Winds of change
China’s officials are promoting bonds as a way to relieve pressure on both the bank loan market and the depressed equity market. While that sets the scene for more rapid growth, it also poses new risks for this underdeveloped market.
Source: Reuters/Jason Lee
After a year of rapid development, bankers in China are expecting the wave of reforms on the mainland to continue in 2013. While they look forward to greater opportunities this should generate, they also see cause for concern.
On the positive side, the move to create a more vibrant local debt market through the creation of new funding avenues is expected to continue, albeit after a period of transition. China’s new political leadership will need time to assert its own direction, and another round of changes is likely this year as the National People’s Congress and Chinese People’s Political Consultative Conference usher in a reshuffle of the top ranks of the country’s many regulatory bodies.
Local market participants are optimistic that the new leaders will continue to develop the country’s debt markets.
“China’s bond market has always been quite policy oriented. The atmosphere is open because the new bosses tend to be rule-breakers, and innovation brings life. I’m expecting more loosening in 2013; I think that is the right trend and can’t be stopped,” said a DCM banker with a top-ranked securities house.
Among the new financing products likely to be on offer are private enterprise and finance bonds for small-medium companies, as well as long-term MTNs for local governments and asset-backed notes.
Not all of these instruments are expected to develop fully in 2013, however. Much of their success will depend on how much volume is generated in each new asset class.
“Clients are glad to know there are diversified options out there,” said Lu Zengrui, a sales officer with Citic Securities. But, he cautioned: “I think volumes are needed to make the new categories more liquid and steady.”
However, even as bankers welcome this official support for their market, they are growing increasingly aware of the risks involved.
China’s debt capital markets have developed quickly since regulators first allowed companies to issue bonds without a bank guarantee as recently as 2005, and investors are becoming more accustomed to credit risk. It is now the world’s third-biggest bond market, after the US and Japan. Key concepts, however, remain untested: without a single default, investors can only guess at their chances of recovery in a bankruptcy situation.
Local governments have stepped in to avert several potential defaults, including that of state-backed Shandong Helon in 2012. More recently, cash-strapped private sector issuers have enjoyed the same support: the government of Xinyu city in Jiangxi province pledged to help LDK Solar repay loans last year, while Shanghai Chaori Solar Energy Science and Technology’s chairman in January said a local government had persuaded banks to defer claims for overdue loans worth Rmb380m (US$61m).
The market’s development is also bringing with it new risks. Reforms in the second half of 2012 have allowed smaller companies to sell bonds for the first time, but the first SME bonds have yet to reach maturity. Most SME deals come with a two-year or three-year tenor, and some mature in only one year. That means the first test of the sector’s ability to repay will come as early as the second half of 2013.
Another test will come from local government fundraising vehicles (LGFVs), which helped cities and provinces amass debts of Rmb10.7trn, or 23% of GDP, as of the end of 2010. China’s first big wave of enterprise bonds – the format for a big portion of LGFV debts – came between 2007 and 2008, leaving a maturity spike looming in 2013.
Those risks have not been lost on China’s regulators, though. The National Development and Reform Commission recently asked local governments to strengthen risk controls for enterprise bonds, and has pledged to set tougher requirements for issuers depending on their asset/liability ratios.
The NDRC has also announced plans to allow LGFVs to issue bonds on behalf of SMEs, via the help of commercial banks. That programme, however, has become inactive.
If maturity spikes were not enough, locals are also concerned about some of the bigger changes coming to the Chinese market.
“To be honest, 2013 is a bit unpredictable,” said Shi Lei, director of fixed-income research with Ping An Securities. “Unlike 2012, we are actually seeing some systematic reforms, such as Basel III, and the red-hot [issue of] shadow banking.”
Yet, when the time comes, market participants are still confident that the government will stop things from getting out of hand.
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