Chinese institutions with dollar-denominated debt would likely fall into default if the U.S. ever imposed sanctions on the Asian nation, according to S&P Global Ratings.

"While such sanctions are highly unlikely, the effects could be severe," the ratings provider said in a June 20 note. Current bond documents also do not protect investors against sanctions causing dollar-debt defaults, it said.

The idea of U.S. sanctions on China has begun to gain some credence amid worsening relations, and the implementation of international embargos on Russia following the invasion of Ukraine. China's banking regulator has taken some steps to manage the impact of potential sanctions, while the Hong Kong Monetary Authority is seeking to mitigate the danger of local banks being removed from the international financial messaging system Swift, Ratings said, citing media reports.

“This suggests to some the risk is real, if remote,” Ratings said.

Chinese lenders could fall into a technical default if direct and secondary sanctions prevented them from making payments or transfers, or from doing foreign exchange involving dollars, according to the note. This "severe-impact scenario" would cause defaults irrespective of lenders' own liquidity and financial buffers.

Bond documents offer little protection as no Chinese financial institution has laid out clear arrangements for payments in alternative currencies, Ratings said, citing an analysis of 170 offer circulars for dollar bonds issued since Jan. 1, 2019.