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Monday, 11 December 2017

Moving to the front row

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Until recently Chinese domestic bond markets took a back seat in the country’s economic expansion, as banks and equity markets provided the fuel for growth. In recent months all that has changed, and fixed income has moved centre stage as the funding source of choice for China’s cash-hungry companies.

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With banks increasingly restrained after balance sheets exploded in the years up to 2010, and equity markets in the doldrums, Chinese government authorities have made moves to streamline the approval process for bond issuance, and to open the market to smaller companies and longer-term borrowers.

“The three main regulatory bodies have made it easier and faster to sell bonds, with the result that issuance up to August this year among non-financial corporates has already reached the volumes for the whole of last year,” said Zhi Ming Zhang, head of China research at HSBC in Hong Kong. “China needs to retain its fast growth and that task has become increasingly capital intensive, which means pulling all levers to make sure corporates have enough money to expand.”

The new focus on bonds represents a step change in the way China manages its credit system, which is traditionally reliant on relationships between borrowers and local banks. Total outstanding bank loans were 123% of gross domestic product at the end of 2011, while corporate bonds were just 11%, according to Credit Suisse.

Still, the lower interest rates and longer tenors of bonds over bank loans have proved attractive, and total debt issuance by Chinese non-financial corporations was Rmb853bn (US$134bn) in the first half of 2012, the most on record and up from Rmb530bn in the same period last year, according to Wind, a Chinese data provider.

China’s corporate bond market is controlled by three distinct regulatory bodies: The National Development and Reform Commission (NDRC), which oversees enterprise bonds, issued by state-owned companies; the China Securities Regulatory Commission, which  manages bonds issued by listed companies and traded on exchange, and the People’s Bank of China, through the National Association of Financial Market Institutional Investors, which has responsibility for commercial paper and medium-term notes, the largest corporate bond sector.

Better  access

A key trend in the recent period has been a move to expand bond market access from large state-owned issuers such as PetroChina, China National Grid and the Ministry of Railways to small and medium-sized enterprises. A key driver of the move has been the NDRC, which earlier this year revamped its approval process so that applications for bond sales can be passed in a few days, rather than a few months previously.

NDRC blessing has resulted in a surge in bond issuance, in particular from debt-laden local government financial vehicles (LGFVs), which looked to refinance debt and lengthen maturities. On the buyside, investors have embraced the relatively low-rated and higher-yielding securities. LGFVs since 2009 have been crucial providers of capital for infrastructure and housing investment.

In addition to their strong momentum in the primary market, LGFV bonds have also performed well in the secondary market. This may be because the NDRC has gone beyond simply approving large amounts of issuance. In June it ordered local governments to review the ability of bond issuers to repay debt maturing in 2012 and 2103, warning that they would be held responsible for potential defaults. With local governments subsequently likely to go to great lengths to avoid defaults, the move was seen as hugely supportive for enterprise bonds.

While higher levels of bond issuance reflect official concern over slowing of economic growth, the issue of defaults may provide a more subtle explanation for the move to allow enterprise bond issuers to refinance and push out maturities profiles

The Chinese bond market has never seen a default, a fact which for some raises questions over its viability, but it came close earlier this year when Shandong Helon, a local government-owned fibre maker, was on the verge of defaulting on Rmb400m in commercial paper. Ultimately, the company was bailed out by the authorities, but it raised a red flag at the NDRC, and perhaps was instrumental in recent moves to relieve short-term pressures on LGFVs.

Still, the Helon bailout was also instructive as to the distance the Chinese onshore bond market must travel to reach a level of maturity that is taken for granted elsewhere.

“In the long run China will need to allow defaults to promote a healthy capital market,” said John Sun, managing director at Citic Securities International in Hong Kong. “However, for the moment the priority is to expand the capital market, and with a lot of small and medium-sized companies with deals in the pipeline the feeling is probably that a default would be undesirable this year and next.”

The art of local ratings

Without a default history to rely on, the business of rating fixed-income securities is somewhat of an art, and China’s six internal rating agencies run an idiosyncratic system that bears little resemblance to its developed market counterparts.

“With insurance companies restricted to investing in bonds rated higher than AA, the vast majority of bonds are rated at that level,” said Ivan Chung, an analyst at Moody’s in Hong Kong covering the China bond market. “Single A is basically considered high yield, and you seldom see anything rated below that.”

While the NDRC has been pushing enterprise bonds, officials at the China Securities Regulatory Commission have also been busy, and under the leadership Guo Shuqing, who took over chairmanship of the organisation late last year, have set up an office to study new products for the bond markets. In May the CSRC said it was considering introducing municipal bonds, and in early June it launched a plan to allow small and medium-sized companies to issues debt equivalent to high-yield bonds.

China’s first junk bond sale duly went in June, with a Rmb50m (US$7.9m) private placement by Jiangsu-based Suzhou Huadong Coating Glass Co.

With the three government bond agencies all moving forward with plans to expand their areas of responsibility in the bond markets, there is talk among some observers of increasing levels of competition between regulators to ensure their bond products are most successful in weaning China off its reliance on bank funding.

“All three agencies are being quite aggressive in making their approval process more appealing to issuers – the race is on to make individual sectors as big as possible,” said HSBC’s Zhang.

Merging of agencies?

Amid the increased competition there has been some talk that the agencies may merge, and the bodies held their first meeting to co-ordinate policy on corporate securities in April. However, integration may be some time off, Zhang said.

“There has been talk about that for quite some time but it’s unlikely to happen soon. There are entrenched interests across the three bodies, and I really can’t see anything changing until after the party congress [in Beijing in October] or really until after the middle of next year.”

Patience may also be advisable for foreign banks looking to get a slice of the underwriting action in China’s bonds markets, dominated by local banks, which have distribution networks that foreign players cannot touch. Foreign banks wishing to take part in bond issuance programmes must register as local entities, following the example of UBS, which has set up in Beijing as UBS Securities.

Only HSBC Holdings, meanwhile, has won approval to underwrite non-financial debt on the interbank bond market, but has yet to lead manage any sales. The London-based bank is top underwriter in Hong Kong of so-called Dim Sum bonds, denominated in renminbi and sold offshore.

As bond issuance increases, foreign investors are keen to get on board, and have a route into China under the qualified foreign institutional investor programme, which allows overseas financial institutions to invest in local markets. Until recently, however, investing was restricted to exchanges, for all except central banks and sovereign wealth funds. That changed in recent weeks when foreign asset managers were for the first time given permission by regulators to buy into the interbank markets, opening the door to bond fund managers such as BlackRock and Pimco.

“In the environment we are in now, when economic growth in China is slowing, equity is not very attractive,” said Armand Yeung, managing director at Central Assets Investments in Hong Kong. “That makes it a particularly good moment to open up investment in credit.”

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