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China economy

China needs independent bankruptcy courts to kill off ‘zombie’ firms, legal expert says

Local government intervention is preventing proper handling of inefficient, debt-ridden public sector companies, academic says

PUBLISHED : Saturday, 26 May, 2018, 3:42pm
UPDATED : Saturday, 26 May, 2018, 9:24pm

Beijing should make better use of its bankruptcy law to eradicate state-owned “zombie” companies and non-performing assets, a distinguished Chinese professor said, a move that would serve President Xi Jinping’s efforts to restructure the economy and reduce financial risk.

Courts should seek to become more professional and be given greater authority to determine whether firms would benefit from “reorganisation” or should simply be liquidated, said Li Shuguang, dean of the graduate school at China University of Political Science and Law in Beijing.

In the meantime, they should be given greater independence so they can operate without interference from local governments, he told a symposium on deleveraging hosted by the National Institute of Financial Development in the Chinese capital on Thursday.

“We must set up an independent bankruptcy court system, ideally under the existing circuit courts, to prevent local protectionism and defend investors’ interests,” Li said.

Although China has 92 bankruptcy courts – located in major cities across the country – they tend to reject most liquidation requests filed by creditors as a result of pressure from local governments, which prefer to draw up restructuring plans to suit themselves.

Li also proposed the establishment of a public hearing system to help judges make informed decisions, and the creation of pre-packaged bankruptcy plans to quicken the pace of reorganisation.

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The professor helped draft China’s bankruptcy law, which was enacted in 2007, and is currently advising the National Development and Reform Commission, the country’s top economic planning agency, on the legal aspects of its nationwide deleveraging campaign.

Li’s comments come at a time when Beijing is battling widespread and deep-rooted financial risk, much of which is associated with heavily indebted state-owned companies. These industrial behemoths are often prevented from going bust, because local governments need them not only as a source of tax revenue, but also to provide jobs, which in turn helps maintain social stability.

The problem for Beijing is that despite the already precarious state of such firms’ balance sheets, they frequently demand additional financial and policy support.

Such was the case with state-owned Dongbei Special Steel Group, which despite defaulting on 10 bond issues last year, was rescued under a restructuring plan, approved by a local court, that wiped out 80 per cent of its debt.

At the end of last year, China’s corporate debt stood at about 130 trillion yuan (US$20.36 trillion), or 159 per cent of its gross domestic product.

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At its inaugural meeting in April, the Xi Jinping-headed Central Commission for Financial and Economic Affairs emphasised the significance of reducing state-owned enterprises’ debt to the nation’s macroeconomic deleveraging efforts.

The bulk of China’s corporate debt – much of it implicit government liabilities – can be attributed to the public sector.

Li said that in the years immediately after the bankruptcy law was enacted it was rarely cited. It was only when the government stepped up its efforts to reduce industrial capacity and debt levels that the number of corporate cases began to rise – to 9,542 last year, from 2,031 in 2014.

Nonetheless, the figure for 2017 was still tiny (about 0.2 per cent) in relation to the 3.6 million Chinese companies that ceased operations in the year.

“Its use is similar to the level of Greece [adjusted for scale],” he said. “The normal proportion should be about 10 per cent.”

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China’s State-owned Assets Supervision and Administration Commission said it eliminated 400 zombie companies last year, although it also made clear its preference for restructuring rather than liquidating troubled enterprises, in the interest of saving jobs.

Speaking at a press conference in March, commission chief Xiao Yaqing said the watchdog was seeking to reduce risk in the public sector by enabling more debt-for-equity swaps, opening new fundraising channels and encouraging greater private investment.