China’s securities watchdog has issued warnings to six local credit rating agencies and plans to tighten regulation of the sector, in a move that foreign investors will welcome amid the rapid opening of mainland bond markets.

This follows a series of investigations into seven rating agencies by the China Securities Regulatory Commission (CSRC).

The regulator said on Friday it had sent warning letters to China Chengxin Securities Rating (CCXR), Dagong Global Credit Rating, Golden Credit Rating International, Lianhe Rating, Pengyuan Credit Rating and Shanghai Brilliance Credit Rating. A total of six representatives from these firms were asked to attend “supervisory interviews".

The regulator also said it had carried out the investigations since September through its bureaus in Beijing, Shanghai, Shenzhen and Tianjing, with a view to assessing the strength of their internal compliance and management. The CSRC did not explicitly publicise the outcome of the investigations, but China Bond Rating Company, one of the seven, did not receive a warning letter.

The watchdog said there were nine major flaws in domestic rating agencies’ practice, including: a lack of standardised criteria and procedures for the same level of rating; the rating methodology and model used for ratings are different from those the agencies disclose; and a lack of sufficient due diligence on ratings.

The CSRC also criticised agencies’ failure to comply with certain rules, resulting in, for example: the lack of a review system for the credits covered; the lack of published reports to follow up on credit rating changes; and incomplete documentation for ratings.

It said it would impose strict regulations on rating activities, in a bid to improve the country’s capital markets, which are being swiftly opened to foreign participation.

The Chinese central bank moved in February to open the country’s Rmb48 trillion ($7.4 trillion) interbank bond market, the world’s third largest, to foreign institutions except hedge funds. 

Foreign fund managers have frequently expressed concern about mainland rating agencies, as at least 30% of the onshore corporate bond market is rated AAA by the three largest – CCXR (38% market share), Lianhe (25%) and Dagong (20%). The trio held an 83% market share of onshore credit ratings as of last August, according to Goldman Sachs. 

Hence most foreign fund houses plan to increase their credit research capabilities around mainland bonds in expectation of the market’s growth. For example, Singapore-based Fullerton last Friday said it planned to add a fixed income analyst in its Shanghai wholly foreign-owned entity (WFOE), and other firms are thought to be considering setting up onshore WFOEs with research teams (if they don't have one already).

Chinese fund managers have learned painful lessons from rising credit defaults last year, and have been urged to strengthen their credit analysis capabilities. In the Shanshui Cement commercial paper default saga last September, local rating agencies downgraded the credit three months later than US firm Standard & Poor’s issued a warning about the offshore dollar bond. 

China's onshore non-financial corporate bond market stood at Rmb18.7 trillion at the end of 2015, making it the second largest after that of the US, according to Standard Chartered.