Asia Pacific Distressed Debt 2010

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ASIA-PACIFIC DISTRESSED DEBT OUTLOOK 2010 DECEMBER 2009

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CONTENTS Foreword

1

Research methodology

1

Survey findings

2

Guns N' Roses and the Chinese bankruptcy law

16

Looking ahead to 2010

20

Contacts

23

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FOREWORD

But the respondents to the survey are more sanguine about Asia’s prospects: almost everyone surveyed - 95% to be precise - think that Asian economies will outperform the US and Europe in the coming year. That doesn’t mean that Asia won’t provide distressed investors with the opportunities they are looking for. The majority of the respondents to this survey expect the number of defaults in Asia to either remain the same or increase in 2010. But at the same time, these participants indicated that finding actionable investment opportunities is a problem. Indeed, 59% of those surveyed stated that less than 25% of the situations they have explored represented an actionable and attractive investment opportunity. There are a number reasons for this, but no doubt, the fact that there are so little debt trades in Asia is the main factor which prevents investors from taking advantage of so many situations. Regulatory issues are also at work too: 57% of the respondents stated that regulatory restrictions against lending directly to onshore companies, particularly in China, means that enforcing rights over security is extremely difficult. Because of these regulations, offshore investors have, over the past few years, been ‘forced’ to lend to the offshore holding companies of Chinese domestic companies, the ultimate beneficiaries of such loans. However, as the FerroChina and Asia Aluminum cases underscored this year, offshore lenders in such situations often find that they are structurally subordinated to onshore (Chinese) banks that are quick to freeze the borrower’s assets at the first sign of unruly foreign creditor behaviour.

Indeed, this year’s survey indicates that a large majority of investors now see China as the most difficult market in which to operate, whereas in the previous two years’ surveys, China could only tie with, or take second place, to Indonesia for this dubious award. China also stands out in this year’s survey as being the country that is likely to be the source of more defaults than any other country in Asia. But it also ranks second (behind Australia and ahead of Japan) as having the most attractive distressed debt opportunities in Asia. No doubt, investors see the massive amounts of liquidity in the Chinese banking system and the government’s determination to reflate the country’s economy as providing more investment opportunities in the year ahead.

FOREWORD AND RESEARCH METHODOLOGY

Asian equity markets have soared, hard commodities boomed and Hong Kong property prices zoomed, and yet, as this survey shows, there is plenty of scepticism that the global economic recovery now underway is sustainable.

Regulatory restrictions and dysfunctional legal systems are cited as the biggest factors behind the difficulties in enforcing security rights in Asia, but investors clearly blame bad loan structures for the problems they have in recovering value: A whopping 94% of survey participants stated that security pledges over shares and other collateral in India, Indonesia and China had not proved as effective as had been expected when the loan deals were entered into. Meanwhile, 81% said the structured loan products, such as private placed loans arranged during the 2006-2008 boom years, did not provide adequate protection to creditors. In this context, it’s difficult to see where the most risky emerging market debtors will find new funding, particularly if the rally in Asian high yield bond and equity markets doesn’t hold up in 2010. And without those markets, creditors could find them stuck in the same trap of having to ‘amend, extend, and pretend’ for much longer than they had anticipated. Luc Mongeon Editor, Debtwire Asia

RESEARCH METHODOLOGY In October 2009, Debtwire canvassed the opinion of 100 people involved in distressed debt on their views of the Asia-Pacific distressed debt market in 2010. All responses are presented anonymously and in aggregate.

1

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SURVEY FINDINGS Who was surveyed?

Opportunities in the Real Estate sector are expected to increase the most in 2010

Please describe yourself:

Do you expect opportunities for distressed investors in the following sectors to increase, decrease or stay the same in 2010?

11%

13%

Private equity investor

Real Estate

84

Oil, gas and mining

62

Manufacturing

58

Financial Services

52

10

6

Proprietary trading desk at bank or investment bank 6%

36

2

24

18

Financial advisor

34%

Bank/investment bank credit risk management/credit workout dept

Technology

47

Auto manufactures/ Suppliers

40

37

11

45

8

51

Retail

39

Industrials and chemicals

37

51

Construction

38

47

9

49

12 12 15

Transportation

27

Paper and packaging

16

75

9

Telecom

16

73

11

Consumer products

10

Utilities

8 0

53

49

20

41

84 10

Remain the same Decrease

Legal advisor

31%

Increase

Hedge fund

5%

8 20

30 40 50 60 70 Percentage of respondents

80

90

100

• Echoing sentiments expressed in last year’s Distressed Debt Outlook, once again an overwhelming number of respondents - 84% of those surveyed believe that opportunities for distressed investors would increase in the Real Estate sector. Interestingly, this is the largest percentage group to expect opportunities in any given sector to increase. • Compared to 2008, the largest drop in expected opportunities is in the Consumer space. Last year 68% of respondents expected opportunities in this space to increase. This year a mere 10% expect opportunities to increase while the rest of the respondents are almost evenly split between expecting opportunities to either remain the same (49%) or decrease (41%). • However, one respondent cautioned, saying “even when the economy is recovering, [the] consumer industry might still be in distress due to lagging effects.” • In 2008, respondents expected distressed debt opportunities to increase or remain unchanged in most sectors as a result of the financial crisis. In this year's survey, a subset of investors are predicting that opportunities will in fact decrease, a sign that markets are recovering.

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Most respondents predict that China will offer significant distressed debt opportunities

What type of situation will be the most likely source of distressed products in 2010?

