Chinese local government finance units seek unorthodox way to raise funds

A man works at the construction site of a new financial district in Beijing, China May 23, 2017. REUTERS/Thomas Peter/File Photo

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  • Stricter rules encourage LGFVs to seek unconventional means of financing
  • Fundraising Efforts Bypass Regulatory Review
  • Direct financing via the Internet, social networks make you tick
  • LGFVs offer big yields to attract investors and risk a debt explosion

SHANGHAI, June 15 (Reuters) – Shut out of the bond market and shunned by banks, a growing number of cash-strapped Chinese local government finance units are tapping into a loosely regulated funding channel to woo cash-hungry retail investors directly. yield.

In recent years, China has embarked on a deleveraging campaign to reduce systemic risks after local government finance vehicles (LGFVs) racked up billions of dollars in debt since the 2008 financial crisis.

Last year, Beijing further tightened the screws on loans to LGFVs, which are investment companies that build infrastructure projects on behalf of local governments.

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The squeeze has driven LGFV “direct funding” debt products – typically registered through loosely regulated local asset exchanges and sold to the public via the internet with a hint of government backing – soaring over the past year. .

LGFVs are offering to pay yields of more than 8% – around three times the benchmark lending rate – revealing their desperation to raise funds and meet political mandates to support a COVID-stricken economy.

One such company is Weifang Binhai Tourism Group Co, which sells investors 500 million yuan ($74.04 million) of debt yielding 8.5% to 9.5%, to fund engineering projects and replenish cash, according to a sales pitch.

The company wouldn’t have gone this route “if we could sell bonds cheaply – we’re not stupid,” said Liu Yang, finance manager at government-owned Binhai Tourism in Weifang city, New York. east of the country. Shandong province.

Liu says many LGFVs are struggling because they are unable to raise funds in the bond market or through trust companies. The blow came last year when regulators curbed bond sales by LGFVs and prevented banks from lending to these state-owned enterprises, and “all the banks rushed to call back the loans “.

Weifang Binhai is not alone. About 50 LGFV debt products are on sale through the Junxing Wealth investment website, attracting individual investors with reported annual returns of 8.0-10.2%. More and more private investment products of this type are promoted via the Internet or via social media.

There is no official data on the total size of these products, as they are not sold through regulated financial institutions. At least 245 such debt products have been sold since last year to meet the financing needs of LGFVs, according to an estimate by Huaan Securities. An LGFV typically raises several hundred million yuan through such a debt system.

INNOVATIVE

“For LGFVs in economically weak areas, or owned by county and district level governments, it is difficult for them to refinance through bond issuance, so they need to come up with something innovative,” said said Ivan Chung, associate managing director at Moody’s Investors. Service.

Risk-averse investors generally avoid LGFVs in China’s southwest, northwest and northeast provinces, as well as lower-rated bonds, Chung said.

Net bond sales by AA-rated LGFVs have more than halved so far this year, according to Minsheng Securities.

But the practice of LGFVs selling private debt to the public via the internet, with a veiled promise of a government guarantee, raises eyebrows.

In a brochure promoting the debt sold by Luoyang Gaoxin Industrial Group, little mention was made of the financial health of issuers. Instead, descriptions have focused on the financial strength of the government of Luoyang city and the central province of Henan, where the LGFV is based.

“That doesn’t seem right. Any LGFV can issue debt, but the point is, you can’t imply that the local government is behind your back,” said Rocky Fan, an economist at Guolian Securities, adding that such promotion violates the central government’s implied prohibition. guarantees.

These LGFV debt schemes also risk violating rules on private investment products, which must only be sold to qualified investors, while limiting the number of investors to 200, said a lawyer who declined to comment. be identified as he is not authorized to speak to the media.

These products “appear to be illegal fundraisers,” the attorney said.

Wealth management sold through banks, trust companies and brokerages would be subject to very rigorous scrutiny. A debt crisis in the real estate sector has already led to a years-long crackdown on illicit finance.

The Luoyang city government could not be reached for comment. China’s securities watchdog did not immediately respond to Reuters’ request for comment.

REASON TO EXIST

As debt control intensifies, more LGFVs are likely to default on private debt in 2022, S&P Global Ratings predicts.

Bincheng Investment, an LGFV seeking to raise 100-200 million yuan from individual investors at yields of 8.2-9.0%, says it makes sense to borrow from individuals.

“This new financing tool is legitimate and meets the needs of individual investors,” an official from Bincheng’s finance department said, speaking on condition of anonymity.

“There are many products on the market that offer much higher interest rates than bank loans…and there’s a reason they exist.”

($1 = 6.7530 Chinese yuan renminbi)

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Reporting by Samuel Shen, Jason Xue and Andrew Galbraith; Editing by Vidya Ranganathan & Shri Navaratnam

Our standards: The Thomson Reuters Trust Principles.

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