Novum Alpha - Daily Analysis 22 September 2021 (10-Minute Read)
A terrific Wednesday to you as markets stabilized after China's real estate giant Evergrande Group missed a crucial interest payment and as payments on some bonds becomes due today.
In brief (TL:DR)
In today's issue...
The past week has a been a volatile time for markets, but in a game of chicken, the trick is to not blink first.
Even as China's real estate giant Evergrande Group missed an interest payment on Monday, it's become apparent that Beijing isn't willing to risk imploding its entire property sector at one go.
Evergrande Group managed to negotiate the timing on its interest payments and there are growing expectations that bond payments due on Thursday are likely to follow the same strip as China's central bank floods financial system with liquidity.
In Asia, markets were mostly higher on the prospect of the Evergrande Groyup entering into an orderly restructuring with Tokyo's Nikkei 225 (-0.58%) down, while Sydney’s ASX 200 (+0.67%) and Hong Kong's Hang Seng (+0.51%) managed to stem losses, while Seoul remains closed for a holiday.
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1. China's Evergrande Group Misses Key Interest Payment
Like watching a train wreck in slow motion, China’s second largest real estate developer China Evergrande Group missed interest payments due on Monday to at least two of its largest bank creditors, taking the cash-strapped developer closer to one of the country’s biggest debt restructurings.
As of late Tuesday Singapore time, Evergrande hadn’t made any of the interest payments that were due as of Monday as stocks continued to plunge in response.
Chinese banks, almost all of which are state-owned, were fully expecting Evergrande to miss the deadline after China’s housing ministry informed them that the real estate developer would be unable to pay on time.
But in a country where the line between Beijing and its banks is unclear at best, it’s as yet uncertain if lenders will formally declare Evergrande in default.
Because little happens in China without Beijing’s acquiescence the odds are that lenders are waiting for the developer to propose a loan extension plan before deciding on what to do next.
An official taskforce has been convened in Guangzhou to investigate Evergrande and while Beijing has been mute on its findings or purpose, observers have noted that the formation of such committees typically prefaces some form of restructuring.
The next crucial day will be Thursday, when Evergrande is due to pay interest on two bonds, and expectations are high that it will miss those payments as well.
Like playing a game of chicken, Beijing’s stony silence in the face of the unfolding crisis is unnerving global investors, with concerns over a wider fallout seeing risk assets tumble.
Thankfully, the silence may end soon, with the People’s Bank of China resuming daily open-market operations today after a holiday break.
Time is also running out in terms of business days, with China’s “Golden Week” holiday looming on the horizon, where millions of Chinese (pandemic conditions permitting) will be traveling across the country to spend time with family and enjoy a little bit of down time.
Investors holding on to their positions with white-knuckles can take some comfort that Evergrande’s biggest creditors are basically Beijing, with China Minsheng Banking Corp., the Agricultural Bank of China and the Industrial and Commercial Bank of China among the real estate developer’s primary lenders.
Beijing has the power to both destroy and revive and few analysts are expecting that the Communist Party will allow China Evergrande Group to implode on itself, given that a full 29% of China’s GDP relies on its property sector.
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2. Whether the World Plunges into Another Financial Crisis Depends on Beijing
While the ball is firmly in Beijing’s court, global investors have not blinked.
Global investors not only didn’t dump China Evergrande Group’s bonds, just months before China’s second-largest real estate developer started facing liquidity issues, they actually took on more positions.
Funds managed by BlackRock and HSBC added to their holdings of Evergrande bonds, even as the real estate developer looks to be on the brink of default.
As recently as last month, BlackRock bought up five different Evergrande dollar-denominated bonds through one of its high-yield funds, according to data from Morningstar, holdings which have risen sharply this year as the fund’s assets under management rose.
Data from Bloomberg shows that the world’s biggest asset manager BlackRock had total exposure of some US$400 million to China Evergrande Group.
Meanwhile HSCB’s high-yield fund unit was also a net buyer of Evergrande’s debt as recently as July, increasing its bond holdings of the embattled real estate developer by 38% since February, according to Morningstar data.
Yet it’s not altogether surprising that some of the biggest investor’s in Evergrande’s offshore bonds continued to add to their holdings, even after prices had started falling.
Put into context, the vast bulk of Evergrande’s US$300 billion in liabilities is owed to onshore lenders, and China’s banking system is essentially an extension of Beijing, which means that ultimately it’s up to the powers that be to determine if that debt goes into default.
S&P Global Ratings expects Evergrande to default this week, with close to US$20 billion in dollar-denominated bonds outstanding from two offshore subsidiaries.
But that’s also because the ratings agency is looking at things in China from a U.S. perspective – whether or not an onshore bond goes into default or gets restructured is more a function of fiat than of contract.
Ultimately what happens next will depend on whether Beijing’s apparatchiks want an orderly reduction in debt in China’s highly-levered real estate sector, or a financial implosion that risks dragging its economy and the rest of the world into a recession.
Given the reaction by officials in the wake of the recent crackdown on China’s tech companies and the backlash in the markets, there’s an outside chance that bureaucrats had not expected as swift and as severe a reaction, as evidenced by their highly publicized attempts to placate investors.
On several occasions, high ranking Chinese officials had sought to assure investors that Beijing had no interest in sweeping away the private sector, investors can assume that they have no interest in sweeping away their economy either.
3. Wall Street is Lobbying Regulators to Loosen Up on Cryptocurrencies
Cryptocurrency advocates are finding an unlikely ally in the very industry that they’re seeking to disrupt – Wall Street and the legacy financial institutions.
Even as U.S.-listed cryptocurrency exchange Coinbase Global (+0.82%) has shelved it’s proposed digital asset lending product, on threats of litigation by the U.S. Securities and Exchange Commission, the global financial industry has urged regulators to refrain from imposing strict capital rules on the nascent sector, warning that these requirements would drive activity underground and deprive banks of the benefits of the technology.
Lobbyists representing banks, asset managers and the blockchain industry wrote to the Basel Committee on Banking Supervision that its proposals would make it too expensive for banks to participate in the rapidly growing cryptocurrency industry and its associated technologies.
The move by the financial services industry comes amidst heightened interest in the cryptocurrencies, even as regulators attempt to reign in the vibrant and innovative sector.
The world’s most powerful banking standards setter, the Basel Committee, proposed in June that cryptocurrencies should incur the toughest possible capital requirements, making it prohibitively expensive for banks to deal in digital assets.
Last year, the U.S. Comptroller of the Currency had, in an interpretive letter, made it clear that U.S. banks could accept deposits to back stablecoin issuances, but with cumbersome compliance burdens that has since seen little take-up of the opportunity.
The Basel Committee has proposed splitting capital requirements for banks holding cryptocurrencies into two distinct regimes – for so-called “security token” type offerings, including stock tokens and stablecoins, using a modified version of existing rules on minimum capital standards of banks.
But for other cryptocurrencies, including Bitcoin and Ether, a more “conservative” regime requiring banks to hold at least $1 of collateral against $1 of cryptocurrency was proposed by Basel.
The latter requirement makes it costly not just from an economic perspective, but also a compliance perspective for banks to stay on top of their exposure and to ensure that they do not fall foul of capital requirements.
Against a backdrop of declining yields and growing interest in cryptocurrencies from investors, banks and financial services providers have been jostling to establish a beachhead in the nascent sector, but a lack of regulatory clarity and heavy compliance burdens are slowing that progress.
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Sep 22, 2021
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