Following a record level of defaults on corporate bonds, China is permitting the trading of matured defaulted bonds for the first time on two state-owned financial asset transaction platforms.

The first completed transactions were in matured bonds of Wintime Energy, China’s second-biggest defaulter of 2018, and three transactiions with a total value of 282 million yuan (CNY) – around US$41.6 million – of Wintime’s defaulted bonds were carried out in February and March at Beijing Financial Assets Exchange (CFAE).

According to reports, the Chinese central bank believes that once the trading of these defaulted bonds become normalised over the CFAE and its own China Foreign Exchange Trade Center (CFETC) that will become an important tool in stabilising the market and to prevent “malicious escape from debts”.

As prices on the CFAE are transparent and subject to market forces, the valuations of these bonds could potentially be used as reference prices for a future junk bond market. Buyers of the defaulted bonds will count on the defaulter eventually paying up, while sellers will benefit by being able to recover a portion of their losses.

The reports also suggest that the People’s Bank of China (PBOC) financial market department is developing specific rules and regulations for the trading of defaulted bonds.

Two test cases

Wintime and Jiangsu Hongtu High Technology Co are the only two companies whose defaulted bonds have been traded so far. Wintime, a coal producer in the northwest province of Shanxi, had outstanding debts totalling CNY 63.2 billion and defaulted on bond repayments of CNY 18.8 billion in February.

Shanghai-listed electronics manufacturer Jiangsu Hongtu High Technology was punished for falsely claiming that investors had agreed to extend the repayment period for a bond on which it subsequently defaulted.

Introduction of the new trading mechanism comes after defaults on Chinese corporate bonds rose to a record 120 billion renminbi (RMB) last year, exceeding the combined amount for the previous 4 years which totalled RMB 110 billion. In the first four months of 2019, Chinese bond issuers defaulted on RMB 23.3 billion worth of bonds over the first four months, a 70% increase over the same period last year.