The wild west of the Chinese bond market that regulators want to tame


In China’s junk bond market, investors gamble when companies tumble. Some win big, others lose big.

Some investors in junk bonds, often referred to by the industry’s pink term “high yield bonds,” got an annualized return of 20%, some hoping to make 40%, said an investment banker with a company medium-sized brokerage. “High yield bonds have seen a bull market over the past two years.”

In China, most insurers and mutual fund managers avoid junk bonds because they are not allowed to invest in lower quality bonds. Meanwhile, brokerage firms and private fund managers willing to take more risk for higher returns can hardly come up with reasonable investment strategies for junk bonds.

The main problem is that the Chinese junk bond market has developed in a way that has made it difficult to properly assess bonds, due to inflated ratings, implied government guarantees and a game of chat and the ongoing mouse-over between regulators and companies that use a price-distorted bond issuance method.

These issues have caught the attention of regulators. In August, six state departments, including the People’s Bank of China (PBOC), called for efforts to develop the high-yield bond industry in a regulated manner.

The question of size

Internationally, junk bonds refer to those with a credit rating below investment grade – BB + or less by S&P Global Ratings and Fitch Ratings, or Ba1 or less by Moody’s Investors Service. Also known as speculative grade bonds, these bonds are deemed more likely to default, but could offer investors a greater reward for the risk by paying a higher return.

There is no precise estimate of the size of the Chinese junk bond market, which formed spontaneously when more and more companies defaulted. Part of the problem is that national regulators do not have a definition of junk bonds, although market insiders typically identify them by the level of their yield. A rating agency, Shanghai Far East Credit Rating, uses 8% as a threshold and estimated that China’s stock of junk bonds reached 960 billion yuan ($ 149 billion) at the end of June. That compares to around $ 2 trillion in the United States, according to Liu Lu, an analyst at Ping An Securities.

“Different institutions have different standards for what counts as a high yield bond, resulting in different estimates of the size of the market. Additionally, there is no reliable data on actual returns,” one said. fixed income investment professional.

Yields on junk bonds in China tend to be higher than in many other countries. At the end of July, high yield bonds denominated in US dollars of Chinese issuers were posting an average yield of 12.8%, against 8.9% for junk bonds in Asia, according to data compiled by UBS Asset Management (Hong Kong).

The high yields on Chinese junk bonds are due in part to a series of bond defaults by real estate developers and a series of debt crises among local government finance vehicles (LGFVs). An FTSE Russell index measuring the performance of Chinese high yield dollar-denominated bonds estimated their average yield to maturity at 12.69% at the end of September. And for junk bonds issued by real estate developers, which accounted for 63% of the market value of all outstanding Chinese junk bonds, the figure was 16.77%.

Structured issues

China’s main junk bond market is mostly “structured issuance,” a creative way some Chinese companies have used to raise funds that they would not otherwise be able to obtain due to their high credit risks.

With structured issues, an issuer with a lower than average credit rating purchases part of its own bond offering, or has another entity bought it, to inflate the size of the issue. This can create a better image for his show by showing that there is enough interest in the market. This better image, in turn, helps attract real buyers who are willing to accept a lower yield on their bonds. Lower rated LGFVs, private companies and even some public companies have resorted to this shady practice.

The tactic started to gain popularity in 2018, as China was rocked by fears of default. At the end of the year, Zhou Hao, chairman of China Chengxin International Credit Rating, said in a speech that the actual value of private companies’ fundraising was far less than their bond issuance because a large part of the bonds were bought by the issuers themselves, previously reported Caixin. .

The high yield bonds generated by structured issues mask the credit risks of issuers, creating problems for both investors and regulators.

Many analysts and industry insiders see structured issues as a threat to the stability of the bond market. In November, a self-regulatory body in the interbank market – one of China’s two main bond markets – banned companies from subscribing to issues of their own bonds or buying them indirectly through related parties. In 2019, the Shanghai and Shenzhen stock exchanges issued similar bans.

There are no official statistics on the extent of junk bonds generated by structured issues in China. In a June 2019 report, analysts at CITIC Securities estimated that there were 1.5 trillion yuan of bonds outstanding with structured issues, accounting for about 8% of the total corporate bond market in China.

Save the market

The Chinese bond market is fragmented. Overseen by multiple regulators, it suffers from an underdeveloped legal oversight system and insufficient mechanisms to protect investors and punish wrongdoing, according to an analysis by China Chengxin.

All of this is also true for the country’s junk bond market, although this segment faces deeper issues. In China, junk bonds are concentrated in two areas already rich in debt risks: real estate developers and LGFVs.

The real estate market has accumulated huge debts over the years, its problems manifested in the financial instability of behemoths such as China Evergrande Group.

LGFV debt has also become a popular option for junk bond opportunists in recent years due to the implied government guarantee. However, in order to invest in LGFV bonds, connections with local governments are sometimes a necessity, especially in some counties and districts of cities in southwest China with relatively high credit risks.

“You have to live in this county and befriend the local authorities before you can invest,” said one experienced junk bond investor. The investment banker with a mid-sized brokerage house said it was impossible to get in touch with bond issuers there without intermediaries who charge fees to both issuers and investors.

Another issue that makes it difficult to get a feel for junk bonds in China is the market’s surprisingly high credit rating. Of the 3,539 issuers of three types of corporate bonds in circulation in China at the end of June, the share of issuers rated AA or above was 98.5%, 94.1% and 87, respectively. , 8%, according to an industry report. In a world where junk bonds are generally determined by credit ratings, the situation in China makes it difficult for investors to tell which bonds are most at risk of default.

Industry insiders have called for rules to better protect investors, which could help solve the problem of selling high-risk bonds to individual investors who cannot identify and are unwilling to take the risks of hold junk bonds.

Also read the original story. is the English-language online news portal for the Chinese financial and business news group Caixin. Nikkei has an agreement with the company to exchange items in English.


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