Rate each country based on its expected distressed debt opportunities in 2010

3% 2% 1%

Refinancings

6%

LBOs

Indonesia

35

Australia

36

Equity-linked notes

India

21

Other Share-backed financings

11%

58

Private placements

Pre-IPO financings

9%

China

68%

16 31 8 36

Japan

17

8

South Korea

16

5 58

Thailand

15

8

Hong Kong

6 11

Malaysia

16 27

5 2 11

18

4 12

Vietnam 2 11

71 11

• 11% of the respondents expect LBOs to be the most likely source of distressed products in 2010. One respondent said he felt LBO situations in Australia would be particularly affected. • The number of respondents who expect private placements to be the most likely sources of distressed products has more than halved to 6% in this year's survey, down from 15% in last year’s edition.

“Whilst there are undoubtedly numerous distressed situations in China, we are yet to see many investors buy into distressed debt with a view to forcing a restructuring on the debtor and shareholders. To the extent that opportunities exist, it is more likely to be found in funding shareholders in buying debt back at a steep discount, given the creditor side execution risks in China.” Scott Bache, Partner, Clifford Chance

2

10

3

19 4

19

New Zealand 2 80

8 15

10

20

30 40 50 60 70 Percentage of respondents

No distressed debt opportunities

3 10

22

Singapore 13 69

0

1

14

Philippines 22 70

• Similar to last year’s findings, an overwhelming majority of respondents said refinancings will offer the lion's share of distressed situations in 2010. The number of respondents expecting distressed situations to arise out of refinancings increased from 61% last year to 68% this year.

3 13

66

57

Few distressed debt opportunties

14 18

63

Distressed debt opportunities Some distressed debt opportunities

5

5 3 80

Taiwan

7

38

43

Significant distressed debt opportunities

2 8

38

SURVEY FINDINGS

68% of respondents expect refinancings to be the most likely source of distressed products in the coming year

80

3 90

100

• China, Indonesia and Australia are again at the top of the list of countries expected to witness significant levels of distressed debt opportunities of debt to emerge in the coming year. However, in last year’s report the clear majority believed that these countries would offer significant distressed debt opportunities, while in this year’s report more respondents state that they see only some distressed debt opportunities. • One respondent stated that “export-oriented countries” would offer the majority of distressed debt opportunities and added that this is where firms are looking for debt financing in a short time frame to meet their needs”. • In relation to China, which overall is seen as the country that will offer most distressed debt opportunities, one respondent said that “there will be countries like China where there are lots of distressed situations, but it does not necessarily mean there are opportunities for investors”. • Japan is interesting in that it is a mixed bag: while 17% of respondents believe the country will offer significant distressed debt opportunities, 14% believe it will in fact offer no distressed debt opportunities at all.

3

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SURVEY FINDINGS A slim majority predict that the amount of defaulted debt in Asia will increase in 2010

China is also predicted to see the largest increase in defaults say 49% of the respondents

Do you expect the amount of defaulted debt in Asia (inclusive of Japan and Australia) in 2010 to:

Which countries do you expect to see the largest increase in defaults?

Increase Remain the same Decrease

28%

49%

China

49%

Indonesia

26%

Japan

23%

Australia

17%

India

16%

Korea

5%

23%

• Just under a half (49%) of respondents expect that the amount of defaulted debt in Asia to increase in 2010. • One of these respondents took a particularly gloomy view saying that “the recovery is very far away. Many companies are in trouble but did not announce it, so they will gradually come up next year”. Another respondent, who also felt that the amount of defaulted debt would increase, put his opinion in context saying that while he felt it would increase “the rate would be slowing down”. • Meanwhile, 23% of respondents said they expect the amount of defaulted debt in Asia to remain the same. One of those surveyed said that “the worst [was] over in 2009”. • At the other end of the spectrum, over a quarter of the respondents predict that the amount of defaulted debt in Asia will decrease in 2010 with one respondent even saying that “most of the problems [have been] resolved by government”.

Vietnam

2%

Thailand

2%

Philippines

1%

Malaysia

1% 0

5

10

15

20

25

30

35

40

45

50

Percentage of respondents (Respondents may have chosen more than one answer)

• 49% of those surveyed believed that China will see the largest increase in defaults. One of those who responded this way linked their opinion specifically to performance in the property sector. • Indonesia, a country that already sees a fair share of distressed debt situations, is expected by 26% of the respondents to see the largest increase in defaults in the coming year. • Only 2% of the respondents believed that Vietnam will see the largest increase in defaults, explaining that “local investment pools are small [and it is] not easy to raise money”.

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Tellingly, 46% of those surveyed believe that Australia will offer the most attractive distressed debt opportunities, followed by China

Which countries do you expect to see the smallest increase in defaults?

Which countries offer the most attractive distressed debt opportunities?

Australia

49%

China

19%

India

11%

Singapore

Japan

20%

Indonesia

20% 9%

Korea

4%

Taiwan

33%

India

6%

Indonesia

46%

China

21%

Japan

Australia

6%

Singapore

3%

3%

New Zealand

1%

Malaysia

2%

Vietnam

1%

Thailand

2%

Brunei

1%

Vietnam

0

5

10

15

20

25

30

35

40

45

50

Percentage of respondents (Respondents may have chosen more than one answer)

• 49% of those surveyed believe that Australia will see the smallest increase in defaults. One of those surveyed linked his opinion to the mining boom experienced by Australia.

