IFR Asia China Securitisation Roundtable 2017: Part 2
KYSON HO, HSBC: Some of the concerns that Jerome raised are also good for the development of the market. When everything is Triple A and all the deals repay within half a year, investors don’t really differentiate between good deals and bad deals. As economic conditions become less positive and different issuers also adopt different structures, in particular revolving deals and longer tenors, investors really have to think more. Then there will be more incentives for issuers and investors to demand well-structured transactions that are appropriate for the particular environment and the asset class.
CRISTINA CHANG, CITIGROUP: Yes, it’s a good point. The Chinese market is developing new structures or tweaks to existing structures, and the revolving format is one example. Often the way that they implement that structural tweak isn’t necessarily done in the right way to take into account the features of that particular asset class. They’ll just borrow from a similar transaction, but the triggers may not make sense for the asset class.
I think the market still has to mature from a structuring perspective to ensure that transactions have the right features that are appropriate for the asset class.
IFR ASIA: Roy, from a legal viewpoint, how different are the offshore and onshore structures? What do people need to be aware of when they look at an onshore deal?
ROY ZHANG, KWM: There are many differences, of course, but the good thing is when China started the securitisation market back in 2005 it built on international standards. Many of the people around this table, actually, helped build up the market infrastructure at that time.
So I would say the market started at quite a high level, with good legal structuring and documentation. Since then, the regulators in China have set quite high expectations around structuring and disclosure, so the market players in China – including banks, credit firms and various advisors and professionals – they all try to do more high-quality deals to use that as a selling point. Because the market is quite competitive, people are choosing good originators, good sponsors, good assets and also trying to find new asset classes so that they can claim to be the best or the first in a particular market.
That’s understandable, especially in an evolving market. That’s why we’re seeing international banks and advisors helping Chinese banks to structure their deals and present the selling points to both local and international investors.
IFR ASIA: There used to be a view that China was afraid of repeating the mistakes made in the US market – subprime mortgage securitisation and so on. Are those safeguards still there?
ROY ZHANG, KWM: The dynamics have changed quite a lot since the financial crisis. China now has a big alternative capital market, with all sorts of shadow banking products and various investment schemes which are more tailored for local retail investors. The regulators are trying to deregulate, but at the same time they are concerned that leverage in China may be too high.
In the property sector, for example, developers want to use all sorts of funding channels to help their expansion. In addition to their traditional bank loans or bond funding, they want to use various schemes including ABS products. That drives innovation in the market. The regulators want to promote innovation but they have to be careful, and they compete with each other to have really good products in their market. We’ve seen the two stock exchanges are doing quite a good job. Also NAFMII, I think they are also quite good.
So they are all issuing more detailed guidelines to the market, and that’s a good thing.
IFR ASIA: We’ve seen some innovation in terms of asset classes – theme park securitisations, I think, cinema tickets. How far can that go?
LESI ZUO, STANDARD CHARTERED: As Roy mentioned, the interbank bond market definitely has higher standards. The exchange market, under the CSRC, has products that are also of high quality. Also, you have non-standardised products, which surprisingly mainly go to individual retail investors.
I think the regulators on the one hand want to clamp down on risky deals which may bring more risk into the system. On the other hand they are broadening the range of so-called ‘standardised’ products, so you may see some of these kinds of asset classes later on, for example in the ABN market.
IFR ASIA: How can you tell which ones are non-standardised products?
LESI ZUO, STANDARD CHARTERED: Basically the interbank market is more like the public market. There’s no limitation in terms of the number of investors you can sell to. The exchange market is actually private because you have a maximum of 200 investors.
For some of the asset classes in the exchange market the structure may not be based just on the cash flow itself; some of the deals have the corporate credit behind them. So that’s why some people look at it as an alternative to bond issuance.
From what we see so far, we expect NAFMII and PBOC to apply high standards when corporate issuers use the ABN format.
