Chinese corporate bonds, particularly those denominated in US dollars, have seen an increase in defaults, raising the spectre of a broader systemic collapse if these continue to pile up.
From zero defaults in 2017, Chinese offshore corporate dollar bond (OCDB) defaults totalled some $3.4 billion in the first 10 months of 2018, according to research from Japanese bank Nomura.
A weakening Chinese currency is one major factor behind that rise, as it's made it more expensive for renminbi-earning Chinese companies to pay their dollar debt obligations. The renminbi has depreciated by about 6.5% against the US dollar so far this year.
On top of that are the growing US-China trade tensions, which have served to further undermine the already slowing Chinese economy and created a tougher operating environment for companies. The US imposed a 10% tariff on $200 billion of Chinese goods and 25% tariffs on $50 billion of Chinese goods between July and September this year, while the latest Chinese economic growth figures have fallen short of expectations.
Given this negative backdrop, we asked an Asian fixed income specialist, an emerging markets corporate debt expert, and an emerging Asia economist whether Chinese corporate debt represents a systemic risk to domestic and global markets, and how investors are looking at the asset class.
The following extracts have been edited for clarity and brevity.
Ho Shaw Yann, Asia head of fixed income
JP Morgan Asset Management
With regard to Chinese corporations issuing US dollar-denominated debt, we don’t believe rising defaults pose a systemic risk. In the majority of instances, defaults may be due to the unwillingness to price inventory to sell or mismanagement of risk control/hedging. These situations tend to lead to banking lines being cut or collapsed, hence the defaults. However, these are idiosyncratic instances rather than a systemic issue.
Where we have seen an increase in Chinese corporate debt defaults, namely in companies issuing debt in the onshore renminbi market, the main reasons involve failings of governance or a lack of investor relations knowledge, lack of communications with investors or waiting until too late to call upon provincial governments to help. In most cases, strategic industry players willing to call on assistance may have gotten some support from provincial banks and other sources.
In the context of both Chinese corporations issuing in US dollars and in the onshore renminbi market, we believe the situation is already under control and relatively well-managed. However ... further [increases in] onshore defaults could potentially damage the confidence of investors in US dollar bonds issued by Chinese corporates, hence perpetuating a vicious circle for funding avenues.
As defaults have risen in the onshore renminbi corporate [bond] market, that has correspondingly dampened sentiment in the offshore US dollar [bond] market. Nonetheless, there are few overlapping names present in both markets. In addition, most OCDB are issued by more sizeable industry players. As a result, the market generally tends to have a relatively higher governance standard.
Aidan Yao, Senior emerging Asia economist
Axa Investment Managers
A confluence of factors has hit the Chinese corporate bond market in 2018, creating almost a perfect storm for some of the high-risk segments. Rising external headwinds from the Sino-US trade war clearly dealt a heavy blow to investor confidence, but a more important driver has been the evaporation of shadow banking liquidity that significantly tightened credit availability for high-risk private-sector borrowers. The latter constituted the vast majority of corporate bond defaults this year.
But with just over $13 billion of defaults as of the end of October in a roughly $5 trillion credit market, the default rate, while rising, is still significantly below those of other mature markets. Hence, we do not see this as posing a systemic threat to the financial system, but [rather view it as] a healthy development that market forces are being gradually unconstrained to price credit risks. The latter is important to cure the chronic ills, such as moral hazard and implicit guarantee, in Chinese fixed income.
Notwithstanding its long-term benefits, the short-term consequences need to be properly managed in the current environment of growing bearish sentiment towards China. We think greater policy supports, particularly those targeting private-sector enterprises, should help to ease the pace of credit defaults in 2019.
Alaa Bushehri, Head of emerging markets corporate debt
BNP Paribas Asset Management
In our view, although we cannot discount that an uptick in default rates may result in a systemic risk, a systemic risk is not our base case scenario in the Chinese corporate debt market. Our view reflects that, to date, there have been limited surprise credit events and no specific sector-concentration in defaults.
Issuers have been navigating through a challenging macro backdrop coupled with tougher capital market conditions, both of which could continue to be present into fiscal-year 2019. An increase in defaults within any region and/or sector [would] create negative sentiment while investors look to understand the specific drivers leading to these credit events.
The challenging macro backdrop, tougher capital market conditions and an uptick in defaults has resulted [in a] material widening in spreads across the asset class. This offers investors the opportunity to allocate to fundamentally sound issuers who have seen their spreads widen indiscriminately.