Evergrande and Implications for Debt Capital Markets

By Jake Rickman​

What do you need to know this week?

Evergrande is one of the largest Chinese property developers. It is also one of the most indebted companies in the world. They have borrowed more than $300bn, which means they owe more than the GDP of 150 countries.

Evergrande has signalled that they may not be able to pay back their debt. Because they owe so much money to over 300 banks and lending institutions (these are Evergrande’s “creditors”), investors around the world fear that their default could spread to the rest of the Chinese market and beyond.

The worst-case scenario would be a global “credit crunch”, which is where the cost of borrowing gets more expensive because Evergrande’s creditors, being global banks, restrict their future lending.

Why is this important for your interviews?

The Evergrande saga has wide implications for investors around the world. If you can explain how and why, you’ll go a long way to demonstrating your commercial awareness because it ties together so many different areas of business and finance.

To understand how Evergrande’s default might cause a global credit crunch, you’ll need to know a little bit about “debt capital markets” (“DCM”), which may sound complex, but just refers to where big companies go to borrow money.

The market is made up of borrowers (such as Evergrande) and their lenders (all 300 of them). Just like you can buy and sell a share in a company, when a lender loans a borrower money, the debt itself is capable of being traded. This is called a “debt security”, which refers to any kind of IOU (usually either a loan or a bond).

Lenders get scared when they think their borrower won’t repay their amount as agreed, which is why they have certain protections in place. These protections include “taking security” over “assets” (like real estate). When the lender defaults, the security gives them the right to sell the assets to pay off the debt. In practice, this is a big risk: it’s expensive and complicated. Many lenders prefer to sell their debt to another investor just to recover a portion of the money upfront and let the other guy deal with the headache. But when a single company owes so much money, it becomes much harder to sell because there are a couple of hundred other lenders trying to do the same. This drives the price of the debt significantly down.

If these lenders cannot sell these debt securities to someone else, they will not be able to lend to others because lenders only have so much money to lend. Given that many of Evergrande’s creditors are global institutions like investment banks, this may turn into a global issue if there are a critical mass of global lenders stuck with these loans.

How is this topic relevant to law firms?

When a company borrows money, there will be a contract containing all sorts of terms and conditions that the lender and borrower will have both agreed to. In this sense, all loans and bonds are just contracts.

Evergrande has borrowed from hundreds of different lenders. There are hundreds of different contracts. The terms of each contract will be different: some borrowers will be in a better position than other borrowers because some contracts will grant the lender the right of “securitisation” (see above). Other contracts will not (this is referred to as “unsecured debt”).

Each lender will need a team of lawyers to work out exactly what the terms and conditions of their contract say. The amount of outstanding money, the number of different lenders, and the fact that much of the debt is secured to Chinese real estate property make this a harrowing and complex event for each lender’s legal team.

Law firms with renowned debt capital markets teams, like White & Case, Allen & Overy, and Kirkland & Ellis, will be well placed to advise in advance of Evergrande’s default. If they actually default, firms with strong insolvency practices with a focus on creditors’ rights will also join the fray: think of Akin Gump, Weil Gotshal, & Manges, and Linklaters, to name a few.

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