SURVEY FINDINGS

Australia is predicted to see the smallest increase in defaults, but interestingly compared to the previous chart, 21% of respondents believe it will in fact be China

1% 0

5

10

15

20

25

30

35

40

45

50

Percentage of respondents (Respondents may have chosen more than one answer)

• Despite being described by so many people as the least likely country to see an increase in defaults, 46% of respondents believe that Australia will offer the most attractive distressed debt opportunities. One of these respondents qualified his statement by linking it to the local legal system that meant that distressed debt opportunities in Australia, as well as in Thailand, Korea, Malaysia and Singapore, were most attractive. • One respondent who invests in Asian distressed debt said “I actually do not think Asia is a good place to invest in distressed debt. The laws and situation on security is just not good enough to protect investors.” • Interestingly, this question also elicited the response that opportunities are “more corporate-specific than geography [related]”.

5

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SURVEY FINDINGS The majority of respondents see light at the end of the tunnel and expect sustainable recovery within a year

Opinion is almost evenly split between those who predict a W- and an L-shaped global economic recovery

When will the global economy enter a sustainable recovery?

What kind of global economic recovery do you think is being experienced, or will be seen?

6%

7%

W-shaped

Already underway

6%

6 months 29%

L-shaped

15%

V-shaped

1 year 2 years

40%

U-shaped

3 years

20%

Longer

8%

38%

31%

• The majority of those surveyed believe there is light at the end of the tunnel. 28% of those surveyed believe that a sustainable recovery of the global economy is already underway, while 8% and 31% believe that is will happen within six months and one year respectively. • However, while many of those surveyed are fundamentally optimistic, there are still words of caution. • One of those surveyed – a person who feels that sustainable recovery is already underway – qualified his statement by saying that recovery is “only underway in Asia” and that “in US and Europe they're just printing money”. • Meanwhile, one respondent who expects sustainable recovery to take place in a year’s time also says that the world economy is currently “at a stage of balancing” and that we will “probably see a more sustainable recovery around [the] second semester of 2010”.

• The jury is out on what kind of economic recovery will be experienced: 40% of respondents expect a W-shaped recovery, while a similar number of respondents (38%) expect recovery to be L-shaped. • Those in the L-camp further say that they expect a “painfully slow recovery” and that they foresee “strong growth and a slow steady recovery which will be over a longer period of time”. • Meanwhile, those in the W-camp say the “back-end will not be as low as before” and predict that the “second dip will be less severe”.

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An overwhelming majority of respondents (91%) believe that structured loan products available to investors in the 2006-2008 period have not provided adequate protection to creditors

Will Asian (excluding Japan) economies outperform the economies of the US and Europe in 2010?

Have the structured loan products, such a private placed loans (inclusive of pre-IPO debt and share-backed loans) that were available to investors in the 2006-2008 period provided adequate protection to creditors?

5%

Yes

9%

No

No

95%

SURVEY FINDINGS

An overwhelming majority of respondents believe the Asian economies will outperform those of the US and Europe in 2010

Yes

91%

• An overwhelming majority (95%) of respondents expressed their confidence in the Asian economies and believe they will outperform the economies of the US and Europe.

• Of those surveyed, 91% said they felt that structured loan products available to investors in the 2006-2008 period have not provided adequate protection to creditors; only 9% felt this was the case.

• One of the respondents explained that this recovery would be “centred around China” explaining that the “Chinese government has the ability to present [its] views on how the global system works” and is “quick and decisive to react”.

• Of those who felt that these products did not offer adequate protection to creditors, some had very harsh words to say. One said that “some … are out-right frauds” while another commented that “the jurisdiction in China inevitably leads to inadequate protection”.

• Meanwhile, another cautioned that “much of Asia's growth in recent years can be attributed to exports, but since the decline in the US dollar and consumer market, Asian countries will have to look for other ways to boost GDP”.

7

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SURVEY FINDINGS The majority of respondents do not believe that having security pledges over shares and other collateral in India, Indonesia and China is effective

The majority of respondents attribute the difficulty of enforcement rights over security in these structures to regulatory restrictions against lending

Have security pledges over shares and other collateral in India, Indonesia and China proved as effective as had been expected when loan deals were entered into?

To what do you attribute the difficulty of enforcement rights over security in these structures?

6%

No Yes

Regulatory restrictions against lending

57%

Dysfunctional judiciary and/or corrupt government

52%

Inadequate structuring

44%

Poor documentation

31%

Poor due diligence

17%

94%

Inefficient, disorganised creditor group

• Of those surveyed, 94% feel that security pledges over shares and other collateral have been effective when making investments in India, Indonesia and China. • Those that believe they are ineffective have been outspoken with their criticism. One investor says that “the pledges are worth nothing" while another said that “lending criteria need to be re-thought as movement and values of equities [are] too rapid, [it] does not give them any protection and so in practice it does not work”.

7%

Nefarious debtor tactics

1%

0

10

20

30

40

50

60

Percentage of respondents (Respondents may have chosen more than one answer)

• 57% of respondents claim that regulatory restrictions against lending pose the greatest difficulty of enforcement rights over security. • On the flip side, only a very small number of respondents (1%) believe that nefarious debtor tactics create the difficulties. • In the comments, many respondents mentioned China and the fact that in this country many different problems make the process additionally difficult. One interviewee said that the insolvency laws are quite new and one of the most problematic issues is a dysfunctional judiciary where implementation and interpretation of these laws [differs] between different provincial areas”. Another said that “there are a lot of political issues” and as an example added that “bankruptcy laws in China make it difficult for offshore parties, while the structures of lending are very complicated for deals”.

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There was a surprising response to the question regarding the success of troubled loans which have been restructured or resettled

What percentage of loans and/or bonds (including CB and exchangeable bonds) in your portfolio(s) could be classified as:

What percentage of troubled loan and/or bonds in your portfolio(s) have been successfully restructured or settled?

