China’s bond market has grown into the billions with only domestic agencies – who hand out AAA ratings with unbelievable ease – allowed to determine the creditworthiness of these offerings while international agencies have been left out of the picture.
Despite recent moves by the world’s "big three" credit raters to expand operations, there seems to be no definite timeframe for their full-fledged entry into the ratings business.
Chinese companies raised US$8.2 billion through bond sales in 2005, doubling the previous year’s tally, but the market remains massively underdeveloped. By comparison, US companies matched this figure on Tuesday, June 6 alone. America is in the midst of a corporate bond sales surge as firms work towards refinancing US$630 billion in maturing debt this year.
A similarly vibrant market in China would open up a new fund-raising avenue for companies and reduce their reliance on bank loans.
However, debt securities sold in China are only tagged with credit ratings from dubious domestic sources. The "big three" global agencies – Fitch Ratings, Moody’s Investors Service and Standard & Poor’s – have been sidelined. They are currently focusing on assessments of sovereign bonds, government debt issued in a foreign currency, and the credit risk of firms listed abroad, while hoping regulators will open the field for them.
Amassing accurate data on Chinese companies remains extremely challenging. Limited disclosure of corporate information and unreliable audited financial statements are common problems. At the same time, as the debt securities market grows, it has become apparent that domestic raters may be downplaying risk.
Agencies have certainly been generous with top ratings in their chase for market share, leaving mainland fund managers concerned about a bond market that could turn bad as it is full of issuers with undeserved AAA ratings.
In April 2004, for example, domestic ratings agency China Cheng Xin International Credit Rating gave AAA ratings to the big four state banks while overseas analysts said the lenders were technically insolvent and inefficient.
International ratings agencies are understandably more than a little worried about controlling the quality of ratings issued through joint ventures with domestic partners. For a more mature market, a true picture of risk will become important.
"What will change [the situation] is if you have a large number of foreign investors come in," said Bruce Richardson, managing director of research at Xinhua Finance. "They will demand international credit ratings."
It seems there is no urgent need for a shift of policy as foreign capital is flowing from other sources such as trade, he said, but as Chinese firms seek funds for expansion they will need to "deepen financing channels". Why not skip the appointment with the bank manager in favor of commercial paper or longer term debt?
Bound by no rules
The ratings industry was not covered in the conditions attached to China’s accession to the WTO in 2001. Regulation is not centralized. The People’s Bank of China (PBOC), China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission, China Insurance Regulatory Commission and the National Development and Reform Commission (NDRC) are all interested in corporate debt.
Indeed, it is claimed that there are divisions over who has jurisdiction over this area. The South China Morning Post reported in July that the NDRC is likley to be forced to surrender regulatory control over corporate bonds to the CSRC by the end of the year. The hope is that the more reform-minded securities regulator will breathe life into the market.
In May last year, the PBOC allowed firms to issue bills maturing in a year or less. Market players welcomed a simpler registration process for commercial paper (CP) compared to that for corporate bonds.
"Everyone in China is excited because they can do CP," said Richardson. Most bonds are from the government, virtually ensuring them a AAA stamp of approval. "The government will print money to pay these bills if there’s any risk of default.".
In April, Moody’s signed an agreement to buy a 49% stake in Cheng Xin – pending regulatory approval – bringing in management expertise, technical know-how and training for local analysts. It was not the first foray into the maket for Moody’s.
In 1999 it teamed up with Dagong Global Credit Rating but the partnership was terminated about three years later. The holding in Cheng Xin – purchased for an undisclosed price – could be increased if permission is granted by the authorities. As a licensed agency, Cheng Xin will provide domestic ratings.
"We think the joint venture is probably the best solution at this moment – instead of 100% owned – so that’s what we are doing," said Michael Ye, managing director of Moody’s in Beijing. "Right now we are not doing domestic ratings. We are certainly doing cross-border ratings; we are also providing some risk management-related training for banks."
The longer Moody’s waits for government approval, the more the rumors swirl, with some sources even claiming that the regulators have already agreed to ban all overseas involvement in rating domestic firms. "I certainly hope to get approval ASAP," said Ye.
Beijing-based Cheng Xin was the first nationwide domestic credit rating agency to be granted approval by the PBOC in 1992. Fitch previously owned a 30% stake and the International Finance Corporation, the private investment arm of the World Bank, held 15%, but withdrew in July 2004. Cheng Xin specializes in convertible bonds, corporate bonds and short-term commercial paper.
Assessing future risk
"The company itself [Moody’s] is enormously profitable," said Ye. "In China, yes, we do generate some revenue. But China is more of a long-term strategic market for us than for short-term financial gains."
That leaves international companies looking for more solid footing.
Standard & Poor’s has established a representative office in China and a joint venture geared towards index products for the capital markets. Standard & Poor’s first set up shop in China in 1992 with a sovereign credit rating of the nation. Analysts from Standard & Poor’s Asian Equity Research cover leading stocks in sectors including energy, healthcare, IT, materials, telecoms and utilities.
In January, 2004 the company entered the domestic capital markets with partner CITIC Securities, launching the S&P/CITIC 50 A-shares tradable index and S&P/CITIC 300 A-shares benchmark index. In June last year they established the S&P/CITIC China 30 Index to track some of the more than 250 stocks listed overseas.
Xinhua Far East China Ratings was established in 2002 by Xinhua Finance and Shanghai Far East Credit Rating – China’s first independent debt rating company – to assess risks and encourage transparency.
"Currently the foreign ratings houses are not allowed to write ratings in their own names," said Richardson.
"In the meantime there are other ways for the international credit ratings agencies to make money."
Building a database or introducing statistical programs and experience from emerging markets will keep things ticking for now, but the global credit rating agencies will continue to wait in the wings.