CRISTINA CHANG, CITIGROUP: It is somewhat ironic that in the Chinese market overall you have very, very high standards, with thorough reviews and often very long approval times for transactions issued into the interbank bond market. Then on the other side of the spectrum you have the non-standardised, shadow banking market, where people are doing quasi-securitisation deals on all sorts of untested asset classes, with no track record and very high interest rates, where there is absolutely no review at all by any regulator.
LESI ZUO, STANDARD CHARTERED: Going back to your question about comparing the onshore and offshore structures, it’s worth noting that the interbank market regulators – the PBOC and CBRC – have relaxed some regulatory aspects of these transactions by introducing a filing and registration process, which can significantly shorten the time to market.
The overall environment is still highly regulated, compared to the offshore market. For example, you can’t just introduce new asset classes or new structures. You have to have some informal consultation with regulators, where they will tell you what they will support.
That is good and bad. At this stage of market development, I think this kind of guidance is very important in terms of upholding market standards. But on the other hand, compared to the offshore market, it’s much less flexible for market-driven innovation.
IFR ASIA: What’s the newest development in the standard asset classes? Jerome, can you tell us what you have looked at recently for the first time?
JEROME CHENG, MOODY’S: There are many new developments. The trust structure ABN has actually allowed some of the corporates to get into the interbank bond market, so we can expect some non-traditional asset classes. In the US, for example, they have market place lending, and you can also see this kind of transaction in Europe. In China, it’s also about new financial issuers like Ant Financial and JD.com; they sponsored internet finance receivable-backed ABS in the CSRC market. In addition, you may see something similar to standard lease receivables.
IFR ASIA: Interesting. Kyson, any view on the new asset classes that might present new opportunities?
KYSON HO, HSBC: New asset classes or new structures in the interbank bond market would include RMBS targeted at international investors. Jerome has published material on that as well. There’s also consumer loans and revolving structures. The big development everyone has talked about is the ABN format that NAFMII published recently. That introduces corporate originators rather than financial institutions or auto-finance companies, and different corporates will have different types of cash flows or receivables. So you potentially could see much more divergence once it gets implemented.
IFR ASIA: You used to be able to do some of those under the specific asset management plans – SAMP. Has that disappeared now?
ROY ZHANG, KWM: That’s in the CSRC market. The regulator there has talked about introducing the trust structure into those deals, but there has not been much progress in that regard so they have to still follow previous model using SAMP structure.
From a domestic investor’s perspective, the structure is not a big concern, given that people generally believe in the legal and traditional framework. For an international deal that’s maybe another story, although we have been helping review some structures under the current legal regime. We are pretty much certain we can give a positive opinion on that point, but given that there has really been no test in judicial practice and no official interpretation, some people, especially from the international community, still have concerns.
CRISTINA CHANG, CITIGROUP: I think a lot of the new asset classes in the CSRC market – and may be coming to the NAFMII market where there are corporate issuers – are moving towards what we call a future flow securitisation, which is looking at the future business flows of a particular corporate.
I don’t believe the transactions are structured or credit assessed as rigorously as you would expect in an international future-flow securitisation. For example, what are the corporate risk elements related to those flows? What is the likelihood of that business continuing to originate those flows? Historically, what sort of debt service coverage can you expect?
I think in China there seems to be a view that any company that has operating cash flows can do a securitisation. That’s typically not the case in the international market.
JEROME CHENG, MOODY’S: On cross-border issues, there has already been some sort of securitisation. The Bank of China has issued its Green covered bond, which is backed by a portfolio of Green bonds issued domestically in China.
KYSON HO, HSBC: Strictly speaking that’s a secured bond.
JEROME CHENG, MOODY’S: It’s true that it is more like a secured bond, but you can see the intention to develop the market. At the moment in China, there is no covered bond act, so it’s not possible for them to issue a statutory covered bond at this point in time. Even if you cannot issue such bonds, hopefully, you can gradually change some elements to arrive at a real covered bond as time progresses.
The regulators have done quite a bit. NAFMII has a lot of disclosure requirements, and you can see the servicing reports of various different transactions on ChinaBond.com.
