Foreign investors should expect to suffer from Evergrande’s woes.

The investigations and detentions of current and former top executives of China Evergrande Group, formerly the biggest Chinese property developer by sales, signal that the Chinese government will exert more control of China’s troubled property market, industry observers suggest. They warn that foreign holders of Evergrande’s shares and bonds will be last in line to receive repayment, if any.

Evergrande’s liabilities totalled RMB2.39 trillion ($327 billion) in the first half of 2023, the Hong Kong-listed firm disclosed in its most recent interim report. As of August 31, the unpaid debts due from Hengda Real Estate Group – the principal subsidiary through which Evergrande operates the bulk of its business in China, totalled RMB278.5 billion. Hengda’s overdue commercial bills currently amount of RMB206.8 billion, while the firm also has 1,946 pending lawsuits involving even more capital.

Exacerbating the company’s corporate humiliation – as a result of which the business is under investigation and prohibited from issuing bonds – last week, Evergrande announced that Hui had become “subject to mandatory measures” due to “suspicion of illegal crimes”. The news propelled the once Forbes-rated richest man in China into disrepute, while media reported his colleagues – former chief executive, Xia Haijun and former CFO, Pan Darong, as having been detained by police.

The market apparently welcomed the news of police control, with the company’s share price soaring by 21.9% to 39 Hong Kong cents as of the afternoon of Tuesday, October 3, following share suspension at the end of last week.

“I am not sure how this news can give confidence that Evergrande can avoid liquidation, and it will likely worry the heads of other struggling (Chinese) real estate firms,” wrote Bill Bishop, a former media executive with experience working in China.

“The central government will not simply let all these developers go bankrupt without any penalties and the owners will face different levels of punishments,” a managing director of a property advisory firm, told FinanceAsia, declining to be named.

The police restrictions on Hui mark a turning point, indicating that Chinese government will take more control of the country’s embattled property sector, a senior hotel executive told FA.

He suggested that the government would seize Hui’s 59.8% share in Evergrande, worth HKD 4.23 billion ($540 million), in order to merge it with a state-owned enterprise (SOE).

“It’s hard not to see this process as liable to strengthen the state at the expense of the private sector. As a rule, the model is that the government steps in – represented sometimes at arms-length by SOEs, in concert with regulatory action, “Steve Vickers, CEO of Hong Kong-based risk consultancy, Steve Vickers Associates, told FA.

“Investigations usually result in arrests and convictions, and often stray into other sectors, following patronage networks or other linkages. The fallout lasts years, usually,” he added.

Chinese president, Xi Jinping, has never believed in the “trickle-down effect” of wealth creation, Diana Choyleva, a senior fellow of the Asia Society Policy Institute and chief economist at China-focussed UK think tank, Enodo Economics, wrote in an article posted on LinkedIn last week.

“Official policies are not so extreme, but Xi’s ideological goal is nonetheless to strengthen Party power in both state-owned and strategically important private enterprises, and to subordinate business decisions to the needs of the party.”

“Businesses remain doubtful of Beijing’s promise to allow the private sector to grow amid the government’s focus on security and absolute control,” she added.

Contagion in financial sector

Evergrande's problems have spread to the financial trust sector, Vickers said, explaining that trust companies typically constitute the key lenders in property purchases.

“It is likely that inquiries into trusts and local governments have led back to Evergrande,” he said citing Zhongzhi Enterprise Group, a financial firm that has failed to pay investments on its products since mid-August. Since then, the central government has initiated an investigation into the firm, as well as China’s wider trust sector and other local government finances, Vickers disclosed.

Closer Chinese government regulation of the trust sector is “almost inevitable” he wrote.

He told FA that “the life insurance industry may be the next shoe to drop,” given the appetite of life insurers for exposure to property-related products.

Foreign confidence

Singapore-based management consultant, Patrick Oh, posted on his website last week: “Evergrande’s debt issues [have] spilled over into international markets, as it owed money to foreign investors and bondholders. This [has] raised concerns about potential contagion effects on global financial markets.”

He pointed to how the crisis had eroded investor confidence in Chinese markets and raised questions about corporate governance and transparency.

Evergrande’s equity shareholders are the last claimants and foreign holders of the firm’s dollar bonds are subordinate, an ex-banker told FA.

“They have nothing left to claim. Lawyers have told me they recommended to Evergrande-lending clients to make sure they were secured against its foreign assets such as a building in New York,” he said, nothing that the firm’s current market capitalization equates to just 1.2% of what it held in July 2020.

Will things get better?

Analysts are divided on whether China’s property market will improve or recover.

The senior hotel executive said that, with the government’s move to gain more control of China’s property market, the sector should turn around. He said that the Chinese government could funnel state money to bail out troubled property firms and if necessary, print more Chinese currency to do so.

But others take a firmer line. “The Chinese government will let Evergrande crash in a hard way, and the owner will be punished,” said the property advisory managing director.

Oh remains sceptical, believing that while China’s property bubble has already burst, its socialist economy means citizens will retain roofs over their heads.

Meanwhile, Michael Pettis, professor of finance at the Guanghua School of Management at Peking University, tweeted last week that “Beijing should be racing to develop a well-functioning, rapid bankruptcy process that is largely free of political intervention.