In the wake of its largest number of defaults ever in the first two months of this year, experts believe that new regulations could strengthen foreign investor confidence in China's $18.2 trillion onshore bond market and eventually promote better analysis, particularly from international credit rating agencies that are currently afterthoughts in the local market.

However, they warn that the new rules are unlikely to have an immediate impact on the number of defaults. 

High-profile defaults – missed repayments of principal and interest – from highly rated state-owned enterprises (SOEs) hit Rmb25.9 billion ($4 billion) at the end of February. This is almost twice the amount on the same period last year, according to Bloomberg data.

The most recent case onshore was Chinese property developer China Fortune Land Development. At the end of February, it announced that it had missed payments on more than Rmb11 billion ($1.7 billion) of loans and offshore bonds. In the offshore market, the final quarter of last year saw three state-owned companies, Yongcheng Coal, Tsinghua Unigroup and Huachen Automative, default on a Rmb6.3 billion debt between them.

As a response to recent mounting defaults, China Securities Regulatory Commission (CSRC) announced regulations in two separate policy documents on February 28 to manage corporate bond issuance and introduced a more market-oriented approach to corporate debt ratings.

Under the new measures, Chinese companies will no longer be required to obtain credit ratings before they sell bonds into the public market. It also relaxes some of the issuance entry standards, such as removing hard requirements for ratings.

Cosmo Zhang, Vontobel AM

Even though experts do not expect material changes in the short term, Cosmo Zhang, fixed income research analyst at Vontobel Asset Management, told AsianInvestor the new measures are a reflection of the fact regulators are continuing to progress towards a market-oriented system for onshore corporate bond issuance. Increasingly they are leaving risk analysis decisions to the market. 

“[This means that] it is important that investors follow internal ratings objectively to assess the true default risk of underlying credits, with or without the agency ratings,” he warned.

He believes that may take time before the bond rating and assessment system in China evolves to a more advanced, credible and stable one.

3% PARTICIPATION

A gradual liberalisation of China's onshore bond market will be required to help hasten foreign investor interest in the market.

The country has been opening its doors to foreign investors, but participation remains low. At an online event held by Bloomberg and IMAS on March 9, Clifford Lee, global head of fixed income at DBS Bank, noted that China's bond market will require more liquidity and transparency if it is to attract more foreign capital.

He noted that the country has a long way to go to reach international bond market standards, cautioning that investors need to give the reforms more time.

As of the end of 2020, the foreign ownership ratio in China’s bond market stood at 3%. The continuous relaxation of regulations and barriers to foreign investment has seen foreign holdings gradually rise. in recent years. In 2018, the ratio was around 2%, according to a research report by DBS on March 4.

The report goes on to say that commercial banks currently hold the lion's share of treasury bonds, local government bonds and policy bank bonds in China.

Foreign investor participation would help diversify this. however, Lee noted that "it's not a matter of whether they [foreign investors] will enter the market, it's about when and how much confidence they will show in China’s bond market in longer-term".  

Indeed, some offshore investors have already interest in some of China's high-yield bond products.

Clifford Lee, DBS Bank

“For foreign institutional investors, Chinese high grade and high yield bonds are always attractive,” Zhang said, adding that although the market has seen the high-profile default of several Chinese companies in both onshore and offshore, the overall default rate of China corporates is still lower than that of other emerging market countries. 

FOREIGN AGENCY OPPORTUNITY

The bond defaults have exposed the shortcomings of China's domestic credit rating agencies, and explains the decision to relieve issuers of the need to gain credit ratings.

China's credit rating agencies have long been accused of failing to impartially assess corporate credit risk in the country, preferring intstead to slap very high ratings onto many local bonds. The recent series of defaults revealed how hollow some of these ratings were, with Yongcheng Coal for example drawing a 'AAA' rating from one local agency in October, just one month before it defaulted on Rmb103 billion in bond principal and interest.

One outcome of this, and China's new rules, is that international rating agencies will have an opportunity to shine. 

Danny Chen, chief executive officer at Fitch (China) Bohua Credit Ratings, told AsianInvestor in an email reply that the new rules reflect the regulators’ intention to manage the bond market in a market-oriented way. Fitch (China) is one of the foreign players permitted to conduct rating business in China and Chen believes the new rules will benefit international names that can demonstrate higher independent analysis and transparency.

They will have a lot of catching up to do. In the third quarter of last year, 10 ratings agencies worked with more than 4,000 businesses in China's onshore bond market, of which Fitch and S&P accounted for less than 1%, according to a report from the National Association of Financial Market Institutional Investors.