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More turbulence in China’s property sector – Industry roundup: 12 July

China’s Evergrande Group nearer local bond default

China’s hard-hit real estate sector faces further turbulence as onshore bondholders of property developer China Evergrande Group’s main unit rejected a proposal to postpone repayment of a yuan (CNY) 4.5 billion (around US$671 million) bond, a securities filing made by the unit showed.

Holders of a puttable CNY-denominated bond from Evergrande’s main onshore unit, Hengda Real Estate, turned down a request to further extend payment past an 8 July deadline by six months, according to a Shenzhen stock exchange filing. The group had already defaulted on offshore notes last December. Hengda said that it is in talks with bondholders to reach an acceptable agreement as soon as possible.

Reports suggest that the rejection could lead to a landmark onshore default and encourage investors to adopt a tougher stance towards other developers battered by the China’s property debt crisis.

The CNY4.5 billion worth of bonds, with a coupon rate of 6.98%, were issued by Hengda through the Shenzhen Stock Exchange in early 2020, and became puttable on 8 January this year, according to previous filings by the company.

Hengda earlier won approval from onshore creditors to extend the puttable date by six months to 8 July but has now failed to secure their agreement to further extend the payment to 8 January 2023.

Evergrande has struggled with more than US$300 billion in liabilities and last year defaulted on some payments for its offshore bonds but has been attempted to extend the timetables on onshore payments to avoid technical defaults.

Last week, Top Shine Global, an investor in Evergrande unit Fangchebao, said it had filed a winding-up petition against the developer as it had not honoured a pact to repurchase shares from Top Shine in Fangchebao.

The developer promised to “vigorously” oppose the petition, adding that the lawsuit would not impact its offshore debt restructuring plan, expected to land by end of this month.

This latest development comes amid reports that Chinese property developers face a US$13 billion wall of foreign currency bond payments over the next six months, as a mounting default tally darkens the market outlook.

China’s real estate sector has struggled to come to grips with slowing growth coupled with authorities’ efforts to rein in excess leverage. Waves of defaults have been triggered across the industry, unnerving fixed-income investors who frequently relied on developers’ offshore dollar bonds to deliver outsize returns during the era of ultra-low interest rates.

Real estate company Shimao Group’s default on a US$1 billion bond earlier this month has heightened concerns among bondholders with exposure to Chinese developers, who have long been a central driver of issuance in Asia’s high-yield dollar debt market. The Shimao bond had traded at just 12 cents on the dollar in the last week of June — pointing to high levels of financial distress — ahead of the payment deadline.

Investors desert emerging market bond funds

Investors are reported to have withdrawn US $50billion from emerging market (EM) bond funds since the start of 2022 – the most severe net outflows for at least 17 years and evidence of how a sharp tightening of monetary policy in developed economies and the war in Ukraine have impacted on the asset class.

Data from JPMorgan shows that a “perfect storm” of adverse developments for developing economies has triggered severe net outflows net outflows from EM fixed income funds, even worse than figures recorded in 2015 during a period of grave concern about China’s economy.

“It has been very dramatic,” said Marco Ruizer, portfolio manager for emerging markets at US financial services multinational William Blair, adding that the combination of rising global inflation, tightening of central bank monetary policy and Russia’s invasion of Ukraine had all impacted on emerging market debt.

Strong shifts from EM bonds, generally considered riskier than their developed market counterparts, have driven prices down sharply in 2022. The benchmark index for dollar-denominated EM sovereign bonds, JPMorgan EMBI Global Diversified, has delivered an aggregate return of minus 18.6% this year, putting it on track for its worst annual run on record.

Emerging markets were already suffering disproportionately from strained finances caused by the Covid-19 pandemic, even before this year’s headwinds came.

The US Federal Reserve’s rate hikes this year and planned further rises are particularly toxic to emerging markets, as they have increased the fixed returns investors can earn by holding ultra-secured US debt, which is eroding the bond’s appeal. Issuers with weak credit profiles. Some investors are also concerned that tighter US monetary policy and mounting economic pressure in other major markets such as Germany and Italy have increased the risk of a broader economic slowdown.

The global shock to commodity prices resulting from Russia’s invasion of Ukraine has been a boon to some raw material-exporting developing countries. “A large part of our universe are commodity exporters, so a lot of those countries are reaping the windfall, “said Ruizer.

