Barbarians at the Gate of China Finance?

China had a very good financial crisis, emerging confident enough in its own financial system to experiment with short selling currently limited to stock index futures and credit default swaps, both of which have built a fairly bad name for themselves in the West over recent years.

But apparently what China's next wave of economic reform really needs is leveraged buyouts and high-yield - i.e., junk - bonds.

That was the message from Wu Xiaoling, the highly respected former deputy governor of the People's Bank of China and currently a member of China's legislative body. Speaking at a private equity forum in Beijing Sunday, Ms. Wu said that China probably couldn't accept the high levels of leverage seen in developed markets, but if Beijing wants to realize its professed goal of consolidating certain industries, then companies have to be able to raise debt for the purpose.

'Of course there are risks involved with leverage, but [it's not always viable] to do M&A with 100% of your own capital,' she said.

'China's current problem is not that leverage is too high but that it's extremely difficult to raise debt for the purposes of M&A.'

In September the State Council said it would encourage companies and local governments to promote consolidation in heavy, polluting industries and would roll out M&A regulations that would relax restrictions on private capital, encourage fund-raising through stock and bond issues, give tax incentives, and step up state investment and financial support to speed up the consolidation.
'The whole world is deleveraging, but China needs to leverage up,' Ms. Wu said.
She also said that China should develop a high-yield bond market so that companies could raise debt for planned acquisitions.

But what does this mean for China's private equity sector? High levels of leverage are central to the private equity model in Western economies, helping to amplify the returns to investors. But private equity funds have struggled to raise debt to make acquisitions in China, in part because China has no real system in which private-equity buyers can use a company's assets as collateral. That deters banks from taking the risk of arranging financing.

For that matter, private equity firms have found it very difficultto even take controlling stakes in Chinese firms, let alone buy a firm out in its entirety.

Certainly Ms. Wu's choice of audience to discuss the merits of leveraged buy-outs would suggest she thinks that private equity firms perhaps should be allowed in on this M&A revolution. And a junk bond market would help private equity investors bypass the banks and their collateral requirement by raising funds directly from the market. But while Ms. Wu was broadly supportive of private equity's role in the economy, she didn't explicitly say financial investors should be allowed to raise debt for buyouts.