Chinese Government Bond Default Prompts Complaint Against International Credit Rating Agencies

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Defaulted creditors demand investigation into improper credit ratings assigned to China sovereign bonds.

Sovereign Advisers today announced the filing of a complaint with the International Organization of Securities Commissions (IOSCO) alleging a pattern of deceptive practices, including inappropriate sovereign credit ratings with respect to the offer, sale and trading of obligations involving the foreign currency debt of the People’s Republic of China.

IOSCO is comprised of individual securities commissions in different countries around the world, whose membership mandate is, in part, “to provide mutual assistance to promote the integrity of the markets by a rigorous application of the standards and by effective enforcement against offenses.”

The complaint (http://www.globalsecuritieswatch.org/IOSCO.pdf) filed by Sovereign Advisers specifically addresses instances involving failure to disclose the existence of a defaulted series of full faith and credit sovereign obligations of the Chinese Government which remain outstanding in a state of selective default by the Chinese Government. The complaint documents specific instances involving deceptive practices and inadequate disclosure with respect to the international sale of sovereign bonds issued by the Government of the People's Republic of China.

Sovereign Advisers, a private risk analytics firm based in the U.S., has requested IOSCO to distribute the complaint, filed on behalf of defaulted creditors of the Chinese Government, to securities regulators around the world for investigation and possible regulatory sanctions in connection with the improper offer, sale and trading of recently-issued Chinese government bonds.

A large group of defaulted bondholders organized as the American Bondholders Foundation, whose members have suffered both selective default as well as discriminatory settlements involving their claims, is demanding a congressional investigation into improper credit rating procedures including the failure to properly assess the “willingness to pay” metric as indicated by the existence of a series of defaulted Chinese government obligations held by U.S. citizens.

The Government of the People’s Republic of China continues to evade payment to U.S. bondholders, while enjoying a reported $610 billion in foreign currency reserves, reflecting an increase of over $200 billion during just the past twelve months.

The foundation is currently pursuing multiple collection avenues on behalf of defaulted creditors, and is contemplating possible legal action through the Belgium commercial courts to seek a judgment authorizing seizure of interest payments at the time of payment by China to investors in recently-issued PRC sovereign bonds.

The complaint alleges that Standard and Poor’s Ratings Group has inappropriately assigned a “BBB+” investment-grade sovereign rating to China’s long-term foreign currency debt, rather than the appropriate “SD” (selective default) rating classification mandated by the existence of the Chinese Government’s defaulted series of full faith and credit sovereign bonds.

Kevin O’Brien, president of Sovereign Advisers noted that the individual heads of Standard and Poor’s, Moody’s Investors Service and Fitch Ratings were each explicitly notified in writing of the existence of a defaulted series of full faith and credit sovereign obligations of the Chinese Government in 2002 yet failed to take action to correctly reflect this fact in their respective credit ratings, and in fact either affirmed or upgraded the existing ratings in 2003 to coincide with the Chinese Government’s bond sale occurring the same month. Mr. O’Brien states, “frankly, I was astounded by this. I find the conduct of the major international credit rating agencies regarding this matter to be nothing short of egregious. I simply cannot understand how a country which is presently in default on a series of full faith and credit sovereign obligations and which, despite having the ability to honor its sovereign debt, continues to evade payment to bondholders in contravention of international law can enjoy an investment-grade debt rating.”

Sovereign Advisers recently issued a downgrade of the long-term foreign currency debt of the People’s Republic of China to sub-investment (speculative) grade (http://www.garp.com/risknews/newsfeed.asp?Category=10&MyFile=2004-09-21-9418.html). Mr. O’Brien went on to state, “as a private firm, we do not accept compensation from issuers, and as a result we are able to steer clear of potential conflicts of interest. When such conflicts manifest in the form of artificial or inflated debt ratings, this poses a significant risk to the investing public.” Mr. O’Brien also suggested that investors who purchased recently-issued PRC sovereign bonds, and who were unaware of the existence of a series of defaulted full faith and credit sovereign obligations of the Government of China at the time of purchase, may wish to contact a securities class-action law firm such as Lerach Coughlin or Milberg Weiss to investigate whether proper disclosures were made regarding these issues.

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Kevin O'Brien