At the same time, the rising cost of oil and other raw materials are taking a toll on large energy importers such as Turkey. Since most commodities are priced in dollars, the weakening of the currencies of emerging market countries against the US dollar exacerbates these cost pressures.

Hong Kong “risks losing international hub status”

The costs of relocating their operations elsewhere have so far prevented a corporate flight from Hong Kong despite the city state’s disruptive anti- Covid-19 quarantine rules, but companies' willingness to pay those costs is rising, warns a government-backed advisory body.

Laurence Li Lu-jen, chairman of the Financial Services Development Council (FSDC) said that the pandemic had limited what might otherwise have been an exodus of international firms and warned of that same “stickiness” making it difficult for Hong Kong to attract companies back once they establish operations elsewhere. The FSDC is charged with maintaining the city’s status as an international hub.

“There is a cost to both the firm and the person to relocate a role,” Li writes in the Council’s just-released annual report. “In the past couple of years, Hong Kong has benefited from this stickiness. But firms and people are increasingly willing to pay the cost. If the roles and people are relocated, over time they will become sticky in another place. Attracting them back will be an uphill task.”

The city state must retain its role of connecting China to the world and should further integrate with the Greater Bay Area, the advisory body’s chairman says.

Separately, an industry report says that Hong Kong needs to allow financial sector employees to travel freely to retain its global investment and banking hub status. Quarantine rules and flight bans have prevented most business travel. However, its new health chief has rejected calls for quarantine-free travel in the near future and to live with Covid-19, even as the city relaxes some restrictions amid a surge in new cases. 

Lo Chung-mau, appointed Secretary for Health by Hong Kong’s new Chief Executive John Lee, said in an interview with local newspaper Oriental Daily that it’s unreasonable to pursue a full-blown border reopening with mainland China or the rest of the world, and that the government is currently targeting reducing inconveniences to allow more people to travel. The city would see far more than 9,000 deaths were it to live with the virus, Lo added, citing the large numbers of deaths in the US and UK after the countries lifted their anti-Covid restrictions.

Euro approaches parity with the dollar

The steady rise in the value of the US dollar against other major currencies has seen it about to reach parity with the euro for the first time in 20 years.

The euro has depreciated against the greenback by about 12% since the start of 2022. Fears that the continent faces a period of recession have been fuelled by resurgent inflation and energy supply uncertainty caused by Russia's invasion of Ukraine.

The European Union, which received about 40% of its gas through Russian pipelines before the war, is attempting to reduce its dependence on Russian oil and gas. At the same, Russia has reduced gas supplies to some EU countries and recently cut the flow in the Nord Stream pipeline to Germany by 60%.

The pipeline shut down on 11 July for scheduled maintenance due to last 10 days, although German officials believe that it may not be turned on at the end of the maintenance period.

The energy crisis comes alongside an economic slowdown, which has cast doubts over whether the European Central Bank can adequately tighten policy to bring down inflation. The ECB announced that it will hike interest rates this month for the first time since 2011, as the eurozone inflation rate sits at 8.6%.

Many analysts believe the ECB’s action is too little, too late and that a hard landing is all but inevitable. Germany recorded its first trade deficit in goods since 1991 last week as fuel prices and general supply chain disruptions significantly increased the price of imports.

Kuwait and Bahrain conclude US$11.6 billion bank merger

Kuwait Finance House (KFH) has agreed to buy Bahrain’s Ahli United Bank for about US$11.6 billion, concluding a deal more than three years in the making and one that ranks among the banking sector's biggest this year. The combination, a rare example of a Middle East cross-border deal, will create the seventh-largest lender in the Gulf region, with around US$115 billion in assets.

The initial offer in 2019 was worth US$8.8 billion, with KFH offering one share for every 2.32558 Ahli shares. KFH will now offer one share for every 2.695 shares of Ahli, implying an offer price of US$1.04 per share, a 13% premium to the stock’s close on 6 July. Kuwait’s central bank, which had asked KFH to reconsider the deal during the pandemic in 2020, approved the purchase the same day.

KFH’s shares have risen 66% over the interim period, valuing the lender at US$25.8 billion. Ahli is up 27% in the same period, giving the bank a market value of US$10.3 billion.