0-20%

11%

21-40% In payment default

65

18

10 4 3

SURVEY FINDINGS

The majority of those surveyed have 20% or less of the loans and/or bonds in their portfolio in payment default or in breach of one or more covenants

Less than 10% Up to 25%

41-60% 7%

61-80%

Up to 50% More than 70%

81-100%

Not applicable In breach of one or more covenants

50

23

20

13%

4 3 57%

0

10

20

30 40 50 60 70 Percentage of respondents

80

90

100

• 65% of those surveyed say that 20% or less of their loans and/or bonds in their portfolio are in payment default while 50% say that 20% or less of their loans and/or bonds in their portfolio are in breach of one or more covenants. • At the top end of the scale, a mere 3% responded said that 81 to 100% of the loans and/or bonds in their portfolio are in payment default or in breach of one or more covenants.

12%

• Given that around 75% of those surveyed are in some way credit investors, it is surprising to see that 57% of respondents stated that this question does not apply to them. The implication is that these investors have no loans or bonds in their portfolios that are in some way in default.

9

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SURVEY FINDINGS Another surprising response…

An overwhelming majority of respondents claim they have adequate resources to deal with problem debtors

At present, what percentage of resources does your fund devote to negotiating debt restructurings and/or settlements?

Does your fund or bank have adequate resources to deal with problem debtors?

1%

13%

Less than 10%

Yes

Up to 25%

No

Up to 50% More than 70% 20%

Not applicable

54%

12% 1%

• For those who admit to having defaulted loans and bonds in their portfolios, it seems that working out settlements and or restructurings does require considerable time and resources: 20% stated that negotiating restructurings/settlements took up 25% of their resources; and another 12% said this took up to 50%.

99%

• Almost all of those surveyed (99%) say that their fund or bank has adequate resources to deal with problem debtors.

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Roughly the same amount of respondents expect there to be more or the same amount of leverage in their portfolio in 2010

What percentage of your fund’s resources are presently dedicated to making new investments?

Do you anticipate using more, less or the same amount of leverage in your portfolio in 2010?

11%

0-20%

More

22%

Same amount

21-40% 9%

29%

Less

41-60% 61-80%

38%

81-100% 6%

SURVEY FINDINGS

Majority of respondents have 40% or less of their funds currently dedicated to making new investments

No specific amount

19% 26%

40%

• The majority of respondents have 40% or less of their funds currently dedicated to making new investments – 29% say that up to 20% of their funds are allocated in such a way and another 26% say that is it between 21% and 40% of their funds.

• Roughly the same amount of respondents expect to have more or the same amount of leverage in their portfolio in 2010 – 38% of those surveyed say it will be more, while 40% say it will be the same amount.

• The rest of the respondents say it is over 40% but a noteworthy 11% say that no specific amount that has been set aside to make such investments.

• One of those who said it will be more put the sum into context explaining that it will not be “up to the 2007 level”. Another said that “companies are looking for some good opportunities to work with and since lending banks will start to loosen up a little, leverage may increase”.

• One of the respondents who said that up to 40% of his funds investments are currently dedicated to making new investments explained that in the first semester of 2009 “a minimal amount [was put] towards investments [but in the] second semester huge improvements in percentage [were made]”.

“Until arrangers and investors start insisting on minority equity type protections onshore, particularly in China, Indonesia and India, they will continually be disappointed and frustrated with the lack of traction an offshore security package gives them in a distressed situation. Frankly, if you're not lending against the assets onshore, you are in effect subordinated equity.” Scott Bache, Partner, Clifford Chance

11

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SURVEY FINDINGS Majority of respondents say that less than 25% of distressed debt situations in Asia they have explored in 2009 have represented an actionable and attractive investment opportunity

Compared with the US and Europe, a majority of respondents say that in Asia IRRs are higher

Excluding advisory work, what percentage of distressed debt situations in Asia that you have explored in 2009 have represented an actionable and attractive investment opportunity to your bank/investment fund?

How does the Asian market (excluding Japan and Australia) compare to the US and European markets?

9%

2%

Less than 25%

IRRs higher

20%

26-50%

IRRs are similar

51-75%

IRRs are lower

76-100%

30% 55%

59%

25%

• Excluding advisory work, 59% of respondents say that less than 25% of the distressed debt situations they have explored in Asia in 2009 have represented an actionable and attractive investment opportunity.

• A clear majority of those surveyed feel that, in Asia, internal rates of return are either higher or on par with those made in the US or the European markets, 55% say they are higher, while 25% say they are the same.

• One of the respondents even put the figure as low as 5% saying that the market has not been “attractive” and added that the “global economy has been terrible”.

• One respondent, among the 20% of respondents who believe IRRs are in fact lower, says that emerging markets are over-hyped. He adds, “What you see is not always what you get.”

“Given the distinct advantage that shareholders have over foreign creditors in many distressed situations, this is hardly a surprising result. Generally, if it's not a financial sponsor owned borrower or a distressed situation in Australia there are few, if any, attractive opportunities to get involved in distressed situations at the moment in Asia. To be successful, you need leverage over the shareholders and management over and above your rights as a creditor.” Scott Bache, Partner, Clifford Chance

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The majority believe that less than 25% of restructurings/settlements in 2010 will be dealt with via a debt rescheduling with haircuts

Opportunities in distressed debt investing in 2010 will come mostly from:

What percentage of debt restructurings/settlements in 2010 do you expect to come from:

3%

SURVEY FINDINGS

A clear majority of respondents said that the majority of opportunities in distressed debt investing in 2010 will come from trading in secondary debt

76-100%

9%

Trading in secondary debt

Debt rescheduling

58 11

Exchange offers

21

14

32

9

51-75%

Private equity Buying debt at discounts with a view to participating in the debtor’s restructuring Funding sponsor-led debt buy backs

23%

26-50% 15

36

Debt buybacks 22 33 Debt-to-equity conversion

25

Asset sales

13

Covenant resets

22

Convertible/ exchangeable bonds

15

0-25%

42

59

80

65%

• A strong majority of those surveyed (65%) expected the majority of opportunities in distressed debt investing in 2010 will come from trading in secondary debt. • Only a small group (3%) expected funding in sponsor-led debt buy backs to offer the majority of opportunities. • In addition, one of the respondents said that he felt many opportunities “would be event-driven” and related to “rescheduling”. Another raised the “possibility the Limited Partner market will surface more in the coming year although this market is not that mature”.

