Some retail holders of China CEFC Energy Group’s defaulted USD 250m, 5.95% unsecured bonds due 2018 have filed a complaint to the Securities and Futures Commission (SFC) of Hong Kong over sole bookrunner CLSA Ltd’s handling of the deal, as per a letter to the regulator seen by Debtwire.
The holders, who sent the letter in October, have also reached out to lawyers in Hong Kong and the US about potential legal action against the firm, said two sources familiar with the matter.
Central to the allegations is that CLSA didn’t publicly disclose at the time the bonds were issued in 2016 that it took up the largest position, and then supposedly, it didn’t act with appropriate alacrity as CEFC was collapsing and the broker’s parent, China Citic Group, was picking up one of the estate’s prized assets.
Whether warranted or not, the complaint highlights the potential conflicts – actual or assumed – emerging from the growing influence in the APAC international credit market of financial firms backed by large conglomerates.
The complaint also highlights the central role retail investors – generally high net worth – have taken in battling for fairer treatment for Asian credit investors, a position often ducked by institutions wary of the negative attention. The two sources familiar said retail investors have learned that, as a Chinese idiom goes, “Crying kids get more milk.”
CLSA declined to comment. CITIC Group didn’t respond to requests for comment. SFC didn’t respond to requests for comment.
In the dark
One of the holders’ key complaints in the letter to the SFC is that CLSA didn’t disclose to investors that it ended up subscribing to around 40% of the sprawling Chinese energy trader and financial conglomerate’s USD 250m issuance because of the limited third-party interest for the deal. As one of the few active brokers in the name, the firm then kept the secondary price close to par while seeking to sell down its position, the letter alleges.
Two sources close to the firm confirmed that it took tens of millions of USD of the notes in the primary and then gradually partly reduced its exposure both by selling into the secondary market and repackaging the notes into financial products.
An APAC credit-portfolio manager said he didn’t see any regular prices for the highly illiquid name from any other dealers or brokers until the default, when the credit began appearing in the runs from a distressed-focused APAC-based broker and a European bank-dealer desk. A US-based credit broker also began including the name in its monthly runs only following the default.
As Debtwire reported, at the time the deal was being marketed, investor interest was weak because of questions about CEFC founder and then-Chair Ye Jianming’s background, including how a non-state-owned company was able to move into the nationally important oil-trading sector dominated by state-owned companies. The company quickly grew so large that, in the year before its 2018 collapse, it was able to reach an agreement to acquire a 14.16% stake in Russian state-owned oil company Rosneft Oil Co for USD 9.1bn. That deal, which had financial backing in place largely from Russian bank VTB, eventually collapsed along with CEFC.
Chairman Ye was listed in 2016 as number two by Fortune magazine on its global 40 Under 40 “measure of power, influence and success in business.” The blurb explaining his place on the list highlighted that the then-39-year-old “mysterious tycoon … runs a USD 42bn-a-year oil business” with global reach and state-owned partners, “making him a rare, powerful private player aligned with the Chinese government.”
However, in what the holder letter alleges was a material omission, the 2016 offering circular for the bond deal mentioned Ye only twice, without specifying his role or detailing any biographical information other than that he was CEFC’s founder. The limited personal information raised eyebrows even at the time the deal was being marketed, particularly since the offering largely hinged on whether investors got comfortable with Ye’s mysterious background, as Debtwire reported at the time.
At least some of the CLSA bankers marketing the deal indicated that Chairman Ye might be a grandson of Marshal Ye Jianying, one of the founders of the People’s Republic of China, as Debtwire reported. If true, that might have explained how the company was able to develop as it did. Turns out, it doesn’t seem to be the case, as per a 2013-2017 investigation by two highly regarded China watchers, Australians Andrew Chubb and John Garnaut.
In early 2018, Chair Ye was detained by Chinese authorities, triggering the group’s downfall and a flurry of media reports citing questionable trade-financing transactions by the conglomerate and massive funding provided by China Development Bank (CDB).
Shortly after the detention, a CDB-led group of CEFC lenders quickly took control over company finances in March 2018 and effectively oversaw an out-of-court liquidation until various group entities were put into PRC and Hong Kong insolvency processes beginning in July 2018.
The complaint letter to the SFC accuses CLSA of being slow to take action after CEFC’s multiple domestic-bonds defaults beginning in May 2018 despite supposedly having more than the required 25% of the 5.95% bonds to call a cross default and accelerate unilaterally.
As Debtwire reported on 27 November 2018, an ad hoc group representing more than 25% of the USD notes due 26 November 2018 had by then formed and engaged Kirkland & Ellis as its legal advisor. CEFC’s payment of the 25 May 2018 coupon on the bonds with the approval of CDB – even though the first domestic bond default happened four days earlier – discouraged large holders from taking aggressive action at their first opportunity.
