans to foreign investors. A Huarong default could lead some international bondholders to sell their bonds in Chinese state-owned enterprises,and make it more difficult for Chinese companies to borrow from foreign investors,a critical source of funding.

Concerns about the company’s ability to raise fresh money prompted two ratings agency to put Huarong on a “watch” notice — a type of warning that means its debt could be downgraded,a move that would make its ability to borrow even more costly.

Even as the government crafts a plan to downsize Huarong,the company has sought to calm investors’ nerves,promising that it can pay its bills. Speaking to state media,Xu Yongli,vice president of Huarong,likened his firm to other critically important Chinese financial institutions.

“The government support received by Huarong is no different,” he said.

The New York Times