These are some of the developments that also might be used for cross-border deals. Then, of course, it may take a little bit longer for the cross-border market to develop in comparison to the domestic market. It’s a gradual process.
KYSON HO, HSBC: The interesting point about the Bank of China Green covered bond is not so much whether it looks and smells the same as a European covered bond. I think that discussion is missing the point. The more interesting question is what is driving this? If you look at the transaction, there are at least two key drivers. One is Green financing, that’s very clear. We have very rarely seen one bond with two levels of green certification.
The other – more important – point goes back to the theme of the globalisation of the renminbi in the onshore market. Regulators are trying to encourage offshore investors and give them as many ways as possible to look into the onshore interbank bond market. Having a senior secured bond with a security package that is secured on a portfolio of onshore bonds, as well as an international rating, may go down well. The thinking is to give international investors as many opportunities as possible, and that trend is not disappearing anytime soon. The globalisation of the onshore market is going to be a more powerful trend going forward.
IFR ASIA: International investors would rather a Chinese covered bond or ABS looked as much like the international standard as possible.
ROY ZHANG, KWM: As Jerome mentioned, it’s constrained by the legal framework. In China, from my so many years’ experience, I have learned not to wait for that to change. In other markets in Asia, typically things would start with an ABS law. In China that didn’t happen.
I still remember more than 10 years ago when the first regulations were coming together, people were hoping for an act at the National People’s Congress level. That was raised but they said it was not possible. There were too many other more important laws to be made, so this ABS act is not going to be there.
That’s why all the ministry-level agencies have come up with their own regulations to support ABS as much as possible. That’s also why there are going to be some fundamental gaps between some asset classes and structures in China and international standards. Some can be done in a pragmatic way. Some are probably never going to happen. You have to accept that the onshore market is not going to be the same as you see elsewhere.
LESI ZUO, STANDARD CHARTERED: Last year we saw some interesting deals using a quasi-REIT structure. I think that’s a big market with huge potential for commercial properties in China. We don’t have a regulatory framework for the REIT structure. Perhaps it will never be there, so for CMBS and REIT deals people have to be innovative and try to find alternative ways.
JEROME CHENG, MOODY’S: I think with this new ABS structure, CMBS is now possible; at least a single-borrower CMBS structure is possible.
IFR ASIA: We haven’t talked too much about CLOs. I noticed from the research I was looking at before that’s quite a major market now. What’s the latest there, Jerome?
JEROME CHENG, MOODY’S: Issuance slowed quite a bit in 2016. The CLO was the dominant asset class in 2014 and 2015, contributing about 80% of market issuance in those two years. While CLO issuance has dropped, we have seen the rise of other asset classes, like RMBS – the banks’ prime mortgages and the housing provident funds – and non-performing loans.
If we look at the CLO product from an international perspective, the immediate question is the credit assessment of the underlying obligors. In the US, they have this big range of middle-market loans, and most of the underlying obligors are rated. So if you look at a CLO portfolio in the US, for the majority of the names, you already know their credit quality, whereas in a China CLO, the situation is the reverse. Most of the names are not rated, and it can be difficult to access the underlying information.
IFR ASIA: This goes back to the question about whether things have been stress-tested so far. If your CLO happens to include exposure to an industry that is suffering from over-capacity at the moment then potentially there’s huge stress there.
JEROME CHENG, MOODY’S: Right. Our expectation is that these over-capacity issues will affect the performance of transactions with concentrations in certain regions and certain industries that are under stress. Overall, because China’s economy has been stabilising somewhat, it’s not really a distressed economic environment. Even if we are expecting to see some deterioration, it’s not like the market is about to fall off a cliff.
IFR ASIA: Let’s end with a round of predictions for 2017. Will it be the breakthrough year for trust structures or real estate securitisations, or is it going to be dominated by auto ABS again? Jerome, let’s go to you first.
JEROME CHENG, MOODY’S: In the interbank bond market, for sure, auto ABS will continue to be busy. You can actually see from the quota registrations, as we discussed earlier. From the originators’ perspective, they have a genuine need to sponsor ABS transactions. So we expect continued issuance.
