China economy faces threat from obscure financial tool that could trigger domino effect of defaults
- China Minsheng Investment Group triggered wave of US$800 million in ‘cross defaults’ when it failed to make a debt payment
- Experts warn that this could be ‘the tip of the iceberg’ with regard to financial instrument only used in China since 2016
A high-profile debt default in China has fuelled concerns over an obscure financial instrument that is growing in popularity among debt-laden companies and which could shock send waves through the industrial economy.
Last week, China Minsheng Investment Group, the nation’s largest privately-owned investment group, failed to make a debt payment, which triggered US$800 million in “cross defaults”, according to a statement filed to the Hong Kong stock exchange.
Michael Every, Asia-Pacific senior strategist at Rabobank, warned that “the fact that US$800 million of cross defaults were triggered following a conglomerate making a late debt payment could be the tip of the iceberg”.
A cross default is a clause in a loan or bond contract that puts a borrower in default for breaching another of its debt obligations. For example, a cross default contract may state that a person automatically defaults on a car loan if they default on their mortgage.
Chinese companies in recent years have included cross default clauses in debt agreements for their subsidiaries and affiliates as a means to secure easier funding. Essentially, the clauses allow less creditworthy companies to borrow on the strength of their parent company. The practice is especially common in industries with overcapacity issues, such as coal and steel, among lower quality private companies, as well as local government-linked companies.
