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China’s long road to a credit culture may be set for a boost if efforts to unify the many fragmented debt markets pay off. What’s next for the corporate sector?

China’s efforts to develop its domestic capital markets into a real alternative to bank funding have already fuelled the rapid growth of onshore bonds and spawned countless new products. There are signs, however, that the pace of progress may be about to accelerate even further.

For the first time, China’s three bond market regulators are working together to help companies meet their funding needs.

China Securities Regulatory Commission chairman Guo Shuqing clearly outlined this common goal in March. In an interview with the People’s Daily at the time, Guo said the overreliance on bank credit in a financial system could lead to systemic risk, and the development of China’s bond market was seriously lagging.

Now, word has it that China’s State Council has added its blessing to develop the country’s bond market.

Shi Wenchao, secretary of the National Association of Financial Market Institutional Investors (NAFMII), regulator of the domestic inter-bank commercial papers and mid-term notes, told domestic media at a meeting on June 19 that, as China’s economic growth is slowing, the State Council had approved suggestions to control bank lending and expand the bond market.

Shi said the move was intended “to improve the structure of the economy and the transformation of commercial banks”.

According to a Credit Suisse research report, developing a corporate bond market will help balance risks within the financial system and offer an alternative to bank loans, especially for borrowers of long-term debt, as banks are usually very reluctant to lend for a long term.

Currently, control over China’s bond market is split between three regulators – the CSRC, the National Development and Reform Commission and the People’s Bank of China.

Now, on orders from the government, the three are working together for the good of a bigger and better bond market.

“We are competing with one another, but, at the same time, we have the same goal to expand China’s bond market, and make it more market-oriented,” Shi said in his speech.

New products

Indeed, under this common goal, the regulators have spared no effort in expanding the market either with the introduction of new fundraising tools, or revisions to existing rules to allow companies to issue more debt.

In May, Leshi Internet Information & Technology became the first company listed on China’s Nasdaq-style ChiNext board to issue corporate bonds, marking the PRC bond market’s first big step towards the creation of a high-yield market.

“We are competing with one another, but, at the same time, we have the same goal to expand China’s bond market, and make it more market-oriented”

The Rmb200m (US$31.6m) transaction came with the highest coupon in China since at least 1996, at 9.99%.

That record, however, is set to be broken soon with a steady flow of privately placed enterprise bonds from the country’s small- and medium-sized enterprises.

Suzhou Huadong Coating Glass’ tiny, but noteworthy, two-year deal of Rmb50m was sold in early June at 9.5%, in China’s first private enterprise bond from the SME sector. A number of other transactions of different sizes, ranging from Rmb20m to Rmb250m, have also been filed with the stock exchanges of Shenzhen and Shanghai. The deals, with tenors of one to three years, offer coupons between 9.5% and 13.5%.

Pure B-share listed companies, which have been more or less barred from refinancing since 2004, are also in the process of issuing corporate bonds.

The CRSC, after allowing ChiNext companies to sell corporate bonds and introducing SME private enterprise bonds, has approved Foshan Huaxin Packaging’s plan for Rmb800m of corporate bonds, the first fundraising of its kind from the B-share market.

Elsewhere, NAFMII has handed in a proposal to the central bank that would allow issuers rated AA and above to issue more debt.

NAFMII has proposed excluding commercial paper from an indebtedness limit of 40% of net assets applicable to Chinese companies. Subject to the PBoC’s approval, NAFMII is effectively increasing the cap on MTN issues from higher-rated companies.

The move is expected to multiply the potential market for CPs and MTNs. Some 993 issuers will benefit from the new rule, according to a CICC report.

Bankers estimate the new rules will allow those companies to sell debt of up to Rmb5.33trn, comprising Rmb3.43trn of CP and Rmb1.9trn of MTNs, up from the current Rmb1.63trn limit.

Although it is far from clear if the new market will develop quickly, DCM bankers welcome the introduction of these new types of paper as they signal a further boost to China’s booming bond market.

“It’s like hosting a dinner. Whether or not the guests like the dishes, you first have to bring put them on the table,” said a DCM banker. “With all these different options, the guests have their choice and make their comments, and the host improves the fare all the time. A market with more choices is the first step towards maturity.”

The newer items on the menu also need to be especially attractive.

“To convince people to try the new options, instead of sticking to the old ones, we need to make the new dishes more delicious and even become a must-order item on the menu,” the DCM banker said.

Many other market participants echoed this view, pointing out that the early response to a new product matters a lot to its future development.

“I think, at this stage, these new fundraising tools need to attract more participants from both the issuer and the investor sides,” said Wei Mingda, an analyst at Ping An Securities’ fixed-income desk. “It only makes sense to study yields curve, investment values or even the default risks, when the market is big enough to provide enough samples.”

Need for bigger volume

Besides opening new fundraising channels, the regulators are also allowing more investors to participate in the country’s various bond markets.

NAFMII’s Shi said the regulator would expand the investor base for private MTNs beyond commercial banks. CSRC, on the other hand, is said to be looking to allow mutual funds to invest in private enterprise bonds.

The China Insurance Regulatory Commission is also making a similar move. In a meeting with insurance asset-management companies earlier this month, the regulator pledged to relax further its rules on investment channels for insurers’ assets.

“CIRC is allowing securities companies and fund management companies to manage the insurers’ assets, which means the funds can be invested at higher risk-tolerance levels,” said one of the people who attended the meeting.

This follows another relaxation in mid-May. At that time, the CIRC allowed Chinese insurers to invest in bonds listed on stock exchanges and interbank markets that are sold through bookbuilding exercises, a move which can channel billions of renminbi from the insurance sector into the country’s domestic corporate bond market.

“To convince people to try the new options, instead of sticking to the old ones, we need to make the new dishes more delicious and even become a must-order item on the menu”

Du Zhiguo, a bond sales officer at ICBC, said all these measures would definitely help sell private deals that typically suffer from poor liquidity and, in turn, attract more issuers to the market.

Despite all the positive signs – the new products, larger investor base, many more potential issuers – there is still one thing that remains untested in China’s bond market. Since the birth of the country’s modern capital markets, not one issuer has defaulted on its bonds.

Earlier this year, Shenzhen-listed chemical company Shandong Helon, which issued Rmb400m of one-year commercial paper, maturing in April 2012, narrowly escaped the fate of being party to the first default in China’s bond market history after the local government and banks bailed it out.

Long way to go

That episode has taught domestic investors that a listed company is not necessarily a safe borrower – something that is regarded as common sense in foreign markets.

But, without the precedent of a default, investors remain unable to price the risk of a company going bankrupt.

While some would even welcome a default as a test of recovery expectations, bankers believe the first such case is unlikely in the near future. Instead, they are turning their focus to how the regulators can help control market risk with the emergence of risky products, such as high-yield bonds.

“The regulators should come up with some ideas on introducing more tools to hedge risk or a more market-oriented pricing and rating system, in order to cope with the huge potential risks in the emerging high-yield bond market,” said a banker.

“We need a sophisticated investor protection system,” said an investor who had held Helon’s CP at one point.

A recent CSRC push to unify all of the regulators’ separate entry standards, bond disclosures, credit ratings and investor-protection rules may help.

In a statement on its website on May 31, CSRC warned that split regulatory control over different segments of the bond market could lead to systemic risk in the long run, stressing the need for unification.

The Credit Suisse report supports that view. “We think it would improve the system efficiency in a great way, if CSRC can consolidate the regulatory power across all bond sub-segments/products,” the report said.

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