Local Chinese state-owned enterprises (SOEs) can no longer assume that their debt will be guaranteed by their local governments, according to a new notice from the National Development and Reform Commission (NDRC), the Chinese government body that oversees bonds. The notice also slapped restrictions on offshore bond issuance by local SOEs and local government financing vehicles (LGFVs).
LGFVs and SOEs are both state-owned institutions in China, but LGFVs are usually directly controlled by local governments and perform financing functions on their behalf, while SOEs are more profit-driven and market-oriented.
For the first time, LGFVs are restricted to issuing offshore debt only to refinance existing medium to long term bonds that mature within a year, according to the NDRC notice. Otherwise, LGFVs are no longer allowed to issue bonds for any other purposes, including refinancing short-term debt.
The hidden or implicit debt of China's local governments could be as high as Rmb40 trillion ($5.8 trillion), with much of that debt taken by LGFVs for infrastructure development, said S&P in a report in October last year.
The purpose of this measure is to curb the risks of offshore medium to long term debt and the hidden or implicit debt risks of local government, the NDRC explained.
Local SOEs will be responsible for their offshore debt, and local governments are not allowed to guarantee it. Indeed local governments are forbidden from directly repaying or promising to repay their local SOEs' offshore debt.
The NDRC notice called on local SOEs to improve disclosure on their offshore bond issuance. To highlight the disassociation of local SOE debt from local governments, the notice said: “In bond prospectuses, it is strictly forbidden to include misleading propaganda information indicating possible connections with government credit.”
Only local SOEs which have been operating for at least three years are allowed to issue offshore bonds.
The NDRC announcement is in line with the Chinese regulators’ stance in controlling the rise of implicit local government debt and eliminating investors’ expectations of implicit government guarantees for local government-owned enterprises.
China’s local government debt to GDP ratio increased to slightly over 20% last year from roughly 19.5% in 2017, according to Natixis and Bloomberg.
“For official provincial debt, it expanded rapidly in 2018, after a reduction in 2017. This surge of official debt could be a result of local government difficulties to finance through shadow banking,” said a recent Natixis report.
For investors, the impact of the regulation on better-quality local SOEs should be limited. “However, issuers with worse and non-transparent financial profiles could be subjected to higher repayment risks in refinancing with tighter approval process and weaker implicit guarantee from the respective local government,” said Gary Ng, an Asia economist at Natixis.
Most of the investors which buy offshore bonds of local SOEs are overseas units of Chinese investment firms.
There were defaults of onshore bonds of local SOEs in the second quarter of last year, but that went down to zero in the first quarter this year.
LOCAL SOES ISSUE BONDS
Offshore bond issuance by central and local SOEs fell to less than $5 billion in the first quarter this year from roughly $10 billion in the first quarter of last year.
But several local SOEs have decided to tap the offshore market, including Sichuan Railway Investment Group, Kunming Traffic Management and Kunming Dianchi Investment.
Sichuan Railway, owned by the local government of Sichuan province, plans to issue US dollar senior unsecured debt to finance construction, refinance debt and for general corporate purposes. Fitch Ratings expects to assign these bonds the investment grade rating of A-.
Kunming Traffic also plans to issue Reg S senior unsecured notes. The company is wholly owned by the local government of Kunming, the capital of Yunnan province. Fitch is expected to rate Kunming Traffic’s bonds at BBB-, the same level as the Kunming Traffic itself.
Kunming has mandated Standard Chartered and ABCI as joint global coordinators, bookrunners and lead managers, and China Minsheng Bank, CMB Wing Lung Bank, Industrial Bank Hong and Bank of East Asia as joint lead managers and bookrunners to arrange investor meetings in Hong Kong, starting on June 18.
Kunming Dianchi is in the process of issuing Reg S bonds, according to Bloomberg. Also owned by the Kunming government, the company invests in and operates sewage treatment works, as well as infrastructure and high-tech projects.