China Makes Rating Firm Pay for Debt Defaults for First Time

(Bloomberg) -- A Chinese court ruled that a local ratings firm should help compensate some creditors for a construction firm’s 1.4 billion yuan ($216 million) bond defaults three years ago, a first in the country as Beijing raises pressure on agencies to improve their due diligence.

Dagong Global Credit Rating Co. is responsible for repaying up to 10% of at least 494 million yuan of combined debt claims to more than 400 individual bondholders of Wuyang Construction Group Co., according to a ruling by Hangzhou Intermediate People’s Court dated Thursday and seen by Bloomberg News.

Wuyang Construction’s legal representative and actual controller Chen Zhizhang, underwriter Tebon Securities Co., as well as an accounting company and a legal firm are also collectively responsible, the court said, citing their failures to conduct due diligence properly.

Beijing has tightened oversight of the country’s bond market following a surge of defaults since November, imposing short-term bans on new business on two other rating agencies and launching probes into several banks, accounting firms and a large brokerage for alleged irregularities related to bond sales.

The Hangzhou court’s ruling also sets the precedent for bond underwriters, accounting and law firms to be financially responsible for bondholders’ losses, potentially offering a new roadmap for handling such cases in the future.

“This verdict should be the first of its kind in China. It substantially raises the cost of fraudulence and inadequate due diligence in the bond market,” said Yang Hao, a fixed income analyst at Nanjing Securities Co. “Financial intermediaries will become more prudent in the future and investors may also actively explore this approach to seeking compensation.”

Falsifying Documents

Wuyang Construction defaulted on two onshore bonds totaling nearly 1.4 billion yuan in 2017 and was later alleged by China’s securities regulator of falsifying financial documents to win regulatory approval to sell bonds.

In November 2019, the securities regulator fined Tebon Securities for violating rules when it was an underwriter in Wuyang Construction’s 2015 bond sale.

The latest court ruling didn’t specify the amounts of compensation that Chen, Tebon Securities and WUYIGE Certified Public Accountants LLP, the accounting firm, need to pay. It capped the ratio at 5% and 10% for AllBright Law Offices, the law firm, and Dagong Global, respectively.

Calls to Wuyang Construction, Tebon Securities and AllBright went unanswered, while WUYIGE and Dagong Global officials couldn’t immediately comment when reached by Bloomberg.

The verdict came after China’s interbank bond market watchdog last month imposed a three-month ban on new debt grading business for both China Chengxin International Credit Rating Co., in which Moody’s Investors Service holds a 30% stake, and Golden Credit Rating International Co. due to irregularities such as insufficient risk analysis and improper rating models.

China’s domestic rating firms have long been criticized for issuing inflated grades and being slow to detect risk in borrowers, one of the key factors that have capped global investors’ demand for the nation’s local corporate bonds. The authorities have sought to address such concerns in the past two years by allowing S&P Global Inc. and Fitch Ratings Inc. to operate independently in China, but with limited success so far.

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Yongcheng Coal & Electricity Holding Group Co., a state-run coal miner that contributed to the recent spate of bond blowups, held a domestic AAA rating when it defaulted in November. Brilliance Auto Group Holdings Co., a state-owned carmaker linked to BMW AG, saw its ratings cut just weeks before it defaulted on debts in late October.

In a more serious case, regulators in 2018 banned Dagong Global from assessing bonds for a year, saying it gave officials fake information and charged high fees for consulting services, violating its independence as a ratings firm.

©2021 Bloomberg L.P.

With assistance from Bloomberg