Play it again

The jade bracelets and tourist trinkets of Shanghai’s Yu Gardens may soon have a use beyond providing ballast for travelers’ suitcases: They could pave the way for the development of China’s corporate bond market.

 On July 17, Shanghai Yuyuan Tourist Mart, operator of the shops around the city’s famous tourist magnet, issued a tranche of five-year exchange-traded corporate bonds worth US$146 million. The company said it would issue a second  US$146 million tranche at a later date.

The issues, the proceeds of which will be used to boost the company’s liquidity and repay about US$30 million in bank loans, were the first since the China Securities Regulatory Commission (CSRC) stopped the issue of exchange-traded corporate bonds last fall. The company was helped in its early issue by a bit of luck.

"Yuyuan was chosen to resume the issuance of exchange-traded corporate bonds absolutely by accident," said an insider in the capital markets department at Haitong Securities, which underwrote the bond issue. "The only reason is because Yuyuan got approval early from the [CSRC]. It queued early."

It was a long queue: Yuyuan was one of about 40 companies applying for issues. With so few debt financing instruments available to listed firms, the return of corporate bonds was cause for excitement.

Round two

Exchange-traded corporate bonds for listed companies had attracted huge attention from both companies and investors ever since regulatory control switched to the CSRC in 2007 after years of minimal progress under the National Development and Reform Commission (NDRC). However, cavalier investor attitudes toward risk combined with a collapsing equity market convinced the CSRC to halt issuances.

Now, with stronger equity and property markets, the CSRC is trying again. But while it seems clear that exchange-traded bonds will play an increasingly important role in debt financing, the regulator’s ability to direct the market’s development remains an unanswered question.

Ivan Chung, vice president and senior analyst at Moody’s Asia Pacific, well recalls the stampede of retail investors that greeted the CSRC when it took custody of the bond market. "They subscribed to buy bonds and sell [the next day], as if it was an initial public offering (IPO)," he said. "The CSRC was really concerned that retail investors did not understand the underlying risk in corporate bonds, particularly for those companies with lower credit ratings."

Companies flocked to bonds due to the lower cost of borrowing, especially compared with bank loans. "Because of China’s interest rate structure, the lending spread is determined by the central bank, and there’s a powerful incentive to get around that," said Andy Xie, an independent economist. "Essentially you’re… taxed to subsidize the bank’s inefficiencies."

 Exchange-traded bonds were not the only financing channel suspended by the CSRC. Initial public offerings were also halted in September, supporting share valuations by controlling supply. The suspension lasted until mid-July, when the market’s strong performance – the Shanghai Composite Index had risen more than 70% since January – allayed fears over its inability to support new share issues.

The resumption of IPOs was marked by initial caution that soon gave in to the pressures of market enthusiasm. While the CSRC had initially targeted small and medium-sized companies for new IPOs, the success of new listings soon had giants like China State Construction Engineering lining up to take advantage of strong investor demand.

A similar story could play out for exchange-traded bonds. As with IPOs, the CSRC emphasized caution in resuming their issuance; the focus, it said, would be on small- and medium-sized companies. However, the likes of PetroChina and Sinopec have already said they are eager to relaunch plans for issuing bonds delayed by last year’s suspension.

Policy consensus

For now, the government seems happy to allow this development. Ping Chew, managing director and head of Greater China at ratings agency Standard & Poor’s (S&P), says the resumption enjoys wide support in Beijing as part of a concerted effort to reach the annual target of 8% GDP growth.

"There’s generally a consensus within policy circles on the long-term goal of a better [and] more effective bond market," said Chew.

There is less consensus, however, on how to reach that goal. As Chew notes, the myriad regulatory regimes in China mean that wider initiatives falter due to the weight of institutional agendas pushing in different directions. The corporate bond market as a whole is still governed by three different regulators, one for each of the sub-categories.

Exchange-traded bonds of listed firms, regulated by the CSRC, remain relatively small. Larger are the so-called enterprise bonds issued by state-owned enterprises and traded on the interbank market, which still fall within the NDRC’s purview. Also growing quickly are medium-term notes (MTNs), de facto corporate bonds with maturities of between three and five years traded on the interbank market. MTNs and commercial paper, one year corporate-debt instruments, are regulated by the People’s Bank of China.

As a result of these divisions, bond market development has been uneven.While exchange-traded bonds remained off-limits in the first half, overall interbank bond issues rose 72% year-on-year to US$251 billion. Within corporate bonds, which make up just 5% of total issues, exchange-traded bonds are little more than a curiosity.

Analysts say the current state of affairs is a source of embarrassment for the CSRC, which has long had the goal of making domestic exchanges a marketplace for fixed-income securities. Dr Chen Chung-Hsing, head of Xinhua Finance Ratings, points to what he calls a "turf fight" between the CSRC and the central bank as companies turn to MTNs for their debt financing needs.

"The CSRC will be very embarrassed to see private enterprises issuing medium-term notes on the interbank market, whereas what they hope to be able to achieve by promoting the exchange-traded bond has not been able to gain much ground," Chen said.

The PBoC’s decision to allow companies to issue MTNs was born out of a lack of medium-term debt financing options for corporations not eligible to issue enterprise bonds. It was not the first time the central bank had decided to go it alone. Commercial paper was introduced in 2005 to provide an option for companies outside of the regulatory framework of the NDRC.

Like commercial paper, MTNs have been a runaway success. Chung of Moody’s said that the PBoC’s full-year issuance target for MTNs of US$117 billion was reached within six months, and more issuances are on the way. This success has meant better liquidity, and has forced the CSRC to offer higher yields on corporate bonds to attract investors.

The CSRC is also hoping to boost liquidity by lifting a regulation that restricts banks to trading debt on the interbank market, introduced in 1997 after bank capital made its way illegally onto the stock markets through bond repurchasing. Giving banks access to exchange-traded bonds will go a long way toward improving the state of the corporate bond market, said Chen of Xinhua Finance.

"If you exclude banking institutions from exchange trading, you’re not going anywhere."

Continued risks

Even so, Chen cautions that a regulatory decree alone will not guarantee the success of exchange-traded bonds. Regulators continue to shape the markets, but it is investors who ultimately decide which markets will be successful.

There is an important caveat: The possibility of regulatory backtracking is an ongoing risk. Bond issues and IPOs could be halted again if market development doesn’t meet Beijing’s expectations.

"The reform road map is always very patchy," said S&P’s Chew. "And now the focus is short-term stimulus. If things get out of hand… there [may be] some reaction to it. They’ll clamp down."

Still, incentives for development of China’s corporate bond market are strong. More investible assets are crucial to the long-term health of China’s markets, and there is substantial room for growth in bonds as a financing option.

Frances Cheung, rate strategist at Standard Chartered in Hong Kong, notes that companies in China continue to favor bank loans for external financing. "They rely little on equity or debt for funds. I think there’s still huge potential on that side," she said.

Whether that potential will be realized by exchange-traded corporate bonds or other debt instruments – and which regulator will take the lead – remains to be seen. However, outstanding issues including disagreements between regulators will be resolved, observers say.

"Basically, they have to do it," said Xinhua Finance’s Chen.