China Orienwise's debt default lesson for investors buying into mainland bonds

In the heady boom of the mid-noughties, a US$4 million stake in a newly issued bond by China Orienwise, one of the mainland's fastest-growing loan guarantee companies and a niche play on the country's burgeoning credit markets, must have looked a sure-fire bet. Eight years later and that bet is now a cautionary lesson for investors studying the vagaries of the Chinese offshore debt market.

That is because foreign bondholders get short shrift on the mainland when it comes to defaults.

Foreign investors are "essentially taking equity risk", when they buy a Chinese offshore bond, says Ying Wang, a director of corporate ratings at Fitch, as "offshore creditors are structurally subordinate to onshore creditors" and need to negotiate a local court system that favours local parties and is inexperienced at handling international bond defaults.

It is a warning that comes too late to Orienwise bondholders.

Backed by private equity giants General Electric and Carlyle Group, Orienwise made money by guaranteeing loans between state-run banks, used to lending against fixed assets rather than future cash flow, and fast-growing but asset-poor small and medium-sized enterprises. The strategy worked well for a while, helping propel company founder Zhang Kaiyong into the Forbes rich list, and gave credibility to a Morgan Stanley-backed US$100 million bond issued on the Singapore stock exchange in 2006.

One company to snap up 40 tranches of the US$100,000 senior notes, yielding 10.5 per cent, was LIM Advisers, a Hong Kong hedge fund group with US$2 billion under management.