China’s fast-growing dollar-bond market is facing a fresh test as investors that counted on a type of credit-protection pledge seldom seen elsewhere find out just what those promises actually mean.

So-called keepwell provisions, disproportionately seen in the offshore Chinese debt market the past several years, are a sort of gentleman’s agreement – a commitment to maintain an issuer’s solvency which stops short of a payment guarantee from the parent company.

Now, two issuers of debt with keepwell provisions, China Energy Reserve & Chemicals Group Co. and CEFC Shanghai International Group Ltd. have defaulted on their dollar notes in May. They are among the region’s first defaults to carry such agreements, according to Goldman Sachs Group Inc., and investors are about to discover whether they provide the benefit that was promised.

“It would be a good test and may provide a precedence for offshore investors,” said Steve Wang, deputy head of research, BOC International Holdings Ltd. He expects guarantees to be a more standard choice with the further opening of the Chinese capital market.

A failed keepwell deed would be a further blow to China’s dollar bond market, where sentiment is already fragile with prices on junk debt plunging to a three-year low in May. Debt failures have spread after the government’s deleveraging campaign choked off some financing and the surge in Treasury yields raised cost of offshore funding, prompting some issuers to either shorten tenors or resort to floating-rate notes to pull in buyers.

Kept Well?

Chinese dollar bond issuers sell record notes with keepwell structure

Source: Bloomberg

Chinese issuers have total about $100 billion of notes outstanding with keepwell agreements, accounting for about 80 percent of such dollar issued bonds globally, according to data compiled by Bloomberg.

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