Evergrande and China’s Looming Risk to Tether

The stablecoin issuer Tether this week declared that it doesn’t hold short-term debt issued by troubled Chinese real estate developer Evergrande. Since Tether doesn’t disclose specifics about the commercial paper that substantially backs its “stablecoin,” this is a bit like serving a houseguest a sandwich and loudly assuring them that it is absolutely NOT made from diseased horsemeat.

It seems increasingly likely that Evergrande is fated instead for the glue factory. But it could still take Tether with it, depending on what’s actually in that stablecoin sandwich.

Though its main product since its founding in the 1990s has been housing, Evergrande has grown into a huge conglomerate with products ranging from bottled water to electric cars to a soccer team. It expanded by borrowing aggressively, including during periods when China’s economic outlook was seen in much rosier terms globally than it is now.

Evergrande has failed to execute on the promises backing its roughly $300 billion in debt, particularly in housing. Among other signs of serious mismanagement, customers have made large deposits on Evergrande apartments that were never built. Hundreds of customers have protested in front of the company’s offices alleging mistreatment or fraud.

But this is not just about one company: Even if Tether doesn’t specifically hold any of Evergrande’s short-term debt, it could have huge exposure in the form of other Chinese obligations. The developer’s debt is spread across an army of banks and other financial institutions, leading some analysts to worry that its collapse would have systemic impacts comparable to the fall of Lehman Brothers, which kicked off the Great Recession 13 years ago. Debate swirls about whether that impact would spread beyond China, but there’s broad agreement that impact within the country would be near catastrophic.

Evergrande is just the latest major Chinese firm to have serious problems due to apparent fraud or mismanagement. A wave of smaller stock frauds from 2010-2016 were chronicled in the documentary ”The China Hustle”, and Luckin Coffee put an exclamation point on the trend in 2019.

These frauds even show some sign of being tacitly approved by the Chinese government, to the extent that they have targeted investors abroad. It’s been going on for a long time – one analyst who warned about Evergrande’s practices as early as 2012 was temporarily banned from Hong Kong markets by regulators for his “reckless” claims.

China’s loose and reactive (at best) financial regulatory environment is one reason anxiety around Tether has largely centered on whether it holds Chinese commercial paper in general – not just whether it holds Evergrande’s.

Over the past two years, yet another headwind has entered the China mix. After a couple of decades of relative freedom for entrepreneurs (including, as mentioned, the apparent freedom to commit securities fraud), Chinese leadership under Xi Jinping has begun to aggressively intervene in markets. That has included harshly curtailing apparently successful fintech firms like Ant Group and, most recently, instituting restrictions on video games, which can’t be good for Tencent and other firms.

That type of heavy-handed control is at the core of China’s conundrum as an authoritarian state trying to reap the rewards of capitalism. Markets can’t function without transparent information flows, full stop. The systematic suppression that characterizes Chinese markets adds an opaque but potentially huge risk for the holders of any Chinese asset – even if that risk is wrapped up in a supposed stablecoin.