News Analysis: Market-oriented debt-for-equity swaps to lower leverage substantially

China's new debt-for-equity swaps are expected to substantially lower debt levels of companies in the red, improve profitability and allow market forces more say.

The deleveraging effect of the program should be obvious, and model simulation results show that many companies' debt-to-asset ratios will decrease by about 10 to 20 percentage points, Zhao Chenxin, a spokesman for the National Development and Reform Commission (NDRC), the top economic planner, said Thursday.

This round of debt-for-equity swaps will be performed on a market-oriented basis and in accordance with legal principles, stressed Zhao, adding that no cap will be set on the scale of the program.

China's State Council on Monday released guidelines on the long-discussed debt-for-equity swaps, pledging that the scheme will be conducted in an orderly fashion as the country steps up efforts to tackle high corporate debt.

High corporate leverage in China has been a major threat to companies' profitability and to broader financial stability. The country's total debt surged after the 2008 global financial crisis and its debt-to-GDP ratio was reportedly around 250 percent by the end of 2015.

Debt-for-equity swaps refer to transactions in which the debt of a company is exchanged for a predetermined amount of equity of the company.

If designed properly, such programs are generally believed to benefit banks, troubled companies and creditors. They can ease pressure on companies and beef up banks' balance sheets, releasing capital for investment. Creditors can profit when the company's revenue and profits start to rebound.

Similar programs have been adopted in United States and Japan to help companies better position themselves for long term success after undergoing financial restructuring, said Shi Hongxiu, a professor with the Chinese Academy of Governance.

This is not the first time China has embraced such programs, but it was different from the practice of establishing four asset management corporations (AMCs) in 1999 to deal with large piles of non-performing loans and distressed assets of state-owned banks in which administrative power played a big role, Shi added.

This round of the debt-for-equity conversion program is market-oriented and there is no predetermined scale of the plan, Zhao stressed.

Creditors' interests need to be protected, with the market being given the leading role in such programs. The government can formulate good rules, create good market environment and tackle market failures, Shi stressed.

However, market observers caution that the program could be a lengthy process and might undergo ups and downs.

The program will help substantially ease companies' financial burdens, Zhao said at a press conference, adding that "the final outcome and effectiveness will hinge on negotiations between companies and creditors."

The Chinese stock market reacted positively to the plan, with shares related to debt-for-equity swaps posting big gains this week, as investors predict such programs will boost their profitability significantly.

Price of Wuhan Iron and Steel Company Ltd., the listed arm of Wuhan Iron and Steel (Group) Corp. surged by the daily limit of 10 percent to 3.04 yuan per share Monday, and jumped 9.87 percent to 3.34 yuan per share Tuesday, on the heels of the announcement of a debt-to-equity conversion plan from its parent company.

A 12-billion-yuan (1.8 billion U.S. dollar) joint transition and development fund has been set up by stakeholders including China Construction Bank and Wuhan Iron and Steel (Group) Corp. for deleveraging and restructuring of the industry giant.

A large chunk of the funding was from private investors, and it is predicted that the group's debt level can be reduced by 10 percentage points, said Sun Xiwei, chief investment strategist at CITIC Securities.

Debt-for-equity swaps can help improve the efficiency of resource allocation, strengthen banks' capital positions, reduce companies' financial burdens, and speed up the restructuring of these companies, Sun told Xinhua Friday.

The market has a huge amount of capital chasing limited investment opportunities. If companies with strong profitability prospects can be located and the structure of debt-for-equity swaps can be well designed, private investors will be eager to become stakeholders of such programs, said Guo Tianyong, with the Central University of Finance and Economics. Endi