China’s bondholders are increasingly worried that there is little to protect them from being railroaded into bad deals by troubled borrowers amid a wave of virus-related extensions and restructurings.

The country’s 25 trillion yuan ($3.53 trillion) corporate bond market has become an increasingly important funding channel for Chinese companies and government-backed vehicles, but it has limited experience with distress or default.

While bondholders the world over fret about what happens when a company can’t repay them, those in China say they have few established precedents or procedures to guide them.

China’s first public bond default happened just six years ago.

“Onshore investors used to pay less attention to the covenants and provisions,” said Ivan Chung, head of Greater China Credit Research & Analysis at Moody’s. “Credit incidents and defaults in the past two years have alerted investors about these weaknesses. Yet there are still lots of outstanding bonds in the market with weak protection for investors.”

Risks for bondholders are rising even faster now as Chinese officials seek to avert an avalanche of defaults caused by the country’s coronavirus-ravaged economy. They are encouraging struggling companies to extend repayment dates or exchange debt coming due for new bonds - both of which need bondholder agreement.

RISING FINANCING COSTS

Goldman Sachs analysts count at least 10 Chinese borrowers that have avoided defaults this year by extending principal repayments worth a combined 6 billion yuan ($846.80 million).

But not all such agreements have been reached smoothly, and disagreements can carry risk.

Inadequate investor protection threatens to “push up companies’ financing costs ... and reduce foreigners’ willingness to participate in China’s bond market,” said Xin Chen, finance professor at Shanghai Advanced Institute of Finance (SAIF).

China has been courting foreign investors for its local markets to help bolster its currency and fund domestic growth.

One of the latest causes of investor outrage was conglomerate HNA, which gave holders of one $55 million bond just 30 minutes’ official notice of a meeting that would extend by a year its imminent repayment, even though its own rules required 30 days’ notice and exchange rules require 10 days.

HNA subsequently apologised and explained it had discussed the deferral with major bondholders ahead of the meeting. Three big investors accounting for more than 98% of the bonds represented at the meeting voted for the plan, while 29 voted against.

“If authorities give the nod to such a practice, it shows deficiency in our legal protection for bondholders,” Chen said of the move.

HNA declined to comment.

Bondholders in other companies have complained about the way they have been treated. One angry investor found his line cut off mid-question during a call in February to discuss an offer to pay about 40 cents on the dollar for $850 million in Qinghai Provincial Investment Group (QPIG) bonds.

QPIG didn’t reply to requests for comment.

GRABBING ATTENTION

Unlike mom-and-pop retail investors, who dominate China’s stock market, bondholders fear they can’t get officials’ attention because they are mostly institutions, and less likely to protest in the streets.

For example, while mechanisms for shareholder decisions have long been enshrined in national law, a requirement that companies should have bondholder meetings and disclose relevant rules and procedures in bond prospectuses was only added this March.

“Before it was a bit theoretical what would actually happen in a bankruptcy because you never had one. You can do all the preparation you want but you won’t really know what works and what doesn’t. Clearly there have been practical issues,” said Samuel Fischer, head of China onshore debt capital markets at Deutsche Bank in Beijing.

In July, the National Association of Financial Market Institutional Investors (NAFMII), China’s interbank market regulator, will introduce new guidelines for bond trustees - third parties who ensure bond conditions are upheld.

Internationally, these have been independent. But in China, they have typically been the banks and brokers underwriting the deal, who may have conflicts of interest, Moody’s Chung said. The new guidelines strengthen rules around conflicts of interest and disclosure requirements to bring China more in line with offshore markets.

Another thorny issue is courts’ unfamiliarity with bondholder issues. Even if meetings and votes do not follow the rules, investors may struggle to contest those because of a lack of legal precedents, according to Lei Jiping, partner at King & Wood Mallesons.

The China Securities Regulatory Commission (CSRC) and NAFMII didn’t respond to requests for comment.

RISING DEFAULTS

Last year defaults in China’s onshore corporate bond market hit a record 142 billion yuan, according to Moody’s. But that accounts for just 0.6% of the total market, while the default rate in the U.S. bond market is about 1.8%.

The stakes are high for China as Beijing works to reform its financial system and deepen its credit markets to help shift some banking risks. And there are signs that bondholders’ influence may be growing.

Last week, Chinese property developer Gemdale Corp offered holders of its 1 billion yuan 5.29% May 2021 bond a 1.5% rate for the final coupon payment, despite a prospectus clause that said any coupon adjustments must be increases.

The move angered bondholders and prompted sarcastic suggestions on social media that Gemdale had increased the coupon by a negative number. The Shanghai Stock Exchange demanded an explanation.

On Wednesday, Gemdale said that after “careful consideration,” it had decided to maintain the bond’s coupon at 5.29%, and issued an apology.