Debt / equity swaps in the backdrop of structural deleveraging

In December 2015, when supply-side reform was introduced at the Central Economic Work Conference, the Chinese government proposed “deleveraging” for the first time, initiating an active deleveraging process to restructure its economy for better investment returns. Now, adjusting the composition of leverage ratios in non-financial sectors has become the top priority for the deleveraging campaign. In April 2018, the Central Finance and Economics Committee proposed structural deleveraging at its first meeting, establishing varied requirements both for sectors and for categories of debts, asking local governments and enterprises, especially state-owned enterprises, to lower their leverage ratios as soon as possible. On 2 July 2018, the newly elected Financial Stability and Development Committee of the State Council also said that “structural deleveraging would be made the fundamental strategy [for preventing and defusing financial risks]”, signalling more precise deleveraging measures in the future.

In one of the modest measures related to deleveraging, the government has been encouraging the use of equity plus debt schemes and debt/equity swaps (DESs) as financing/refinancing solutions. With regards to DESs, the State Council released the Opinions on Actively and Steadily Lowering the Leverage Ratio of Enterprises and the Guidelines on Market-Oriented Debt/Equity Swaps of Banks (No.54 Guidelines) in October 2016, which (1) require banks to implement market-oriented DESs in an orderly manner with the aim of actively helping enterprises to reduce their leverages steadily; (2) allow banks, implementors and enterprises to agree on the debts and equities to be converted, as well as the prices, terms and conditions of conversion on their own, provided that such agreements conform to state policies; and (3) allow implementors to raise funds for DESs using market-oriented approaches, thus enabling the market-oriented exit of equity holders through the use of multiple approaches or channels. In January 2018, the National Development and Reform Commission (NDRC), the People’s Bank of China (PBOC) and five other ministries and commissions jointly issued the Circular on Specific Policy Issues Concerning the Implementation of Market-oriented Debt/Equity Swaps by Banks (Circular). In June 2018, the China Banking and Insurance Regulatory Commission issued the Measures for the Administration of Financial Asset Investment Companies (Trial) (Measures).

The No.54 Guidelines, the Circular and the Measures mentioned above, which set forth fundamental principles and implementation approaches for market-oriented DESs under the rule of law, pave the way for a new wave of such exercises.

Wu Jiejiang is a partner at Jingtian & Gongcheng