Landmark rating regulation to boost China's bond market

New credit rating regulations will help promote a dependable risk assessment system in China.
The China Securities Regulatory Commission (CSRC) has announced new provisional rules governing the credit rating of fixed income securities and listed companies, in a further effort by the Chinese government to bolster the PRCÆs corporate bond market.

The new rules stipulate that only qualified Chinese credit-rating companies competent in ôsecurities market credit rating servicesö will be authorised to rate bonds, asset-backed securities and other fixed-income securities, as well as their issuers. In addition, such ratings will now be mandatory.

According to China Daily, the credit rating rules involve assets either authorised by the CSRC or listed on the stock markets. The corresponding issuers, listed companies, non-listed public companies, securities companies and fund management companies that invest in securities also fall under these regulations.

This latest CSRC regulation is a first step towards a unified set of criteria designed to promote both efficiency and transparency of the secrities market, which could soon be acceptable by international standards. There are currently four dominant credit rating agencies in China: China Chengxin International Credit Rating, China Lianhe Credit Rating, Dagong Global Credit Rating, and Shanghai Far East Credit Rating. Although they use similar rating criteria as Fitch, MoodyÆs, and Standard and PoorÆs, none of them are fully independent or self-sufficient and all lack credibility due to the state's heavy involvement.

Due to enter into force on September 1, the rules come in tandem with recent trial regulations allowing listed Chinese corporates of a certain rating to raise funds domestically, subject to approval by the CSRC. Lifting mandatory bank guarantees, the rules come in an attempt to liberate corporate bond issuance from government control and to facilitate access to market. The CSRC will now become the chief regulator for such issues, granting approval based on a companyÆs assets, credit rating, internal controls and financials.

Previously, this procedure involved a laborious process overseen by three government-related bodies, namely the CSRC, the central bank and the National Development Regulatory Commission.

In addition, a quota system restricting annual corporate bond issuance to below Rmb100 billion has been abolished. Further, pricing will be set by market conditions and, for the first time, listed companies will now enjoy more flexibility with the use of proceeds, such as repaying bank debt. Funds raised through bonds were previously restricted for use on capital expenditure only.

Both these regulations mark a milestone in the development of ChinaÆs nascent local bond market. ôThe future for ChinaÆs corporate bond market lies in extending the trial rules to all PRC corporations, and allowing more flexibility in terms of the financial performance of those companies,ö says Cao Yanping, a Shanghai-based partner at law firm Clifford Chance.

In addition, China still needs to promote more financial institutions willing to hold corporate bonds such as insurance companies, pension funds and investment funds. According to Chinabond data from October 2006, over a third of ChinaÆs commercial bonds are held by banks and only 16% by security corporations and investment funds. The development of a broader investor base is a critical step in stimulating local corporate bond markets: institutional investors serve as agents for individual investors, and properly match terms and risks of fund demand with supply, so as to realise economy of scale and diversify risk.

Furthermore, ChinaÆs bond markets are generally closed to foreign investors and intermediaries, except for investments via Qualified Foreign Institutional Investors, i.e. foreign institutions allowed by the CSRC to invest in the local securities market. Studies show that, in Asian countries, the larger the proportion of overseas investors in a company, the better the corporate governance of that company. Therefore despite bringing a degree of uncertainty to the market, foreign investors also helps invigorate it.

Foreign issuers are also restricted. So far, the only eligible issuers for Panda bonds, in other words renminbi-denominated bonds from a non-Chinese issuer sold in the PRC, are international development organisations. And the conditions are stringent. They include an AA rating by a qualified rating agency registered in China, prior investment in the country of no less than $1 billion, mid or long-term loans or equity investments in projects in China and three years of audited financial statements in accordance with PRC accounting standards.

Currently, only the Asian Development Bank (ADB) and the International Finance Corporation (IFC) have issued panda bonds, namely a 10-year Rmb1.13 billion and a seven-year Rmb870 million by the IFC, and a Rmb1 billion by the ADB. Concerned about the possible effects on their currency peg, China negotiated for several years before permitting the sale of such bonds in 2005 and 2006, before agreeing that the funds raised would have to remain in China.

ôThe next big move for China's corporate bond market is for foreign corporates to issue local-currency bonds,ö continues Cao, who with Clifford Chance advised the IFC on its Rmb-denominated bond issues. ôThis requires an easing of the eligibility requirements, allowing a more flexible use of proceeds as well an acceptance of internal accounting standards. In addition, the restrictions on currency convertibility is a major obstacle which needs to be lifted if this sector is to really take off.ö
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