China Drops a Silent Economic Bomb: Hints at Bankruptcy Rules for Financial Sector

by John Galt
June 12, 2016 17:55 ET

The one thing that foreign investors had always been able to count on with the People’s Bank of China (PBOC) and the Communist Party of China was that no matter how bad the conditions in their financial sector may get, the government and PBOC will always find away to restructure the debts or ensure the continued operation of the entities to avoid an outright default.

Sunday, during the Lujiazui Forum in Shanghai, that theory was turned on its head. From the South China Morning Post in Hong Kong:

China hints at bankruptcy rules for finance sector

Excerpted:

Mainland authorities have signaled they are ready to accept the threat of volatility from financial institutions going bankrupt, with official calls for an orderly way to let failed players go bust.

Central bank deputy governor Zhang Tao said on Sunday that ensuring the stability of the financial sector did not mean protecting every institution against failure.

“Those institutions that need to be restructured should be restructured, and those doomed to go bankrupt should do so under the discipline of market forces,” Zhang said at the Lujiazui Forum in Shanghai.

Woah. That’s the kind of shot across the bow that should send a shiver down the spines of any investor because if losses are incurred, the odds of any recovery before a magistrate in one of the provincial courts within the communist system is basically nil unless one is part of the Communist Party apparatus inside of China. More from the story at Shanghai Daily coverage of the forum:

Tighter scrutiny call at finance forum

Excerpted:

Tighter scrutiny of the financial sector amid the challenges of global economic growth and China’s financial reform was one of the themes that emerged during the Lujiazui Forum in Shanghai yesterday.

Four top-level officials, including Xiang Junbo, chairman of the nation’s top insurance regulator, spoke during the morning session of the two-day meeting, discussing China’s approach in developing a more reasonable financial market under supply-side reforms.

“China has established a relatively complicated financial system with diversified products,” Zhang Tao, deputy governor of People’s Bank of China, told the forum. “But the general level of our financial services still has much room for improvement, as we should face and solve the structural weakness shown by some specific sectors.”

Zhang spoke about the financial macro prudential management mechanism in cooperation with the government’s plan of leveraging down and capacity elimination, and highlighted the necessity of bringing in financial innovations such as peer-to-peer lending and equity crowd funding into the mechanism. New financial technologies brought explosive development in China’s Internet financial sector, providing services for broader investors, Zhang said.

“Financial innovation itself is affirmative, but at the same time, we should not overlook the risks hiding behind, which calls for further regulation and management to catch up with the pace of sector’s development,” he said.

The final hint as to what is about to hit the markets in the months ahead was dropped by none other than former Deputy Governor of the PBOC, Wu Xiaoling, also via Shanghai Daily:

Gaining without any pain seems ‘illusionary’

NO pain, no gain — that’s what a former Chinese central bank official emphasized yesterday at the Lujiazui Forum as she cautioned China’s policy-makers that it’s time to halt uncalled-for support for certain sectors and let the market play its role.

With China’s real economy remaining sluggish and domestic consumers shifting their demand to overseas, the Chinese government has been accelerating its efforts since last year to combat overcapacity in sectors such as steel and encouraging new industries such as innovation to be the catalyst to revive the economy.

Such change hurts but the pain is a necessary process as Wu Xiaoling, former deputy governor of the People’s Bank of China and now dean of the PBC School of Finance at Tsinghua University, said in a panel discussion on supply-side reforms, financial innovation and macro prudential regulations at the forum.

“Monetary stimulus or credit easing is not a long-term plan,” Wu said. “It’s illusionary for someone to imagine a bright future without growing pains.”

Unfortunately for the Chinese and the world, the markets are inter-linked throughout the web of complex con artist instruments and if China decides to inflict pain on the speculators inside their nation, they might give other markets throughout the world a case of Zika or Ebola. The pain will be widespread and deep but worse will be the shock factor if Western investors are not made whole because of a major Chinese financial company going bankrupt.

Buckle up sparky, it’s going to be a wild end through 2016.

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