Debt rescheduling with haircuts

60

73

6 84

0

10

20

30 40 50 60 70 Percentage of respondents

80

90

100

(Respondents may have chosen more than one answer)

• An 84% majority believes that less than 25% restructurings/settlements in 2010 will be dealt with via a debt rescheduling with haircuts. • Meanwhile 11% of respondents believe that over three quarters of restructurings/settlements in 2010 will be addressed via basic debt rescheduling, while 21% believe over three quarters will be via exchange offers. • One of these respondents said, “we'll see debt buybacks with discounts... and refinancing with lower coupons (say 10% to 6%)”.

13

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SURVEY FINDINGS The majority expect money for distressed investments to come from existing hedge fund investors/prop desks that have been able to obtain new commitments or mandates

In China, creditors are widely expected to face the greatest difficulties in exercising and enforcing their rights over security

Where will the money for distressed investments come from?

Which country do you think is most difficult for creditors to exercise (or enforce) their rights over security? China

Existing hedge fund investors/ prop desks that have been able to obtain new commitments or mandates

60%

75%

Indonesia

27%

India

Newly set up funds

6%

Vietnam

4%

Philippines

3%

Thailand

2%

Malaysia

2%

Japan

2%

49%

US and European funds that have decided to enter Asian markets

18%

0

10

20

30

40

50

60

Percentage of respondents (Respondents may have chosen more than one answer)

• While the majority (60%) of respondents believe that money for distressed investments will come from existing hedge fund investors/prop desks that have been able to obtain new commitments or mandates, 49% also believe that it will in fact come from newly set up funds. • A small group of people (18%) also believe that additional cash will come from US and European funds that have decided to enter the Asian market.

0

10

20

30

40

50

60

70

80

Percentage of respondents (Respondents may have chosen more than one answer)

• 75% of respondent say that creditors will find it most difficult to exercise and enforce their rights over security in China. • Investments in Indonesia are expected by 27% of the respondents to pose similar problems to creditors. • One respondent compared the two countries saying that “we've only seen one of two cases in Indonesia with problems, but things are much worse in China. The legal framework is simply not transparent enough.” • One survey participant commented, “In Asia there are basically three classes of countries - well developed (HK, Singapore, and Australia); then there are the alright ones: Japan, Malaysia and maybe Korea. Then there are ones that would ruin investors: China, India, and Indonesia”.

“We are slightly more positive on Indonesia than the survey participants. We are seeing some interesting opportunities in Indonesia, especially where investors are teaming up with an Indonesian partner who can manage the onshore execution risk. That probably stems from less domestic debt funded capital being available in Indonesia than China.” Scott Bache, Partner, Clifford Chance

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Legal advisors are the first to be called when an investments has defaulted

Which country poses the most significant challenges for creditors looking to enforce their rights in the courts?

Rank in order of priority the parties you would contact when one of your investments has defaulted:

China

SURVEY FINDINGS

Accordingly, China will also bring the most significant challenges for creditors looking to enforce their rights in the courts

1st priority

74%

Legal advisor

63

28

2nd priority

9

3rd priority

Indonesia

28%

India

Financial advisor

22

Investors/ Other creditors

15

41

37

6%

Vietnam

4%

Philippines

2%

Thailand

3%

Malaysia

3%

Japan

0

2%

0

10

20

30

40

50

60

70

80

36

10

20

49

30 40 50 60 70 Percentage of respondents

80

90

100

• Should one of their investments default, the majority of respondents (63%) would first call their legal advisors. Second priority in such a situation is the financial advisor, according to 41% of those interviewed. Investors and other creditors would be the last to be called, say 49% of those surveyed.

Percentage of respondents (Respondents may have chosen more than one answer)

• Once again, China leads the way in terms of challenges for distressed debt investors. A clear majority of 74% of the respondents feel that creditors looking to enforce their rights in the courts in this country will face the most significant challenges. • One respondent says in relation to China that the “situation has not improved for the past year, nor do I expect to see it do so in the coming year”. • Continuing on from the previous chart, Indonesia too will be a difficult environment. 28% of our respondents expect this country to pose the most significant challenges for creditors looking to enforce their rights in the courts.

• One of those that would call the lawyers first, explained this decision by saying that “in particular emerging countries legal advisors can give very useful advice”. • One respondent also pointed out that “logically...I'll contact the defaulting company first”.

