China property’s Enron damp squib may yet surprise

MELBOURNE/HONG KONG, March 19 – When is a USD 78 billion fraud nothing to worry about? Hong Kong’s benchmark Hang Seng Index lost 1% on Tuesday, as markets shrugged off a Chinese regulator’s findings that by booking sales early China Evergrande inflated revenue at its flagship unit by 564 billion yuan (USD 78 billion) over 2019 and 2020 – a whopping 65% of its top line over the period. But as the 2001 demise of Enron shows, the pain can be shared widely.

Evergrande is no stranger to being compared to the defunct U.S. power company, which used all manner of special-purpose vehicles and other tools to hide losses and seemingly boost income. Short seller Citron Research mentioned it in its 2012 report that called the now-bankrupt Chinese group “insolvent” and “fraudulent”; Andrew Left, the hedge fund’s founder, was banned from trading in the Hong Kong market for five years as a result.

One big difference, of course, is that Enron’s descent from market darling to bankruptcy only took a few months. Evergrande and peers like Country Garden have been under pressure since Beijing issued its three red lines in August 2020 to try to rein in the bubbly real-estate market. Moreover, in January a Hong Kong court ordered Evergrande to liquidate; founder Hui Ka Yan was detained last year on suspicion of unspecified crimes. So it’s understandable that investors might be blasé about the latest news.

There could be plenty more unpleasant surprises, though. First, the securities regulator has so far only targeted two years of Evergrande’s accounts. If the watchdog chooses to look further back, the alleged fraud could well be exponentially larger than Enron’s – a politically embarrassing scandal for Beijing at a time when foreign investors are already wary of China.

Auditors will probably be on the hook for some blame, too – in this case PricewaterhouseCoopers’s China affiliate. It quit last year as Evergrande’s accountant, and liquidators were already planning to sue the unit, the Financial Times reported last month. Enron’s collapse famously precipitated, along with the scandal at telecom company WorldCom, the demise of then-Big Five accounting firm Arthur Andersen. The Evergrande fiasco could accelerate the retreat of the Big Four in China. PwC’s mainland, Hong Kong and Macau operations boast over 800 partners.

Banks also may be in the firing line, as JPMorgan and Citi were for work done for Enron. China’s securities regulator has flagged that Evergrande bonds issued off the back of 2019 or 2020 earnings could be fraudulent, which bodes ill for the underwriters.

The latest findings may not change much at Evergrande. But investors are being too sanguine if they think the buck stops there.

CONTEXT NEWS

The China Securities Regulatory Commission on March 18 accused China Evergrande of committing financial fraud by inflating the sales of its flagship unit by a total of 564 billion yuan (USD 78 billion) over a two-year period.

The company did so, alleges the watchdog, by booking sales on its income statement before they were finalised. In 2019 the tactic boosted the top line by 214 billion yuan, representing around half its revenue that year. In 2020 it added a further 350 billion yuan using the same method, or almost 79% of that year’s total.

Because Evergrande relied on these financial statements to raise debt, the CSRC also accused the company of fraudulently issuing corporate bonds.

The regulator also barred founder Hui Ka Yan from the securities industry for life and fined him 47 million yuan.

(Editing by Robyn Mak and Katrina Hamlin)