It’s a type of credit protection mainly seen in China’s $885 billion market for dollar bonds (those sold outside mainland China, denominated in U.S. dollars). The keepwell provision often involves a Chinese company’s pledge to keep an offshore subsidiary that is issuing the bonds solvent — but without any guarantee of payment to the bondholders. (Actual guarantees require regulatory approval but keepwells don’t.) The clauses often include an agreement where the parent will purchase equity interest or assets in the offshore subsidiary as a way of servicing payments on overseas notes, according to an analysis by Fitch Ratings. Terms can vary, with different definitions of default, trigger events or what actions the keepwell provider promises to take.
2. How much is out there?
About $119 billion of Chinese offshore bonds outstanding, or about 13% of the total, have the keepwell structure, Bloomberg-compiled data show. That includes some $25 billion from Chinese real estate firms, a risk-laden but popular sector. A record number of notes with such provisions were issued in 2019 and the pace has held fairly steady.
3. Why are they in the news now?
Investors are pondering worst-case scenarios for China Huarong, whose shares were suspended April 1 after it said its auditor needed more time to complete its financial results. That had investors worried about whether they would be repaid or forced to take a loss and spurred a historic selloff in the bonds. The firm is considered investment grade though its bonds were trading at junk levels in mid-April, in part due to uncertainty over how much protection the keepwell clauses offer.
4. What have the courts said?
In early November a court in mainland China for the first time effectively recognized creditors’ claims on a Chinese defaulter’s offshore bonds that were backed by a keepwell provision. The order in the case of CEFC Shanghai International Group Ltd. could serve as a precedent for others in similar straits, including Peking University Founder Group Corp. That sprawling conglomerate with medical and internet businesses entered a court-led debt restructuring in February 2020. A lot of bonds sold by its overseas subsidiaries had keepwell provision, and the people who bought them are now looking to recoup their money. Some of those bondholders have initiated legal action offshore after Founder Group’s restructuring administrator rejected their requests to recognize claims on five keepwell bonds in August.
Chinese companies began using the keepwell structure in late 2012 in a bid to assuage concerns of skittish overseas investors about a bond issuer’s creditworthiness. They became increasingly popular as policy makers in Beijing adopted a more market-led approach to business and allowed corporate bond defaults to rise. In 2017 the State Administration of Foreign Exchange, a market regulator, issued new rules regarding guarantees that made it easier for domestic companies to bring home cash raised through offshore bonds. But according to China International Capital Corporation, an investment bank, some Chinese issuers have stuck with the keepwell structure because the rules for where the proceeds can be used are more flexible and there are still fewer regulatory approvals required.