“Given the legal obstacles to getting the debtor to the table, this is not a surprising response. Given the higher risk for directors in Australia compared to the rest of Asia, it would be interesting to see the Australian numbers split out as it would be more likely that financial advisor would be just as likely to get the first call because the directors are more likely to act responsibly. Until the rest of Asia catches up with Australia in terms of putting the heat on directors in distressed situations, lawyers will likely be the first port of call.” Scott Bache, Partner, Clifford Chance

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GUNS N' ROSES AND THE CHINESE BANKRUPTCY LAW Scott Bache, Partner, Clifford Chance In 2008, I suggested that Korea looked like Detroit in the 70s but without the good music. Searching for a musical analogy this year, it struck me that creditors in China may be waiting far longer for a fully-developed bankruptcy regime than the 15 years that Guns N' Roses fans waited for the band's widely anticipated, but generally underwhelming, latest album. Like the album, the Chinese bankruptcy law came out in mid-2007 amidst great hype. Reforming the law was a great start but, after two years in force, it can still only be considered a roughly cut demo knocked out by a band with excellent intentions but lacking the experience and technical skills to warrant a major label release. So let's examine a few tracks that I have listened to so far, and see how they stack up. First off the rack is an upbeat rocker called FerroChina. It started off encouragingly enough but stopped and started. It eventually left the listener encouraged, but ultimately looking for a more satisfying ending. For those new to China, the first thing that needs to be appreciated is that political considerations come before rigid enforcement of the law. Sometimes this can be a good thing, and FerroChina is a prime example. When FerroChina's Taiwanese management left China, the local authorities and banks were quick to act and appointed an administrator. This was a very good thing for all concerned. In China, local creditors and employees often implement self-help remedies – in the most literal sense of the words – as soon as the first signs of distress become apparent. Ask any Hong Kong-based insolvency specialist of their experience of these sorts of situations and they will provide countless examples of turning up at a Chinese factory to find the business has been torn apart. In FerroChina, the quick appointment of the administrator allowed the premises to be physically secured before any damage could be done. Also, by stepping in and funding employee wages for a period of time, the local government completely avoided the sort of social unrest that could devastate any city that relies on a few big businesses as its life blood. This undoubtedly preserved value for local and foreign creditors alike. Another point in the process's favour was that, whilst there were some practical difficulties in the foreign and local creditors working together, there was never a suggestion that foreign creditors with onshore rights would be treated differently to local creditors. Moreover, the foreign creditors with the benefit of security got the preferential treatment that they contractually deserved in the final plan. So what is this track lacking, you ask? It has to be the thumping bass line that anchors so many great songs. As many of you know, the key to any successful restructuring is a rigorous process that enables stakeholders to ascertain where the value breaks in the capital structure.

Overall, the administrator did a good job in balancing stakeholders' interests. That said, offshore creditors were not given a real opportunity to test the market to see if the value broke in the offshore part of the capital structure. It may well have been that it didn't, as at the time many of the logical foreign parties who might have been interested in acquiring the assets had their own difficulties that would have prevented them from making a bid and putting some competitive tension into the process. The reality is that the last 12 months has been a terrible time to sell anything, but by not opening up the sale process more vigorously to foreign investors, we will never know for sure that the value did not break offshore. In my view, whilst the end result may well have been the same, by not testing the market more rigorously, China lost an opportunity to demonstrate that it was truly concerned about driving value for all stakeholders in a distressed situation, regardless of whether that value lay in China or offshore. Let's turn to the second track, the controversial Asia Aluminium. AA is a punk rocker that has left music lovers largely divided. Some hate it, saying that the process, similar to FerroChina, lacked any transparent process to determine value and was ultimately a disaster for foreign creditors. Whilst I agree that the process lacked the sort of sophistication that one would like in a distressed deal, the ultimate result may well have been very good for foreign creditors. Undoubtedly, it was a tough song to listen to, but those who stuck with it did get some reward – and that is often not the case in China. At the time, AA's provisional liquidators were criticised for not creating more competitive tension in the process and practically delivering AA to management on a silver platter. On closer scrutiny that criticism seems unwarranted – because while the provisional liquidators may have produced the track, they did not write the song or have much control over the musicians. As in many cases, the provisional liquidators were given only a modicum of co-operation by management in China, so it was very difficult for potential foreign bidders to conduct the sort of due diligence that they would expect when considering such a substantial acquisition. Moreover, the local authorities and banks made it clear from the outset that a management buyout was their preferred option, and major concerns existed about social unrest – AA had about 10,0000 employees. As a result, a tight time limit was given to the provisional liquidators to find a buyer – with the prospect of an onshore bankruptcy if a buyer with a largely unconditional offer was not accepted by 30 June 2009. What could the provisional liquidators do in such circumstances? Management was offering approximately US$100 million to offshore stakeholders and there was a real risk that the offer would fail if AA's onshore subsidiaries were placed into administration.

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However, the provisional liquidators should not be criticised, as they at least gave the market the opportunity to test management's resolve by making a higher bid. So what to make of this track? If you look purely at the numbers, I am not aware of another distressed situation in China in recent times where so much value has been paid to the offshore part of the capital structure. However, I have to agree that it was a very tough listen and that the process was far from satisfying – but ultimately not off the mark for a China restructuring.

GUNS N' ROSES AND THE CHINESE BANKRUPTCY LAW

The only thing they could do was to make the management bid non-exclusive, thereby allowing a better bid to come in at the last moment. Of course, another bid was not forthcoming – given the circumstances, making an unconditional bid would have been suicidal.

So to the last track I have heard recently. For copyright reasons, I can't name this song but let's just say it is practically unlistenable to foreign music lovers. My daughter's school band knocks out music more worthy of international release than this little ditty. In this particular case, the administrator has refused to take advice on foreign law even though the company has entered into a number of contracts with foreign parties governed by foreign laws. He has also sought to apply Chinese law to these contracts – and appears to have got the Chinese law wrong as well. It appears that the administrator sees his job as being to actively reduce the quantum of claims when there is no credible basis for doing so. This is completely at odds with the approach taken by liquidators in just about every country on the planet. By refusing to acknowledge the governing law of contracts and refusing to take appropriate local law advice, he is undermining the basis of what could be, in time, a bankruptcy law in which foreign investors could have some degree of confidence. This track is a disaster and without a substantial rewrite will never be worthy of release. One of the respondents to this year's survey commented that one of the biggest problems in China is that the implementation and interpretation of the Chinese bankruptcy laws differ between provinces. This one comment alone sums up the real difficulties encountered in China more than all others. In my view, it may take far longer than the 15 years that Axl Rose spent perfecting his last album to develop the level of sophistication and certainty required to make China's bankruptcy law truly worthy of an international release. The law will get there, eventually, but it will be a long and hard process. So, until we get there, foreign investors should make themselves "Welcome to The Jungle" that is distressed debt in China.

