Borrowers shift offshore as China gets serious on deleveraging

Rising funding costs and regulators' strict new guidelines for borrowers will prompt a wave of issuance offshore in 2018.

The Asian dollar bond market is about to get even more crowded this year. With tighter credit conditions in China, competition among issuers to attract offshore investors will never have been so fierce.

The wall of issuance, estimated by debt bankers to be around $200 billion, will be amplified by Chinese regulators' clamping down on the use of leverage onshore.

The smorgasboard of offshore bonds adding to last year's record issuance levels will range from first-time local-government financing vehicles (LGFVs) to high-yield property developers, say debt financiers and investors. At least 60 companies have received regulatory approvals to sell offshore bonds in the fourth quarter of 2017, according to National Development and Reform Commission (NDRC) filings. 

“More Chinese companies will raise debt offshore as onshore funding costs are expected to pick up significantly due to rising inflation and tighter liquidity conditions,” said Paula Chan, a Hong Kong-based fund manager at Manulife Asset Management specialising in both onshore and offshore debt markets. “The supply side risk in the offshore market is evident.”  

The People’s Bank of China and three industry watchdogs, the CSRC, CBRC and CIRC, in unison issued specific guidelines last week, calling on market participants to tighten control over the use of leverage in the onshore debt markets and urged institutional investors to establish proper internal control and risk management systems to monitor threats to financial stability.

Under the latest guidelines from the regulators, the ratio of total outstanding bonds to net assets at the proprietary trading unit of a commercial bank should not be more than 80%, while the same metric for other financial institutions - excluding trust companies, asset mangers and fund managers - should be no more than 120%. For securities and futures companies, t he ratio is up to 100%.

The coordinated approach by the industry watchdogs is another sign they are responding the state's call for more efficient vigilance of the markets. The guidelines also intend to curb the sale of wealth management products, which are backed by highly leveraged projects in the property and infrastructure sector.

“The new regulation aims to reduce risk in China’s financial sector by enforcing transparency, removing regulatory arbitrage, containing leverage, and de-layering of asset management products,” Freddy Wong, a Shanghai-based fund manager at Fidelity told FinanceAsia.

China's deleveraging campaign has been building up momentum even before the 19th Party Congress in October. Since the second half of 2017, policymakers including Chinese President Xi Jinping instructed state-owned companies to lower their debt levels.

“A strong pipeline in the offshore market suggests that some of the issuers will have to offer a new-issue premium for their bond sale to attract investors,” said Chan of Manulife.

There is over $50 billion of US dollar debt from a range of Chinese corporate issuers that will mature or is callable in 2018, according to Standard Chartered's estimate. The money raised in the offshore market can be repatriated to onshore for refinancing or stay offshore where it will fund Chinese companies' expansion.

Chinese policymakers are concerned that the country’s economy is increasingly dependent on its shadow banking sector for credit. Non-bank financial institutions, such as trust companies and securities houses, sell short-term risky products to ordinary investors who then buy long-term bonds.

China shadow banking sector was estimated by Nomura to be worth about $20 trillion at the end of 2016.

David Yim, head of debt capital markets for Greater China and North Asia at Standard Chartered, said the latest statement made by the Chinese regulators reiterates Beijing’s stance against over use of leverage by some market participants.

“Some domestic securities houses, for example, use leverage to boost their returns,” said Yim, a 20-year bond market veteran. “The use of leverage and off balance sheet repo transactions can potentially cause severe market volatility if the market conditions turn south." 

If implemented properly, China's deleveraging push could secure China on a long-term growth trajectory and prevent economic bubbles, but tighter credit conditions will ultimately mean that economic growth will have to moderate as a reduction in credit growth leads to a drop in consumer and infrastructure spending.

“China will have to take the pain by reducing the debt in the corporate sector,” Chan of Manulife said.  “Policymakers are ready to sacrifice short-term GDP growth in exchange for long-term prosperity.”

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