As for RMBS, we also expect more issuance. There will be continuous issuance of NPL securitisations, but we don’t expect an explosion it has not been a major asset class in most of the other markets.
Then, we expect some innovations as well; for instance, the trust structure ABN in the interbank bond market, as we discussed. If you look at the economic perspective actually, it is the corporates that have more real funding needs than the banks. The banks are sponsoring ABS transactions for various different reasons, like balance sheet management and risk management, but not really for lowering their funding costs.
IFR ASIA: Are Basel rules and capital requirements a driver for the banks?
KYSON HO, HSBC: I agree with everything Jerome just said, and to your point about Basel regulations, I think that’s valid for some of the longer-dated assets like RMBS. More and more people will be looking, even if they have deposit funding, they’ll be thinking about what they can save from those.
The key sector to watch out for next year is really the corporates in the interbank. That has a lot of potential. I think the first year will still be a lot of baby steps but the potential range of issuers that it could bring in different asset classes will have the biggest impact overall in the medium term.
CRISTINA CHANG, CITIGROUP: I agree. In terms of the long-term development of the market, I think we need to focus on sustainability. Are deals being done for the right reasons? Are those reasons sustainable? Definitely what we’ve seen with respect to the development of auto ABS as an asset class is that, yes, it is sustainable. The originators need this to fund their ongoing operations, so there’s a real reason for them to continue to issue and not just look at a one-off innovation. It’s also sustainable because it is an asset class with a strong track record and generally conservative underwriting and structuring.
I agree with Kyson that the broader corporate sector has a real reason to pursue securitisation. I think the question there is whether that will be sustainable, whether their assets are suitable for securitisation in the way that we normally understand it.
One other asset class that we continue to focus on at Citi is around transportation – aircraft and shipping assets, particular offshore and in US dollars. We continue to look at securitisation and capital markets issuance as a way of funding these assets for our Chinese clients.
IFR ASIA: Excellent. Roy?
ROY ZHANG, KWM: 2017 will be a good year. I think we won’t see many bad deals. After four or five years of development, people are getting far more sophisticated and not just looking to innovate just to get a deal done. Investors, sponsors and underwriters are all looking at the fundamentals of these deals. We’ve seen this very clearly from last year’s deals.
The ABN market, for example, has improved. There are big names coming to the market at originators. They need to do these deals, and they engage with good underwriters, good financial advisors and so on.
For NPL securitisations, actually we’re seeing there could be tremendous growth given there’s a huge need. It really depends how the market infrastructure develops. The market generally lacks mezzanine-level or really local sophisticated investors. We’re seeing more local asset management companies being set up and more distressed investment funds, so hopefully that will provide a huge supply of funds in that category.
LESI ZUO, STANDARD CHARTERED: Firstly I think the captive auto finance companies will be more rewarding. That market is maturing and I think the AFCs are moving from static transaction to revolving structure for funding purposes.
As I mentioned earlier, we’re hopeful for corporate asset securitisation. Also I think you will see a US dollar denominated transaction in the onshore market. You will see cross-border transactions, although whether that can become mainstream is another question.
What’s most encouraging to me is you will see more secondary market activity. Actually in 2016, secondary trading has increased quite a lot. Based on our data points there’s been over 800 secondary market trades in 2016, totalling over Rmb100bn. That’s still relatively small amount compared to the total issuance volume, but it is encouraging, as you need to have a more active secondary market before you can grow the primary market even bigger.
It’s also critical for market development that some professional and specialised ABS investment funds come to play.
You asked about regulatory capital trades. Most of the Chinese banks are actually in need of capital. I don’t think this is going to be mainstream in 2017, but in the medium to long term lots of capital relief deals might be required. They’re not going to be able to do it without professional investors who can understand and take the real risk of the assets away from the banks. We have seen ABS investment funds emerging in 2016, and we’re going to see more in 2017. It is a healthy development for the market infrastructure.
IFR ASIA: Ladies and gentlemen, thank you very much for your time.
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