Bringing more institutional money to China's credit market — including to distressed debt workouts — is "in line with what the government wants to happen," following its success in dismantling a shadow banking industry where retail investors had backed hundreds of billions of dollars of loans to the real estate sector, Mr. Fanger said.
The government "would much rather have a private credit market in China … backed by pensions, insurance companies, institutional investors, investing through funds that are institutional," he said.
Being on the same side as the government is a point that investors globally could find reassuring after Beijing's decree earlier this year forcing listed after-school-tutoring companies to convert to non-profit institutions, wiping out tens of billions of dollars of market value.
If China's NPL pool is set to continue growing rapidly, market veterans predict foreign manager participation is likely to grow more modestly. One reason: The government — with an eye to financial market stability — is likely to keep a tight grip on the pace of new NPL dispositions, ruling out the kind of market-clearing volatility investors dream of.
In China, "you never get that … big bang moment, where the system is awash with bad loans and prices plummet disproportionately," offering the chance to buy distressed loans at pennies on the dollar, noted Mr. McMahon.
Investors can find plenty of opportunity in China's NPL market but the potential returns pale when stacked up against that "El Dorado" moment looming large in the popular Western imagination, he said.
Meanwhile, overseas distressed debt players will continue to look at the opportunity set on the mainland through the prism of the opportunities available to them in other major markets, and some expect the balance of risks and rewards to become more enticing elsewhere.
In five or 10 years' time, interest rates could rise in developed countries, resulting in more defaults of overleveraged companies there, allowing investors to focus on opportunities in jurisdictions they feel more comfortable with, Mr. Leitch said.
Nonetheless, market veterans concede that continued reforms by China could lower the barriers for foreign investors going forward.
In May, for example, China announced a pilot mutual recognition scheme for insolvency courts in Hong Kong and Shanghai, Xiamen and Shenzhen, including the creation of specialist bankruptcy courts. KPMG's Mr. Cowley called that development a "huge step in the right direction," even if the pace of change is likely to remain gradual.
PwC’s Mr. Lau said Beijing’s commitment to continued financial services and legal practices reforms makes him optimistic the number of foreign players setting up local entities or working with local partners on China NPLs will rebound as the COVID-19 overhang fades.
In July, Warburg Pincus LLC, the New York-based private equity firm, announced it and special situations credit manager Wensheng will establish Wensheng Special Situations Asset Management Co., focused on “single credit real estate special situations investments,” according to a Warburg Pincus news release.
The news release provided no details on the two firm’s respective ownership stakes. Lisa Liang, a Beijing-based spokeswoman for Warburg Pincus, didn’t respond to requests for comment.
ShoreVest's Mr. Fanger predicts a bigger change in focus could be afoot, favoring China's credit markets.
If the focus over the last few decades was on the development of the equity markets in China, "there's a good chance that the next few decades will see the development of the credit markets," Mr. Fanger predicted.