China’s Regulators Set Out Plan to Overhaul Scandal-Hit Corporate Bond Market

China’s economic and financial authorities have issued new guidelines for corporate bonds to clear up confusion over issues such as whether the updated Securities Law covers the interbank bond market, reiterate their commitment to unifying rules for different bond markets, and reinforce the need to obey laws and regulations in the wake of a series of scandals and defaults.

A set of “Guiding Opinions” (指导意见) (link in Chinese) on the opening-up, reform and development of the nonfinancial corporate bond market were jointly announced by the People’s Bank of China (PBOC), the China Securities Regulatory Commission (CSRC) and four other regulatory bodies on Aug. 18. China’s bond market is the world’s second largest, with the value of outstanding bonds, including government and corporate debt, standing at 124.6 trillion yuan ($19.2 trillion) at the end of July, PBOC data show. The nonfinancial corporate bond market was worth around 29.5 trillion yuan.

Aimed at “establishing a multi-layered bond market with a sound system, orderly competition, transparency and openness,” the guiding opinions represent a renewed effort by the government to unify rules for the country’s separate bond markets and curb violations. Guiding opinions are documents issued by government authorities to communicate policies and put forward views and solutions on issues of importance.

The document consists of 32 articles and covers a range of issues such as preventing regulatory arbitrage, restricting bond sales by highly leveraged companies, banning companies from buying their own bonds, promoting convergence of the interbank bond market and the exchange bond market in terms of standards, punishment and infrastructure, improving information disclosure standards and effectiveness, strengthening supervision and law enforcement, and improving oversight of credit ratings agencies.

“China’s bond markets are governed by multiple regulators with different sets of requirements, which could lead to regulatory arbitrage,” said Danny Chen, CEO of Fitch (China) Bohua Credit Ratings Ltd., a wholly owned subsidiary of Fitch Ratings Ltd. “Now the unified application of the securities law to bond issuance will help streamline the process and eliminate the difference in regulations. This is a positive step for the development of the industry.”

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One of the key issues (link in Chinese) the opinions seek to clarify is whether the amended Securities Law (证券法), which went into effect on March 1, 2020, applies to nonfinancial corporate debt issued in the interbank bond market (银行间债券市场). The market accounted for 86% of China’s outstanding onshore bonds (link in Chinese) at the end of last year.

While the updated Securities Law and relevant documents clarify the procedure for issuing two types of nonfinancial corporate bonds, regulated respectively by the CSRC (link in Chinese) and the National Development and Reform Commission (NDRC) (link in Chinese), they appear to have omitted a third type: PBOC-regulated interbank bonds.

That ambiguity led to confusion as to whether the interbank bond market had been excluded from the law. A statement (link in Chinese) in March 2020, in which PBOC and CSRC officials said that interbank nonfinancial corporate bonds are regulated by the Law on the People’s Bank of China, added to the lack of clarity.

The opinions make it clear that the Securities Law also applies to nonfinancial corporate bonds issued in the interbank market, people close to regulators said on condition of anonymity.

The guidelines also seek to restrict excessive bond issuance by highly leveraged enterprises, although there are no details about how this will be carried out. They also reiterate a ban on what’s known as structured issuance (结构化发行), where companies who are issuing bonds secretly buy some themselves or have a related party do so to artificially inflate demand.

State-owned Henan Energy and Chemical Industry Group Co. Ltd. and its subsidiary Yongcheng Coal and Electricity Holding Group Co. Ltd., which shook the debt markets last year when it defaulted on a 1 billion yuan bond, had more than 13 billion yuan of bonds involving structured issuance, sources with knowledge of the matter have told Caixin.

A source close to the PBOC said the opinion on structured issuance is intended to push bond market regulators to spell out in their own regulations how they will determine and punish violations.

The document also calls for strict punishment of illegal conduct, such as in the sale of corporate bonds and the use of proceeds, in accordance with the Criminal Law (刑法). Deception in bond issuance was incorporated into the revision of the Criminal Law (link in Chinese) in December 2020, but serious cases of misappropriation of funds raised through bond sales and evasion of debt repayment are not yet criminalized. Regulators will seek to incorporate more bond market violations into the Criminal Law, sources with knowledge of the issue said.

The guiding opinions represent Beijing’s latest push to unify and tighten rules in the country’s two bond markets — the interbank bond market regulated by the PBOC and the PBOC-backed National Association of Financial Market Institutional Investors (中国银行间市场交易商协会), and the exchange bond markets in Shanghai and Shenzhen overseen by the CSRC.

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The two markets have in the past had separate rules for registration, access, legal systems, law enforcement and information disclosure. But in 2012 a high-level inter-ministerial coordinating mechanism (协调机制) (link in Chinese) was set up to coordinate the markets. Since then, a series of measures have been announced and implemented to unify the markets.

In December 2018, the PBOC, the CSRC, and the NDRC jointly announced guidelines (link in Chinese) to establish a unified bond market law enforcement mechanism which would be overseen by the securities regulator.

Last year, financial regulators announced that qualified investors could trade bonds listed on both the interbank and exchange markets through a “connect” mechanism, and published measures (link in Chinese) giving the CSRC responsibility (link in Chinese) for determining and penalizing information disclosure violations of all nonfinancial corporate bonds.

Contact reporter Zhang Yukun (yukunzhang@caixin.com) and editor Nerys Avery (nerysavery@caixin.com)

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