Lenders in the region have started to combine locally after the twin shocks of lower energy revenues and the Covid-19 pandemic. Other big deals in the banking sector in the past two years include last year’s merger of Saudi Arabia’s biggest retail lender National Commercial Bank and smaller rival Samba Financial Group to create the kingdom’s biggest bank. Dubai Islamic Bank also completed the acquisition of rival Noor Bank in 2020 to create one of the world’s largest Islamic banks, with total assets of more than Dirham (Dh) 275 billion (US$74.88 billion).

Last month, First Abu Dhabi Bank completed the merger of Bank Audi Egypt with its Egyptian operations, consolidating its market position in the most populous Arab country.

Hopes of lifeline for struggling crypto firms

Justin Sun, the founder of the TRON protocol – one of the largest blockchain networks – said he is ready to join entrepreneur and CEO of cryptocurrency exchange FTX Sam Bankman-Fried in offering financial support to crypto firms that are struggling with liquidity issues. Sun said he could spend up to US$5 billion on acquisitions, after several companies have reached out to him for help.

FTX has already provided support to Voyager Digital and BlockFi. According to Changpeng Zhao, aka ‘CZ’, CEO of the largest cryptocurrency exchange Binance, between 50 and 100 crypto firms are requesting help, due to the exchange having the “largest cash reserve in the industry”. Sun claimed that a similar number have also reached out to TRON.

According to TRON’s website, their decentralised autonomous organisation (DAO) has US$2.3 billion in reserves. Sun said: “Our interest is platforms with a large user base, both centralised finance (CeFi) and decentralised finance (DeFi) platforms,” adding that he believed that the worst of the recent crypto market downturn was now over.

He added: “I currently think the de-leverage process is passed the worst time, so we just need to clean it up and move forward. I don't think [the] market will be super bullish, of course.”

Meanwhile Voyager Digital has published an update on its recovery plans to return account balances to customers. The firm says that it has US$1.3 billion of cryptocurrency and US$650 million in claims against collapsed crypto hedge fund Three Arrows Capital (3AC) to distribute. Voyager did not confirm how much users will receive, but added that they will be able to vote on the plan. According to reports, 3AC's liquidators report that the current whereabouts of the bankrupt company's founders, Su Zhu and Kyle Davies, is unknown.

CBDC for cross border payments highlights challenges, says BIS

Realising the full potential of central bank digital currencies (CBDCs) will require multinational interoperability and widespread access even to non-citizens, according to a report issued by the Bank for International Settlements (BIS). 

The 61-page report “Options for access to and interoperability of CBDCs for cross-border payments” was endorsed by the intergovernmental group G20 as part of a road map to improve cross-border payments. improve cross-border payments, The International Monetary Fund (IMF) and the World Bank also contributed to the report. The BIS seeks to foster international monetary and financial cooperation.

The report by the BIS, dubbed the “bank for central banks”, recommends that even central banks not actively exploring CBDCs should be involved with the planning process as they will still be part of the “new potential cross-border payments landscape.”

Cross-border functionality must be considered at the early design stages with international cooperation between central banks essential for a functional CBDC, the report says.

Three general ways of achieving interoperability between multiple CBDC systems are identified: compatibility, interlinking or using a single system. The BIS recommends that compatibility would be the easiest and cheapest way to ensure cross-border operationality in the short term, though building interlinking or even using a single system could yield even greater returns in the longer term.

Consideration must also be given to non-residents’ access to CBDCs when both inside and outside a central bank’s jurisdiction, the report says.

Five evaluating criteria are used to analyse how CBDCs can be implemented: do no harm, enhancing efficiency, increasing resilience, assuring coexistence and interoperability with non-CBDC systems, and enhancing financial inclusion.

Concluding there is no “one size fits all” approach for CBDCs, the report says that it is a tool for central banks to assess how CBDCs may be best used to suit their jurisdiction’s particular needs. 

The BIS recently opined that Bitcoin and other cryptocurrencies are unable to address current risks in the economy unless backed by the trust inherent in money issued by a central bank. Similarly, the International Monetary Fund (IMF) has cautioned against more countries following the lead of El Salvador and the Central African Republic in adopting Bitcoin as legal tender.

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