The closure last month of Guangdong International Trust and Investment Corporation (Gitic) came as a rude awakening to many foreign investors. With outstanding liabilities of US$2bn, the collapse of Gitic could prove costly to those foreign banks that have extended it credit to fund infrastructure and property investments in Guangdong province.
The central bank decided to close the institution because of its ?inability to pay maturing debts.? However, the writing was on the wall for several months ?at the beginning of this year, Moody's Investors Service credit rating agency warned investors that the financial outlook for the ?Itic' sector was worsening. It downgraded their rating outlook from stable to negative.
Domestic bond focus
The fall of Gitic has highlighted the role of international credit rating agencies in China. In September, Fitch IBCA, the world's third largest credit rating agency based in London, announced a breakthrough ?the first-ever joint venture between major foreign and domestic credit rating agencies. The tie up with China Chengxin Securities Rating Company also involves the International Finance Corporation (IFC), an affiliate of the World Bank.
The are about a dozen officially recognised credit rating agencies in China, most of which operate on a regional basis. China Chengxin is one of only two agencies with a licence to operate nationally.
"The poor market conditions at the moment may not be right for us to talk about the joint venture, but we're truly excited about its prospects," says Mr. Robin Monro-Davies, Chief Executive Officer of Fitch IBCA.
There seems to be good reason for his excitement, as the world's major bond markets are expected to perform well in coming months following the first interest rate cuts in three years by the US Federal Reserve Board. Central banks of the major developed countries have followed suit.
Bond prices have risen in the past three months, as investors look for a safe home against a backdrop of a worsening situation in Asia, slumping stock markets worldwide and debt default in Russia. "There is no question this is a very bond-friendly environment," said Mr. William Dawson of Federated Investors in the US.
However, Fitch IBCA is unlikely to win international bond rating mandates straight away. New issues have dried up since the Chinese authorities have been tightening their grip on foreign debts, a lesson learned from several Itics and neighbouring economies that over-borrowed.
Fitch IBCA's strategy, according to Monro-Davies, is to concentrate on the domestic bond market. It plans to introduce more professional practices and establish a reputation among local issuers in the hope of winning international mandates once China returns to the international capital markets to raise money. To this end, Fitch IBCA has secured ratings control of the joint venture, appointing Mr. John Banwell, head of the group's corporate actions in Hong Kong, as chairman of China Chengxin's rating committee. Overall chairmanship of the joint venture has been given to Mr. Ling Zeti, the former deputy director of the State Administration of Foreign Exchange, the country's highest body for foreign exchange controls.
Fitch IBCA owns 30 percent of the Beijing-based joint venture, to be called China Chengxin International Rating Company, while its Chinese partner Chengxin has a con-trolling stake of 45 percent. IFC took a 15 percent stake and a Mainland newspaper Gong Shang Shi Bao the remaining 10 percent.
The Chinese partner will transfer its cur-rent ratings business to the joint venture. At the moment, the company rates 267 corporate issuers with outstanding debts worth a total of Yn45bn (US$5.4bn). It also rates 49 non-bank financial institutions as well as several domestic funds.
Credit research, written in Chinese, will be distributed among subscribers and issuers in the local bond market. Estimates show that new bond issues this year could reach Yn25bn-30bn, in line with the government's frantic efforts to speed up spending in order to stoke consumer demand and economic growth. These issues include a few listed companies which, instead of raising new equity funds, will issue convertible bonds. All issuers are required by law to seek an independent rating before issuance.
Fitch IBCA's bold move into China is not without risks. Like other domestic credit rating agencies, China Chengxin is a state-run company and its senior managers are effectively state-appointed officials. Fitch's challenge will be to impose the disciplines of independence and objectivity in the partnership, instead of allowing a culture based on contacts to develop.
The move has certainly caught the attention of its rivals. "We know they were talking to Chengxin and all that But we haven't decided whether to set up a representative office or have a similar joint venture," says Ms. Agnes Lee, associate director of Standard and Poor's.
At the moment, she says, Standard and Poor's monitors the financial standing of nearly 20 Chinese issuers, including sovereign, corporate and financial borrowers. It does this through a network of analysts who are based in Hong Kong, Australia, the UK and the US. Moody's operates its China business in a similar manner.
The big two agencies? lack of a research base inside China makes it easy for issuers to argue that they fail to understand the market.
Shanghai Pudong Development Bank (SPDB), for example, has complained about Moody's assessment of its financial standing, saying that it is unacceptable and inaccurate. In September, Moody's assigned ratings of ?Bal' and ?not prime' for the bank's long-term and short-term foreign currency deposits and ?E-plus' for its financial strength.
The agency said that the ratings were based on a deteriorating economic environment, the bank's short history and its unproven record in dealing with severe market conditions. It has given similar low ratings to Shenzhen Development Bank and China Everbright Bank.
SPDB, Shanghai's only home-grown bank, complained that Moody's lacked a thorough understanding of the country's banking system, especially the state of financial sector reforms. It also accused Moody's of not having complete credit information, and for failing to understand its operations.
"What we aim to do is to provide the market with uniform criteria so that the investor knows instantly that the issuer in China, or wherever, has the same risks as the one with a similar rating in Western Europe, for example," comments Ms Julia Turner, managing director of Moody's Asia. "Everybody is upset if we down-grade them or give them a low rating. Then they will also complain we don't understand them. It's a universal reaction."
Despite this explanation, China specialists at international investment banks have also expressed reservations about Moody's and Standard and Poor's in China. Moody's recent cut of the Mainland's sovereign rating and the ratings of the four commercial banks has been dismissed as having a ?minimal' negative impact. Mr. Ma Guonan, co-head of economic research at Salomon Smith Barney, was quoted as saying that Moody's was "excessively cautious" about the Mainland. The Asian crisis had adversely affected the economy but the Mainland's economic fundamentals had not deteriorated enough to deserve a down-grading, he added.
Mr. Joe Zhang, head of China research at HSBC, believes that the Moody's action was at least one year too late. A downgrade could raise the cost of borrowing for the Chinese government and the banks but Zhang dismissed the ratings as "irrelevant" since the high levels of liquidity in the Mainland mean it is unlikely they will tap the international market in the near future.
"China's foreign exchange supply is too much, not too little, so don't expect the Chinese government or Chinese companies to raise international funds in the next two years," Zhang says. Beijing's fiscal stimulus package would take the form of domestic bond issues, rendering Moody's ratings useless, he adds.
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