Chinese Companies in Pentagon Spotlight Hire Global Banks to Sell Dollar Bonds -- Update

By Frances Yoon

Two Chinese state-owned firms recently labeled by the U.S. Defense Department as "Communist Chinese military companies" are selling billions of dollars in bonds with the help of Western banks.

The label doesn't impose any legal restrictions and in itself has no bearing on whether a company can do business in the U.S. Still, legal experts and financial analysts said the sale was notable because the labeling could be a signal of sanctions to come and could pose reputational risks for the banks that are running the sale and investors who buy the bonds, even though they aren't breaking any U.S. laws.

The bond sales by China National Chemical Corp. and China Three Gorges Corp. also indicate that the Pentagon designation for now isn't hindering international fundraising. U.S., European and Chinese banks are managing the sale and marketing the bonds to global investors.

"While it is unclear what specific policy outcome the Pentagon had in mind when publishing this list, it will take notice that banks continue to do business with these Chinese companies," said Benjamin Kostrzewa, an international trade lawyer at Hogan Lovells.

He said that could play into decisions on whether to take further steps to limit the Chinese groups' access to U.S. markets. In addition, he said: "Banks may face reputational risks if the U.S. government takes swift action against the Chinese companies," such as adding them to lists of sanctioned entities.

On Tuesday, power company China Three Gorges began selling five- and 10-year dollar bonds, according to a term sheet seen by The Wall Street Journal. The day before, ChemChina priced $2.4 billion of dollar bonds along with the equivalent of $593 million in bonds denominated in euros.

Units of Bank of America Corp. and Goldman Sachs Group Inc. are working on ChemChina's bond offering, as are various European and Chinese institutions. JPMorgan Chase & Co. and Morgan Stanley are among underwriters for the Three Gorges deal.

An official at one of the banks said there were no restrictions barring firms from doing business with companies on the Pentagon list. Representatives for the rest declined to comment.

"If American firms are arranging deals for strategically sensitive Chinese companies that are being targeted by parts of the U.S. government, we cannot rule out...tensions with their home regulator if additional sanctions are placed or if things heat up to the next level," said Brayan Lai, senior research analyst for CreditSights.

The Pentagon in August named both borrowers as "Communist Chinese military companies," a designation that stems from legislation passed in 1998. It said it aimed to highlight and counter efforts to modernize China's People's Liberation Army via "military-civil fusion," the use of advanced technology acquired or developed by civilian entities.

In an emailed statement, the Pentagon said it released the information to comply with its statutory requirements, "advance due diligence, and enhance the security and resiliency of our defense industrial base."

"We encourage U.S. government entities, companies, investors, academic institutions, and like-minded partners to use this list as a tool for conducting due diligence with regard to partnerships with these entities, particularly as the list grows," it added.

An earlier list in June applied the same label to 20 other companies. The administration has taken a number of steps to restrict what it says is the flow of goods to China's military. The Pentagon didn't respond to a request for comment.

The Pentagon labeling could be aimed at discouraging other companies from doing business with them, lawyers at Arent Fox wrote in a July briefing. It could also in theory lay the groundwork for presidential sanctions barring U.S. counterparts from engaging in most U.S. commercial activity with the named companies, the lawyers wrote.

China's Foreign Ministry has said the list was made without proof or a legal rationale, and that the U.S. was abusing state power to attack Chinese companies. ChemChina and Three Gorges didn't respond to phone and email requests for comment.

ChemChina's offering document said the listing didn't mean it had been subject to export controls or economic sanctions, and it was able to pay and collect funds as usual.

S&P Global Ratings said it saw no immediate impact on ChemChina's creditworthiness. Similarly, in a research note, CreditSights said the list had no immediate ramifications but increased the risk of other U.S. actions, such as a block or freeze of property or businesses located in the U.S. or in key allied nations.

A Hong Kong-based investor at a U.S. asset manager said the list was concerning for firms like his with large ChemChina bondholdings, since these investments could fall in value if the company were to come under sanctions that damage its financial health. He also said his company's holdings of the bonds could lead to reputational problems.

He said his institution had contemplated trimming its holdings of ChemChina bonds. However, he said the company's bonds offered a higher yield than similar Chinese dollar debt that was hard to ignore.

Xie Yu and Nancy A. Youssef contributed to this article.

Write to Frances Yoon at [e-mail]