Binding Corporate Bonds to Market Principles
China's corporate bond market is rebounding. Since the beginning of July, rates for newly issued corporate bonds and bond yields have declined, reflecting improved market sentiment as default concerns that mounted during the first quarter slowly fade.
But in fact, bond market risk has barely improved.
Dongbei Special Steel, a producer of alloys for automakers and other manufacturers, defaulted on seven bonds with a combined value of 3.1 billion yuan between March 28 and late July. And Shanghai Yunfeng Group Co., a subsidiary of the country's third-largest property developer, Greenland Holdings Corp., was in early August on the verge of defaulting on privately placed bonds for the sixth time.
Some pessimistic analysts have warned about a looming crisis for the corporate bond market. And although bonds were not directly mentioned, the Politburo, the Communist Party's top decision-making body, at a July 26 meeting cited an urgent need to ward off financial risk.
Some local governments have intervened in the corporate bond market in ways that have merely postponed the day of reckoning for wobbly borrowers. In southern China's Yunnan Province, for example, the provincial government recently helped state-backed chemical company Yunwei Co. pay off matured bonds. And a deputy governor of Shanxi Province led coal mining executives from that area of north-central China on a roadshow-like trip to Beijing to boost bond investor confidence and promised the provincial government would work with all firms to prevent defaults.
But as China's economic slowdown continues, investors are turning more cautious. One reason is that local governments are losing their ability to back companies that can't repay bond investors. More importantly, rational decision-making by investors has become more challenging in the face of government intervention activity that lacks a legal foundation and, ultimately, cannot fundamentally resolve credit problems.
Bond risks should be addressed through market-oriented measures. Debt-ridden, poorly managed companies should be allowed to throw in the towel. A zero-default environment is neither sustainable nor necessary.
The corporate bond market serves as an important channel for direct financing and supports the efficient allocation of financial resources. For an economy the size of China's, the market is relatively small. But it is growing.
During the first half, bonds issued by companies raised a combined 1.73 trillion yuan, up 796 billion yuan from the same period 2015, according to the central bank. Bond financing accounted for 17.8 percent of total corporate fundraising in China in the first half, compared to 10.7 percent in the first six months of 2015.
The bond market offers alternatives to companies that traditionally relied heavily on indirect financing – a longstanding financing problem in China that contributes to market distortion and fuels risk. The central government has given high priority to promoting direct financing activities and cutting leverage in order to build a healthier, more transparent financing system during the period of the 13th Five-Year Plan, which ends in 2020.
China needs a healthier, more sustainable bond trading environment that follows market rules, supports efforts to stabilize economic growth, and controls risk. One way to achieve these goals is to eliminate the divisions and territorialism that mark the government's financial market supervision system. Doing so would require major changes to the regulatory landscape. Any effort to improve the bond market mechanism, therefore, could start with steps designed to unify standards for bond market entry and supervision, while cutting leverage and eliminating distortions.
The responsibility of overseeing China's corporate bond market is shared by the National Association of Financial Market Institutional Investors under the central bank, the China Securities Regulatory Commission (CSRC), and the National Development and Reform Commission. These three organizations oversee short- and medium-term financing bills, corporate bonds and bonds issued by state-owned enterprises, respectively.
Currently, standards for new bond issues vary from one supervisory body to another. Yet if these supervisors cooperated more closely, they could together write a new, unified set of standards covering market entry, new bond issuance and information disclosure rules. Moreover, regulatory agencies with enforcement capabilities could be given the power to enforce rules throughout the market.
Reforms are needed now for regulators to keep abreast of a changing market. For example, corporate leverage has increased substantially since funds from bank wealth management products started pouring into the bond market in 2015.
Rules for corporate bonds traded on China's stock exchanges were modified last year, sparking a new issues surge. But the supervisory mechanism was not updated and underwriters for these new issues have failed to adequately control risk.
Regulators should carefully examine leverage-related investment targets and guide banks to properly control wealth management product investments. Quotas for wealth fund participation in the corporate bond market may be considered.
The China Banking Regulatory Commission is currently drafting new rules that will cover wealth management businesses at commercial banks. The rules are expected to include specific limits for credit products in a wealth management fund's portfolio. Moreover, legislators are drafting a proposed amendment to the Securities Law that would lay the legal groundwork for coordinated supervision of the bond market.
Regulatory agencies have spent years working in pairs or larger groups to improve bond market supervision. Bond data reporting rules co-written by the central bank and CSRC, for example, were rolled out in 2014. There is no technical reason why one regulatory body cannot share bond market information with another.
Hu Shuli is the editor-in-chief of Caixin Media
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