China's first default avoided but questions remain

The Shan’xi mines-backed trust product is bailed out but a default of certain financial products will come sooner or later and it will be good for the market.

The threatened default of a Rmb3 billion ($490 million) Chinese trust fund has been avoided but has nonetheless raised awareness internally about the market's inherent risks.

China Credit Trust (CCT), one of the biggest institutions in the country's so-called shadow banking system, said on its website on Monday that it had come to an agreement to repay investors in its Chengzhijinkai No. 1 fund.

The product was distributed through the Industrial and Commercial Bank of China's Shan'xi branch and was due to mature on January 31

According to Chinese-language media outlet Caixin, some strategic investors may take over the coal mine assets that back the trust product, enabling trust investors to get back their principal.

CCT's announcement ends the recent suspense over whether China would soon see its first default, disappointing those who had hoped it would help the country to price risk more effectively by instilling greater market discipline.

However, the possibility of default has already gained much attention and triggered a massive discussion in China, placing a question mark over the degree to which so-called implicit guarantees can be relied upon.

“The CCT product is not the first one that may default, but it’s definitely not the last one. However it can give us more time to prepare for any default,” said one trust investor who has bought such products before and who declined to be named.

Usually the government would step in to guarantee any loss incurred in financial markets but Beijing appears more determined to continue its reforms and instil proper risk pricing, making a default more likely. In the case of CCT and Chengzhijinkai No. 1, it behaved in a relatively restrained manner. 

The government has asked trust companies to report on any risky products set to mature. According to Yang&Lee Trust, a Jiangxi-based trust firm, there are at least Rmb546 billion-worth of trust products to mature in 2014.

Aside from the trust products sold privately to high net-worth individuals and retail investors, the Chinese government is reviewing the country's entire shadow banking system. As a recent Bank of America Merrill Lynch report puts it: “the most volatile part of the system is the financial market and the weakest link of the financial market is shadow banking.” 

In what could be the start of a difficult adjustment process, Chinese local media report that some local government financing vehicles have been asked to review their debts, especially those linked to trust products backed by property, mining and energy assets. As a result of funding difficulties, more than 10 Chinese provinces, autonomous regions and municipalities, including Fujian, Hubei, Inner Mongolia, Anhui and Shaanxi, have had to cut their transport budgets for 2014, according to an ANZ report on January 27.

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