The ad hoc group was led by CLSA’s offshore FICC unit and included two Chinese banks, said a third source familiar. The offshore FICC unit needed the support of the Chinese banks to get past the 25% instructing threshold because, while at least one other CITIC Group arm held the defaulted offshore notes as well, it didn’t want to participate in the action, said the source. That other internal holder was an onshore entity that operates separately from the CLSA offshore FICC unit, said the source.
As highlighted in the complaint letter, while the ad hoc group was organizing, CITIC Group was already plotting to take over one of CEFC’s two main offshore assets – its Czech-focused European arm with interests in hotel, real estate, engineering, a soccer club, a beer brewer and a travel service.
CITIC ended up front of the line for the Czech assets by acquiring debt owed by CEFC Europe to Czech financial group J&T Group for CNY 4bn in May 2018, according to a Reuters report at the time. South China Morning Post then reported in September 2018 that CITIC was in talks to buy the assets for CNY 6.7bn (USD 980m), a 44% discount to its EUR 1.5bn (USD 1.75bn) book value as of May 2018. Debtwire reported two months later that the Hong Kong-court appointed liquidators of CEFC offshore holdco Shanghai Huaxin Group (Hong Kong) deemed the then-prevailing offer level from CITIC as still being too thrifty.
The Huaxin liquidators agreed on 31 March 2019 to sell to CITIC Group the Czech assets for EUR 146m despite some objections from the creditors of the Hong Kong holdco, Caixin reported in April 2019. The article, which has since been pulled from the Chinese publication’s website, said creditors consider the assets’ value should be around EUR 530m.
At the end of 2018, CITIC wrote down its bond exposure to zero, as per the letter and separately confirmed by Debtwire from the third source familiar. A price run seen by Debtwire from a US broker indicates the end-2018 level as 30/35. The notes were indicated this week at 2/4 by a European bank.
Hong Kong- and Shanghai-listed CITIC Securities, which owns CLSA, reported “expected credit losses” for 2018 of CNY 2.19bn, from CNY 702m in 1H18. It reported “impairment losses” of CNY 1.72bn for 2017. (The security firm changed the term for the impairment line item in 2018, citing an auditing-policy change.)
While the total write-off may have been ahead of the market, it proved to be provident. Since shortly after being appointed as Huaxin provisional liquidators in July 2018, PwC has warned the entity’s creditors that their recoveries would be negligible to nil. Huaxin was expected to be the main source of recovery for offshore bondholders because of large intercompany claims from its wholly owned offshore bond-issuing vehicle Wise Source International stemming from the upstreaming of most of the offshore-bond proceeds, as Debtwire reported.
The ongoing consolidated PRC liquidation process for China CEFC and 14 of its onshore units are likely to generate only pennies on the dollar for creditors, including the USD bondholders, given that 83% of the estate’s assets are mostly uncollectable receivables, as Debtwire report in March 2020.
There hasn’t been any payout from the PRC process since it began in November 2019 focused solely on lynchpin domestic holding company CEFC Shanghai International Group, and then expanded in February 2020 to include China CEFC and two other subsidiaries. The most recent update on China’s National Enterprise Bankruptcy Information Disclosure Platform is the bankruptcy court’s August decision to consolidate another 11 subsidiaries into the process, resetting the nine-month completion window.
Excluded from the liquidation process – and thus the possible recovery pool for creditors of the consolidated estate – is the CEFC unit that houses what is perhaps the group’s most high-profile asset. Hainan Huaxin Oil Reserve Base Ltd (海南华信石油基地有限公司) was independently entered into a bankruptcy process in September 2020, as per the Bankruptcy Information Disclosure Platform. That entity owns the nationally strategically important planned 12m cubic metre Hainan Yangpu oil-reserve terminal.
The Shanghai court-appointed administrators of the Hainan holdco released an investor-recruitment advertisement for the project on 20 October, saying the only storage capacity to come online so far was the 2.8m cubic metre phase one in July 2016.
The offering circular for the USD bond issued in November 2016 states China National Chemical Corp had leased 1.5m of the 2.8m cubic metres phase one to store national reserves.
If there is any positive upshot from the mess it is that it prompted two court decisions that could smooth the way for future Chinese restructurings.
In one decision, Hong Kong’s Justice Harris granted in January 2020 the city’s first known recognition of and assistance to PRC administrators. In that case, the PRC administrators of China CEFC’s lynchpin holding company CEFC Shanghai International Group were seeking to fend off offshore enforcement action by the sole holder of the defunct conglomerate’s EUR 29.91m 2.8% notes.
The second decision was by a PRC court and also involved the EUR notes. The Shanghai Financial Court in November recognized a Hong Kong ruling validating the holder’s claims stemming from a keepwell-structure commitment provided by CEFC Shanghai – the first time a PRC court recognized keepwell claims.
Like the complaint to the SFC, the keepwell case was also prompted by a non-institutional investor – an SOE-backed vehicle.