One of the major obstacles in the development of China’s bond market has been a weak credit ratings system. Domestic ratings agencies themselves are not entirely to blame; regulations have long limited their effectiveness. Fortunately, say market analysts, this may be changing.
For years, corporate bond issues were hamstrung by a system that only permitted issues of bonds with bank guarantees. This effectively restricted bond issues to companies that banks were willing to guarantee (large state-owned enterprises), and distorted ratings.
"Because all bonds had to get a bank guarantee, they all got triple-A ratings," said Ivan Chung, vice president and senior analyst at Moody’s Asia Pacific. "There was no differentiation and the role of ratings in pricing was very limited."
The resumption of exchange-traded bond issues by the China Securities Regulatory Commission (CSRC) is therefore a positive development: It provides the market with an additional type of corporate debt issued without bank guarantees.
However, the absence of bank guarantees does not in itself guarantee a healthy ratings system. Dr Chen Chung-Hsing, head of Xinhua Finance Ratings, notes that most of the ratings given by China’s three to five largest ratings agencies remain double- or triple-A.
Another sticking point remains a lack of information about companies issuing bonds. "Many [corporate and enterprise bonds] are issued without understanding actually what the debt payment abilities of these companies are," said Ping Chew, managing director and head of Greater China at Standard & Poor’s. Investors sometimes assume that local governments will support companies with local government links, he said.
The dearth of information is not helped by the youth of the market and relevant laws. China’s bankruptcy regime, for example, was adopted in 2007.
"There hasn’t been a history of defaults or bankruptcies, or liquidation or how to go about recovery," said Chew.
But as more investors endorse ratings, more issuers will seek them, bringing bond pricing more in line with ratings. Only ratings that accurately reflect risk will survive.
"The force of the market will kick-start the development of the quality of ratings," said Chung of Moody’s.