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A COMPLETE SERVICE ACROSS ASIA Clifford Chance provides the full range of restructuring and insolvency services throughout Asia. Our award-winning team has acted on many of the most important restructuring and insolvency matters in the region this year. With over 30 restructuring and insolvency lawyers based in Asia, supported by another 100 lawyers in 18 offices worldwide, we provide a multi-lingual English, US and civil law service, as well as local law advice wherever regulations permit. Experienced in restructuring from every angle We have extensive experience of voluntary and involuntary restructurings – having acted for both creditors and debtors, we understand the tension points that often arise during a restructuring and are well placed to guide our clients to ensure that their interests are best served. As Asia has become more open to non-bank, non-relationship based participants, our involvement in these complex cross-border restructurings has meant that we know and act for some of Asia's most active distressed debt investors.

Clifford Chance has advised on all aspects of restructuring and insolvency transactions; including: • reschedulings • loan-to-own transactions implemented through debt-for-equity swaps • distressed M&A • schemes of arrangement • administration

• voluntary reorganization • court-driven rehabilitation • receiverships • voluntary and compulsory liquidations • bankruptcy

For more information, please contact any of the individuals listed on page 24.

ABOUT CLIFFORD CHANCE International law firm Clifford Chance combines the highest global standards with local expertise. Leading lawyers from different backgrounds and nationalities come together as one firm, offering unrivalled depth of legal resources across the key markets of the Americas, Asia, Europe and the Middle East. The firm operates across Asia, with offices in Bangkok, Beijing, Hong Kong, Shanghai, Singapore and Tokyo. With over 350 lawyers in Asia alone, it is one of the largest international firms in the region, enjoying a market leading reputation across a number of practices.

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LOOKING AHEAD TO 2010 Robert Schmitz, Managing Director, Head of Restructuring and Debt Advisory, Asia, Rothschild To many Asian corporates, the headlines in the last few months have been reassuring. It’s the end of the global recession they are told and Asia is recovering especially well. The markets are also giving very positive signals: most Asian indices have bounced back spectacularly and investors having been piling into rights issues and CB offerings. The debt markets seem to be welcoming back borrowers too, judging by the spate of high yield bond issues, and loans being provided by commercial banks in the last few months. Indeed, even some LBO deals have completed in the last several months. It is in this environment that Rothschild is advising clients that they should continue taking a cautious view. From Rothschild’s point of view, the outlook for 2010 is more complex than the previous two years. In 2008, it was not that hard to foresee a downturn. We had falling leading indicators, inverted yield curves, and extensive data pointing to a recession. In November last year, while the markets were in the midst of a “Black Swan” event, the outlook was virtually a “one-way trade” towards massive distress. Coming into 2010, as this survey shows, the mood among many investors is either careful or pessimistic. There is considerable doubt that the US Federal Reserve will be able to sustain the massive growth of its balance sheet, and hence its support for the economy in the years ahead. Japan’s rise as the most indebted sovereign among the G8 countries also raises questions as to how far the country’s government can support its financial system and increasingly troubled corporates. The recent spike in both US and Japanese bond yields underscores that US and Japanese governments will increasingly find that the printing presses cannot run as fast and as hard as they did over the last year. Over the next few years, a massive amount of debt will be due for refinancing in Asia and the rest of the world. We have already seen attempts to refinance or restructure those facilities, and while some have been very successful, many of the fixes that have been achieved are largely band-aid solutions. Take for example, the kind of exchange offer that proposes that principal outstanding on the notes be reduced, but that the borrower accept, as a quid pro quo, a substantial hike in coupon rates. Here, the borrower has improved the look of its balance sheet but has also taken on the risk that it will not be able to service its coupon payment obligations when or if its market or the economy fails to recover as much as anticipated. Covenant resets made for many LBO financings have also done little to address the issue of unsustainably high leverage. How will these facilities be refinanced when they mature? Companies that need to restructure and recapitalize might be encouraged that commercial banks are lending, but these institutions have gone back to conservative lending practices and are largely lending only to top credits.

Given banks’ lending practices, it is worth noting that, in some sectors, debtors’ financeable, or shall we say, real balance sheets, have contracted by even 30% the value of their underlying assets. This is especially relevant given that there remains considerable global overcapacity in many manufacturing sectors, and that consumer demand, amid rising unemployment in G8 countries, could be anaemic for years to come. In this environment, asset based lending could continue to be constrained. And if the V-shaped economic recovery that some assume is underway instead turns into an L-shaped or indeed W-shaped cycle, then bank creditor committees will tighten even further their grip on bank lending polices. As has been seen from some of the failed or recalibrated offerings in Asian high yield bond markets latterly, investors are still very cautious: companies that have chequered credit histories are either having to pull their deals or think about different ways to fund. Asian equity markets might continue to provide for refinancing/recapitalization needs for a while longer, but as more cash calls are made and if investors are disappointed by earnings, that window could start to shut. Finally, given the rout of the last year, hedge funds will be less able to play the role of last lender of resort. Certainly, new funds are emerging and some old funds have been able to raise new capital but given the scrutiny they are under, their investment practices will have to be much more disciplined and discretionary than they had been. All of this is not meant to paint a wholly negative outlook for 2010, but rather, as we stated earlier, to note the need for corporates to anticipate the problems that could emerge ahead. Certainly, the world’s central banks and governments have prevented the world from sinking into what could have been a global depression. A base for the world’s economies has been set and businesses are better able to see into the future. Also, policies that have been put in place just might be successful in keeping economies well supported in 2010. But the longer term outlook remains quite uncertain, especially if the source of this year’s recovery - the seemingly endless flow of funds from central banks, starts to dry up.

