Although the Chinese corporate bond market dates back some years, it has had a turbulent history. In the early 1990s, there was approximately Rmb68bn ($8.2bn) in issuance but by 2000, and after scores of defaults had hit the market, the figure had fallen back to just Rmb8.3bn. By the end of last year the market had grown to almost Rmb50bn. However, even now, access to the market is severely restricted by government.
Cautious approach
Bankers, who stand to gain most from a liberalised market, are understandably reticent about criticising the heavy regulatory hand, claiming this underlines a sensible, cautious approach. Feng Gao, co-head of Global Markets for Deutsche Bank in China, admits that the requirements imposed on issuers are “quite stiff”, but argues for the government’s approach. He says: “The corporate bond market is small because the government has been cautious about allowing it to develop too rapidly, as it does not want to see any defaults. The government’s concern is entirely correct – they want things to go slowly rather than create instability.”
Frank Kwong, director of the primary trading group at BNP Paribas in Asia, also appears tolerant of the government’s stipulation that issuers need to get a guarantee from a state-owned bank, as well as government approval, which limits the number of issuers who can tap the market. He says: “Only good quality issuers come to market, ensuring that the same problems [of earlier default] are not repeated.”
Defining the market
Others are less sanguine. Professor Xiaonian Xu, of the China Europe International Business School, outspokenly says that China’s is not a bond market by the usual definition. “Over the last few years all the issuers have been state-owned entities, the rating agency is also state-owned [and all the issuers have AAA ratings], almost all the issues are guaranteed by state banks and on top of that, all the coupons are capped,” says Professor Xu. “It is not a corporate bond market as such, it is a quasi sovereign debt market, which is effectively run by the state agencies involved. I have never seen anything like this anywhere else in the world.”
He says that, for the market to develop in any meaningful way, the government needs to “quit the market” but he is sceptical about the government’s true intentions. “I don’t know to what extent the government is willing to change these regulations – but, if they don’t, China will never have a well developed bond market. The killer of any market is government,” he adds.
Creating pressure
Professor Xu believes that one of the current problems is that there is no pressure on the government to change the rules. As the market economy develops further – and in the absence of any bullying from the banking sector – he suggests that corporates may increase the pressure in order to reduce their costs of outside capital. “But at present they would have no influence,” he says.
The result of the current situation is that private companies currently have only two choices for funding – they can either list or secure loans from banks.
Domestic involvement
According to Mr Kwong, most of the bonds are sold to domestic investors – Chinese life and insurance companies, social and credit funds, as well as the retail sector. Qualified Foreign Institutional Investors (QFIIs) are also able to invest in local credit, but he says there has been very little interest from this sector. “This is partly because of a lack of confidence in the market, but also because the government has put a cap on the coupon, so that the maximum amount of interest which corporate bonds can be issued at is just 140% of banks’ savings deposit rates,” he says.
Non-domestic players like BNP, JPMorgan and Deutsche Bank, which are excluded from the bond markets through government regulations, fare little better in the loan markets. According to Carl Walter, chief operating officer for JPMorgan China, the four major banks account for approximately 60% of corporate financing in China – all of which is done on a bilateral loan basis. Chinese banks account for the balance. Mr Walter says: “As a result there is neither a secondary loan market nor a private placement market. We would be very interested to see both those develop, but I doubt the major local banks will push for either. At present there is no great pressure on them to reduce their capital costs.”
Mr Walter says it would be logical for a secondary loan market to develop first, but again holds out little hope for its evolution. “While the second-tier banks are already familiar with the concept, I am not sure whether they have the systems in place to estimate the risks and costs involved,” he says.
Mr Kwong agrees. “Although the loan market is much bigger than the corporate bond market, there is very little loan trading. We envisage that the securities side will develop much faster than the loan side as the speed of deliberation on the side of banking regulators is much slower.”
ABS sector
The third area in which the government has shown little sign of encouraging development is the potentially vast asset-backed securities (ABS) sector. “An ABS market is dear to the heart of everybody that is active in the market. Though this subject has been discussed continuously since the mid-1990s, so far there has been no progress except for a handful of offshore issues,” says Mr Walter.
He argues that the problem lies principally in the absence of regulation, and that until there is a legal framework that defines bankruptcy and remote bankruptcy, and allows for onshore special purpose vehicles (SPVs), the market’s development will be restricted.
A liquid ABS market could be crucial for the local banks that are lumbered with large quantities of non-performing loans (NPLs). Mr Kwong points out how last year several buyers of NPLs came into the market, such as Morgan Stanley, which set up an onshore shop servicing the instruments. “In the future,” he says, “some of those could be repackaged and sold as ABS transactions, which would help free up capital for the local players. The local regulators would, I think, like to see the market develop.”
Few options
At present local investors have little choice – they have no way of hedging or selling short, and are able to invest only in straightforward Chinese government bonds, deposits, equity funds and straight equities.
When the day comes, and the corporate bond market really begins to develop in a meaningful way, Mr Walter believes the local appetite for credit will be considerable. “Also because there are strongly developing social security and insurance systems, as well as a rapidly ageing population [retirement ages are 50 and 55 for women and men respectively, and by 2020 there will be 250 million Chinese over the age of 65], there is a robust need to be able to invest in something with a rate of return that will beat inflation,” he says.
Foreign policy
In all the credit markets, the key for non-domestic players will be to make the assets attractive to foreign investors where their distribution strength lies. Mr Gao admits that four state-owned banks will have an immediate advantage from having been in the market for a long time, but is quick to point out that foreign banks do have strengths as well, such as robust credit processes and governance standards. He adds: “We are therefore pretty confident that we will be in a good position to compete once the market is given free rein. We will perhaps be more conservative but that could be in our favour.”
Mr Kwong, meanwhile, says that the key to foreign involvement will be a reduction to the current capping on coupons. “We are hoping to see a shift to relax that capping soon, and that should help to make the products more attractive to non-domestic investors.”
Foreign investors have already shown some interest in Chinese credit through the limited offshore bond market. Mr Kwong says that despite the lack of appetite among QFIIs onshore, there is “definite appetite” for offshore issues. The caps that apply onshore are of course absent in the offshore market, where foreign investors typically demand higher premiums than Chinese investors. For as long as the onshore caps apply, and appetite for issues remains strong onshore, it is unlikely many issuers will be persuaded to pay more in spread to attract non-domestic investors. However, when these are eliminated, bankers say there will definitely be appetite for Chinese borrowers to issue paper offshore.
Mr Walter says: “This is clear, especially given the amount of interest in China. In July, China’s industrial production slowed to 15% year-on-year, which was the country’s slowest pace in recent months – but that is still three or four times the rate of growth in the US. The economy is growing like crazy, and there is plenty of capital out there that wants to be involved in it.”
Long haul
Debt bankers appear politely resigned to facing what they believe will inevitably be a long slow move to liberating their market. Mr Gao admits there is a need to allow the market to develop, but says that it will have to be a multi-step process. “The Chinese government bond market needs first to be more liquid, with a liquid benchmark for credit markets to blossom. Equally, lenders and investors need to develop credit processes and establish credit histories,” he adds.
Professor Xu, who is less wary of upsetting the local authorities, is far more forthcoming. He says: “My recommendation is for the government just to get out!”
