Two years after the People's Bank of China (PBOC) shut down Guangdong International Trust & Investment Corp (Gitic) with debt of 38.78 billion yuan (about HK$36.31 billion), Beijing continues to muddle its way towards consolidation of the bankrupt trust and investment sector. Months ago, the central bank had proposed a comprehensive restructuring of mainland non-bank financial institutions, embracing an estimated 239 trust companies, holding assets of 600 billion yuan matched by debts of at least that amount. In April last year, PBOC's non-banking financial institutions department chief, Xia Bin, claimed the bank was planning to 'put everything to right once and for all'. That meant consolidation via closure, merger and acquisition and leaving only several dozen survivors. However, outside of a handful of shotgun mergers and forced closures, such as People's Insurance Trust & Investment Corp, the sector's fundamental problems remain festering in the heart of the country's financial markets. Inaction, by default, has become the policy of choice, as mainland regulators have come to realise it is easier to neglect local investment companies facing foreign liabilities and domestic triangular debt than spearhead settlements requiring hefty central government outlays. That was apparent last week, when Hainan International Trust & Investment Corp (Hitic) missed a coupon payment on the Japanese bond market, forcing creditor banks to declare 28.5 billion yen (about HK2 billion) in samurai bonds, sold by the company, in default. Premier Zhu Rongji's presence in Tokyo at the time of the default announcement only underscored Beijing's unwillingness to accept responsibility for the matter. What was most instructive about Hitic's failure, perhaps, was that the province-owned company stood at the centre of a year-long effort by the Hainan government to restructure eight local trust and investments companies. That campaign is now in tatters. Nor was it surprising that, only days after the default announcement, Japanese bond underwriters were reporting that Hitic had been making overtures to settle the bonds by discounting 50 per cent or 60 per cent of their face value. For foreign creditors contemplating legal action, more disturbing news has emerged in recent days from Gitic's own bankruptcy proceedings. In a series of decisions, the company's liquidation committee rejected creditor claims that contracts and guarantees signed by the bankrupt company's Hong Kong subsidiaries, using foreign law, should be admitted for payment. Much of the basis for the committee's decision has been a mainland Supreme Court opinion which holds contracts using foreign law are void if those contracts violate provisions of Chinese law or 'the public benefit of Chinese society'. That reading of the law has lawyers and bankers fuming. They argue liquidators are engaged in a campaign to stretch legal arguments as much as possible in order to reach preordained results. The liquidators also went on to say that foreign creditors held a measure of responsibility for Gitic's failure to register the company's borrowing with the mainland's foreign currency watchdog, the State Administration of Foreign Exchange (SAFE). The liquidation committee conditionally accepted only half of a claim by a syndication of more than 20 foreign banks based on a guarantee made by Gitic's Hong Kong arm on loans originally placed with its Hong Kong subsidiary using contracts under English law. The committee held the banks had a responsibility for 'understanding and exercising supervision over Gitic as to whether the relevant approval and registration procedures' had been carried out with SAFE. That same logic was applied to Gitic creditors making claims arising from derivative transactions, where 'transaction-specific, case by case' approvals from SAFE were to be obtained by the borrower. There is no doubt that these kind of legal and policy manipulations hold some attraction to state officials. Not only does it make trust-sector restructuring more affordable to local governments and bankruptcy less attractive to foreign creditors, but it also provides an added benefit of closing down offshore loan markets to localities which once relied on their guarantees to secure borrowings. Nevertheless, it remains to be seen what permanent damage may be caused to domestic companies and mainland financial markets by such behaviour, particularly as the country prepares to step further into the global economy with its entry into the World Trade Organisation.