The Morning Call wants you to beware

As you may or may not know, one of the mechanisms by which global financial companies are trying to advance ESG (Environmental, Social, and corporate Governance) goals and, thereby, to ward off climate change is through what is called “sustainability-linked” debt.  The way it works is a company and its banker agree to terms whereby the interest rate on the debt is readjusted periodically, based on the borrower’s compliance with any of several key sustainability measures.  If your sustainability score goes up – say you cut your carbon emissions or install solar panels on your corporate headquarters – then your rate goes down.  If, conversely, your sustainability score goes down – your emissions increase or you partner with a fossil fuel company or fail to complete negotiations to increase your supply of certified child-labor-free lithium for batteries – then your rate goes up.  Companies are thusly incentivized to embrace “good” ESG behaviors.

The use of sustainability-linked loans has been growing rapidly in nearly every region of the globe and in nearly every country that participates in global capital markets.  Evert country but one, that is.  As Bloomberg noted recently, companies in one major nation seem reluctant to get on board the sustainability-loan train:

Chinese firms are lagging their regional peers in a key funding method to meet sustainability goals, even as the world’s second-biggest economy pushes to become carbon neutral by 2060.

So-called sustainability-linked loans usually offer creditors extra margins if borrowers fail to meet their environmental goals, giving firms an incentive to make an extra effort. While the volume of such debt has climbed at a record pace in the rest of Asia Pacific, few deals are being done in China.

Huh.  That’s interesting.  We wonder why that might be the case?  Bloomberg suggests the following:

The volume of sustainability-linked loans is floundering in China partly because, in a market that’s keenly focused on official pronouncements, policymakers have said little about them even while encouraging other forms of sustainable financing. Guidelines for environmental lending by the People’s Bank of China released in late May emphasized green borrowings, for example, while not mentioning sustainability-linked debt.

Chinese borrowers may also be reluctant to risk harming their green reputation by missing targets specified by the loans.

Oooooo…K.  That all sounds well and good, but does it make sense?

The second excuse explanation offered by Bloomberg – which appears to be in the business of making excuses for Chinese companies – is probably true for Chinese companies.  But then, it’s also true for Korean companies.  And Japanese companies.  And French companies.  And American companies.  It’s a little like saying that ducks walk funny because they have feet.  No company wants its green reputation besmirched. 

As for the first explanation, that makes more sense but lacks…umm…“context.”

As we noted above, these sustainability-linked loans are pretty straightforward.  A company promises to meet sustainability targets in return for lower rates.  At the end of a pre-arranged period, the company reports its data, the data is verified by a bank audit, and then the new terms are authorized.  Simple, right?

Well, as many of you may have noticed, the keyword in that description is “audited.”  It’s inarguably true that “the volume of sustainability-linked loans is floundering in China, partly because…policymakers have said little about them.”  But that’s only half of the story.  The other half is that policymakers haven’t said much about them because of that word “audit.”  As any schoolboy knows, Chinese “policymakers” – which, let’s be honest, is a pretty anodyne term by which to refer to the Chinese Communist Party – HATE audits, or at least they hate audits performed by people from outside of China.

For decades, anyone who has paid any attention at all to China has known that every single statistic offered by official government sources is false, exaggerated to demonstrate China’s greatness.  Likewise, for years, anyone who has paid any attention at all to China has known that every single statistic offered by Chinese companies is suspect AT BEST.

As you may recall, last week, we noted that BlackRock is very excited to have its investors dump TRIPLE their current investment allocations into China.  It doesn’t take Sherlock Holmes (or even Dr. John Watson) to figure out that BlackRock has an ulterior motive here.  If it didn’t, then it might be worried that you’d remember the phrase “Luckin Coffee.”

First, there was this:

China’s Luckin Coffee, a self-declared challenger to Starbucks, has raised $150 million in its latest round of funding from investors including BlackRock, which values the company at $2.9 billion.

The investment, $125 million of which came from a private equity fund managed by BlackRock, follows a $200 million funding round in November that had increased the company’s valuation to $2.2 billion, Luckin said in a statement on Thursday.

The up-and-coming coffee chain with ambitions to challenge Starbucks in China is backed by investors including Singapore sovereign wealth fund GIC and China International Capital Corp Ltd.
Reuters reported in February that Luckin had tapped three banks including Credit Suisse to work on a U.S. IPO in 2019. The company’s chairman also sought a loan of at least $200 million from banks including Goldman Sachs and Morgan Stanley, sources told Reuters last month.

And then, of course, there was this, less than ONE YEAR later:

The accounting scandal at Luckin Coffee, a start-up that aimed to displace Starbucks in China, has caught out several of the world’s most powerful investors.

BlackRock and Singaporean sovereign wealth fund GIC were among those who invested in private funding rounds in the months before Luckin’s initial public offering last year. Louis Dreyfus, one of the world’s biggest traders of orange juice and coffee, and Melvin Capital and Centurium Capital were also backers.

Shares in Luckin crashed more than 70 per cent on Thursday after it disclosed that an internal investigation had uncovered Rmb2.2bn ($310m) in fabricated transactions.

Several employees, including its chief operating officer, have been suspended and its previous financial statements can no longer be relied on, the group warned.

The disclosure casts considerable doubt over the future of the unprofitable group, which was founded in 2017 by Lu Zhengyao and had more than 4,000 outlets by the end of 2019. In the prospectus for its initial public offering last year, Luckin declared that the coffee chain would be the largest in China by the end of 2019 as it disrupted the “status quo of the traditional coffee shop model”.

Protocol, the tech-heavy independent media publisher, describes the overarching problem as follows:

While Chinese companies listing in the U.S. have auditors, they are often based overseas. What standards do they meet? The PCAOB, whose budget and standards are set by the SEC, doesn't know, since it hasn't been able to inspect any auditor's work in China satisfactorily since 2007.

Concerns about the quality of audits aren't theoretical: Sound financial reporting undergirds the safety of American stock markets — the liquidity and high reputation Chinese companies have pursued by listing their shares abroad. Luckin Coffee, which listed its shares on the Nasdaq in May 2019, paid a $180 million fine to the SEC in December to settle charges it fabricated $300 million in revenue.

Many auditors in China lack strong incentives to provide accurate audits of companies, said Anne Stevenson-Yang, co-founder and research director at J Capital Research. "The auditors are paid by companies they audit," she said. "Of course they have a disincentive to say negative things."

Now, as we say, you know this.  We know it.  Everyone knows it.  So why doesn’t Bloomberg say it?  And why does BlackRock want to pretend otherwise?

These are rhetorical questions, obviously.  Bloomberg and BlackRock won’t say anything for the same reason that the bankers at Lehman Brothers wouldn’t let us say anything some twenty years ago, because it makes things uncomfortable for them; it puts various relationships with Chinese officials at risk.

One more time to be clear: telling the truth about the Chinese government and the Chinese government-sanctioned markets would hurt their business.  And so they don’t.

Chinese companies won’t agree to sustainability-linked loans because that would mean that their books could be checked by outsiders.  And we can’t have that, now can we?

Caveat emptor, in other words.


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