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ABOUT ROTHSCHILD Rothschild is a leading independent advisor on corporate strategy, mergers and acquisitions, debt and equity financing, restructuring and privatizations. Rothschild’s objectivity, its global network, and its commitment to a relationship-driven approach, combine to create value for its clients; building value through stability, integrity and creativity. Rothschild is, through its 1,000 advisory bankers, the trusted advisor to corporates, individuals and governments worldwide, often on a repeat basis. Globally, Rothschild has one of the largest independent restructuring and capital markets practices. The Asian restructuring and debt advisory arm was established in 2006 with dedicated bankers based in Mumbai, Singapore and Sydney. Rothschild acted as exclusive financial advisor to the principal Indian lenders in the Dabhol power company restructuring, one of the world's most complex restructurings. Rothschild also advised Lehman Brothers (Asia) on its sale to Nomura. At present, it is the exclusive independent financial advisor to Garuda Indonesia, PT Arpeni, Suzlon, Semen Gresik and Air India.

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CONTACTS CONTACTS

Rothschild

Robert Schmitz Managing Director, Head of Restructuring and Debt Advisory, Asia T: +65 6531 1437 F: +65 6535 9109 E: [email protected]

Alister McConnell Managing Director T: +61 2 9323 2303 F: +61 2 9323 2040 E: [email protected]

Robert has over twenty nine years' experience with corporate finance, and credit, derivative and capital markets transactions in North America and Asia. Since 1990 Robert has specialized in capital restructuring. He frequently represents shareholders and managements of companies with complex insolvency and fund raising issues.

Alister joined Rothschild in January 2009, heading up Restructuring and Debt Advisory in Australia. Prior to this he established Grand Samuel's independent debt restructuring and advisory business from 2003 and worked for the Australia National Bank.

Rakesh Singh Director T: +91 22 4081 7026 F: +91 22 4081 7001 E: [email protected]

Michael Yao Managing Director T: +852 2116 6350 F: +852 2810 6997 E: [email protected]

Rakesh is the head of debt advisory and restructuring based in Mumbai. He recently joined Rothschild from Morgan Stanley where has was responsible for principal investments in India. He has previously worked with Merrill Lynch and Standard Chartered Bank and has over 16 years of experience in fixed income capital markets, structured finance and leveraged finance.

Michael has over 19 years experience in capital markets, strategic advisory and mergers and acquisitions having worked in the United States and Hong Kong where he has been based since 1993.

www.rothschild.com

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CONTACTS Clifford Chance

Scott Bache Partner, Hong Kong and Head of Asian Restructuring & Insolvency Group T: +852 2826 2413 F: +852 2825 8800 E: [email protected]

Donna Wacker Partner, Litigation, Hong Kong T: +852 2826 3478 F: +852 2825 8800 E: [email protected]

Scott specialises in finance and securities matters with a particular emphasis on corporate restructuring, distressed mergers and acquisitions, and special situation investments. He regularly advises on insolvency issues, security enforcement, distressed debt trading and general banking litigation.

Donna specialises in insolvency, banking and commercial litigation, security enforcement and regulatory matters (both contentious and advisory).

Matthew Truman Partner, Finance, Restructuring and Insolvency, Hong Kong T: +852 2826 3497 F: +852 2825 8800 E: [email protected]

Nish Shetty Partner, Singapore, and Head of South East Asian Arbitration and Dispute Resolution T: +65 6410 2285 F: +65 6410 2288 E: [email protected]

Matthew specialises in complex financing, with particular experience and expertise in banking, restructuring and insolvency. He has worked on some of the most complex restructurings in Asia this year, in addition to advising clients on early-stage refinancing in response to market conditions.

Nish is regarded as a leading expert in the field of dispute resolution, in particular in arbitration, restructuring and insolvency. He has advised on many of the most complex cross-jurisdictional disputes in south and south east Asia in recent years, including insolvency, restructurings, receiverships, judicial managements and liquidations.

www.cliffordchance.com

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© Debtwire Suite 2401-3 Grand Millennium Plaza 181 Queens Road, Central Hong Kong T: +852 2158 9730 E: [email protected] Luc Mongeon Editor, Debtwire Asia T: +65 6224 3527 E: [email protected] www.debtwire.com Remark Christine Song Publisher, Remark T: +852 2158 9762 E: [email protected] Naveet McMahon Publisher, Remark T: +852 2158 9750 E: [email protected]

This publication contains general information and is not intended to be comprehensive nor to provide financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any investment or other decision or action that may affect you or your business. Before taking any such decision you should consult a suitably qualified professional advisor. Whilst reasonable effort has been made to ensure the accuracy of the information contained in this publication, this cannot be guaranteed and neither Debtwire, Clifford Chance nor Rothschild nor any affiliate thereof or other related entity shall have any liability to any person or entity which relies on the information contained in this publication. Any such reliance is solely at the user’s risk. The Mergermarket Group does not necessarily endorse the views given in the content of this report which were provided by Clifford Chance or Rothschild.