Watch This Space: Beijing Says It Won’t Bring Sovereign Bond to U.S. Capital Markets — But For How Long?

(Washington, D.C.): In the immediate aftermath of the Securities and Exchange Commission’s adoption of historic new disclosure requirements for foreign registrants with operations in U.S.-sanctioned countries, the Chinese government reportedly decided last week to withdraw its $1.5 billion sovereign bond from the U.S. market. This is good news for American investors and interests — provided it does not amount to a bait-and-switch scheme, resulting in a below-the-radar-horizon introduction of this issue via offshore venues.

Follow the Money

Ostensibly, Beijing’s decision to place its offering in the euro-dollar and euro-euro markets and possibly other non-U.S. locales was a response to an unfavorable climate created by Chinese aggressiveness resulting in the downing of an American E-P3 surveillance aircraft and holding its crew for eleven days. There is reason to believe, however, that the real reasons for the PRC pull-back are to be found elsewhere. Specifically, the driving factors appear to have been the combined effect of the ground-breaking SEC rule reinterpretations made public on 8 May and market concerns related to the prospective actions of the same well-organized, non-governmental “PetroChina Coalition” that helped to derail a similar $1 billion, undisciplined PRC bond offering in November of last year.

According to a Financial Times article of 16 May by Joe Leahy and Aline Van Duyn:

Recent changes to SEC procedures regarding the amount of documentation required from foreign borrowers might also have delayed the process of issuing a bond into the U.S. market, a situation China wanted to avoid.

“If there was any kind of public filing you would have run the risk of there being noise in the U.S. press, which you wouldn’t want because it would also impact demand potentially,” said one source familiar with the issue….

Conservative elements in the U.S., such as the William J. Casey Institute, regularly lobby against allowing China to sell sovereign bond and share issues in the U.S. on human rights and security grounds. The institute was a key opponent of initial public offerings in New York by state-owned Chinese oil groups PetroChina and Sinopec in recent years.

Other groups, such as the U.S. Commission on International Religious Freedom, an advisory body, has been lobbying President George Bush on the idea of barring Chinese sovereign bond offerings in the U.S. unless the country improves its record on religious freedoms.

Devil In the Details

Evidently, the decision by China and its investment banks to steer clear of the U.S. capital markets even extended to foregoing the exercise of a favorite loophole in SEC’s transparency guidelines, so-called Rule 144 (a). This rule permits the private placement of euro- and dollar-denominated portions of the PRC bond offering with “qualified institutional buyers” in the U.S. without the standard disclosure requirements being satisfied. The use of 144 (a) would, however, have left Beijing open to the sort of pressure aimed at discouraging U.S. pension and mutual funds from holding China’s debt. The SEC is properly concerned about the impact of such campaigns on the value of targeted foreign securities.

Still, it is entirely possible that unwitting Americans will find themselves holding this Chinese offering in portfolio as soon as this summer. European investors can market the debt to offshore U.S. institutional investors (often domiciled in the Bahamas or Nassau), and — following a forty-day “seasoning period” — the debt can be sold to all U.S. investors (institutional or individual) in a U.S. secondary market.

In other words, China may have temporarily abandoned its goal of further penetrating the American bond market (where the PRC already has some $4.2 billion outstanding). The William J. Casey Institute remains concerned, however that U.S. pension funds, insurance companies and other American portfolios could purchase these bonds through a “bank-shot,” in the process implicating their investors in this latest Chinese cash-raising scheme — the proceeds of which can be used for whatever purposes the Communist leadership deems indicated.

Why Europe?

Interestingly, the New York Times [of 14 May] reported that PRC Vice Minister of Finance, Jin Liqun, is insisting in the course of the new sovereign bond’s “road show” that the Chinese “don’t need to borrow.” In fact, the reality is profoundly different. According to Gordon G. Chang, a former partner at Paul, Weiss, Rifkind, Wharton & Garrison in Beijing, “China has less borrowing capacity than many people think; it is not as creditworthy as many people think. Perhaps they think they’ll need the Europeans down the road.” Chang also observed, “The fact that China originally awarded [the bond offering] to three American firms really shows their dominance in the debt market.”

Bottom Line

American investors are on notice: Even though they likely have little interest in helping underwrite — on a pure cash basis — the Communist Chinese government, they must remain vigilant if they are to ensure that their pension and mutual funds and other managed portfolios are kept free of this dangerously undisciplined debt instrument in the event it emerges in this country from some offshore locale, after a mere forty-day hiatus.