Evergrande ‘Ponzi Scheme’ Likely Sparks Major Property Market Restructure

Chinese economy and Hong Kong face dilemma over developer’s US$78 billion fraud

By: Toh Han Shih

China’s already-bleak property market is expected to undergo significant restructuring and, considerably, more pain following the US$78 billion fraud involving the bankrupt Hong Kong-listed China Evergrande Group, which leaves millions of mainland homeowners without homes they paid for and also presents challenges for Hong Kong as an international financial hub as the city seeks to shake off global opprobrium from Beijing’s tightening political takeover.

Evergrande defaulted in December 2021 as the world’s most indebted property developer with US$300 billion of debt. The collapse of what had been the biggest Chinese developer by revenue is a major component of the credit troubles of China’s property market, which is dragging down the nation’s GDP growth. The company’s chairman Hui Ka Yan was detained in mainland China in September 2023. On January 29, the Hong Kong High Court ordered the liquidation of Evergrande.

The China Securities Regulatory Commission (CSRC) accused Evergrande’s main subsidiary, Hengda Real Estate Group, of inflating its revenues by US$78.3 billion in 2019 and 2020, according to Hengda’s announcement on March 18. Hengda inflated its revenue for 2019 by RMB214 billion (US$29.7 billion), double its actual revenue, CSRC alleged, and inflated its 2020 revenue by RMB350 billion (US$48.6 billion) eight times its actual revenue, CSRC alleged. The securities watchdog accused Hengda of fraudulently issuing billions of dollars of bonds based on its falsified financial results and of failing to disclose in a timely manner its inability to repay RMB278.5 billion (US$38.7 billion) of debt.

“Evergrande was a Ponzi scheme and will be a big criminal case with a full loss for all shareholder and bondholder,” said Marco Metzler, a German credit analyst, on his LinkedIn account on March 19. It is the biggest fraud scandal in the history of China and possibly the world.

“We shall see a lot of restructuring in the future, and SOEs (state-owned enterprises) will take over a lot of private enterprises in this sector,” a Hong Kong property advisory executive told Asia Sentinel. “Since real estate and its related sectors represent around 40 to 50 percent of China’s GDP, so it is unavoidable that China’s economy will have to face a hard hit in the next three to five years.”

The Chinese government, he said, “will implement a lot of new measures to the real estate market to ensure all the non-SOE developers will have a healthy balance sheet without overleverage in the future. However, the Chinese government is still too busy to sort out how to avoid the real estate market fall into the spiral downward trend, so all new measures will only be implemented after the crisis is over, which may take years.”

The scandal is also a no-win situation whether Chinese courts follow the Hong Kong court order or not, said the Hong Kong property advisory executive. “If the Chinese court is not going to follow the Hong Kong court order to liquidate Evergrande’s mainland assets to pay back the offshore creditors, then the whole world will question about why these deals structured in Hong Kong can’t protect the foreign investors, which will have huge long-term implications to Hong Kong’s financial credibility and Chinese companies’ global financing opportunities, especially in US dollar debt.”

On the other hand, the executive added, “if the Chinese court follows the Hong Kong court order to liquidate Evergrande’s mainland assets to pay back offshore creditors, then massively troubled Chinese developers with offshore US dollar loans will face similar court orders, then the Chinese real estate market will be affected badly again.”

“This may be the beginning of a painful healing process, starting with prosecution and the removal of people perceived to have been responsible, then consolidation and restructuring of Evergrande using SOE support and then finally winding up of those elements which cannot be propped up,” Steve Vickers, the chief executive officer of Steve Vickers Associates, a regional political and corporate risk consultancy, told Asia Sentinel. “There is little hope for foreign bond holders, especially those who used grey area offshore structures to invest.” 

At a press conference in Beijing on March 9, Ni Hong, China’s Minister of Housing and Urban-Rural Development, said Chinese developers that are insolvent should go through bankruptcy or restructuring, as the government’s priority is to ensure delivery of property projects to home buyers, not protect developers’ business. The Chinese government fears the social instability that can result from Chinese homebuyers who do not get their homes.

“It seems to us that the central government is still not too concerned about the property sector’s downward spiral, a down cycle which has lasted for two and half years,” said a Nomura report on March 10. “We thus expect the sector’s fundamentals to remain under pressure amid limited potential policy support. Given the still-sluggish primary home sales year-to-date 2024, property developers’ cash flows will continue to be under significant pressure.”

Evergrande’s fraud

The CSRC banned Hui from the mainland Chinese securities market for life and fined him RMB47 million (US$6.5 million), according to Hengda’s announcement on March 18. The regulator fined Hengda RMB4.18 (US$580 million) and also penalized several of the company’s former senior executives.

Hui Ka Yan, whose name in Mandarin is Xu Jiayin, resorted to “especially evil tactics” to instruct Hengda executives to inflate financial results, the CSRC alleged. “The circumstances of this are particularly serious.” In the language of the Chinese Communist government, being accused of “particularly serious” crimes spells a death sentence or long imprisonment for the accused.

Hui will not be executed but will probably be jailed for 20 years to life, said a China watcher who asked not to be named. “Hui must be seen to be punished heavily because he is now being used as a scapegoat to appease the millions of people who have bought the unfinished flats (of Evergrande), despite having paid for them.”

Hui could have undertaken a fraud as huge as this only with the support of Chinese officials and influential political families, added the China watcher.

Question marks also hang over the fate of PwC, the international Big Four accounting firm which audited Evergrande’s financial statements. On August 15, 2022, the Hong Kong Accounting and Financial Reporting Council announced it was investigating Evergrande’s financial statements for 2020 and the first half of 2021. The audit watchdog also disclosed it was investigating PwC for its audit of the 2020 financial statements.

Fraud had earlier been detected in Evergrande. On February 18, 2022, a holder of Evergrande bonds, Liechtenstein-based Financial Market Partners Capital (FMPC) Consulting AG, filed an allegation of criminal conduct for insolvency fraud against Evergrande in the Cayman Islands, where the property developer is registered.

Last month on his LinkedIn account, Metzler predicted, “The management will be alleged of fraud operating a Ponzi scheme since the beginning of operations and deliberately delaying the winding-up to benefit from fire sales. Projects in mainland China will be taken over by the local and national government. There will be (absolutely) nothing left for international bondholder and shareholder and even the liquidator will chase for the payment of winding-up the complex group.”

On June 21, 2012, Andrew Left, a US short seller, published a report on the website of his firm Citron Research accusing Evergrande of presenting fraudulent information to the investing public. Ironically, in October 2016, Hong Kong’s Market Misconduct Tribunal banned Left from trading securities in Hong Kong for five years for his allegations, which have just been confirmed by the Chinese government. On August 26, 2016, the tribunal said Left had published “false or misleading information” in his damning report on Evergrande.

Toh Han Shih is chief analyst of Headland Intelligence, a Hong Kong risk consultancy