China’s economy is slowing, profits are falling and its stock market is drifting down, but its corporate bond market is moving in the exact opposite direction: it is booming.
Bond issuance was up about 60 per cent by volume in the first half from a year earlier. By comparison, virtually all other forms of financing were sluggish. Equity issuance fell, new bank loans were barely up and off balance-sheet lending contracted.
The fact that corporate bonds have bucked this trend is an important and positive development. It indicates that China is gradually making the transition to a direct financing model, reducing an over-reliance on bank credit that officials and analysts see as one of the major dangers for the economy.
Banks have long been the primary source of capital in China. Total outstanding bank loans were 123 percent of gross domestic product at the end of 2011, while corporate bonds were just 11 percent of GDP, according to Credit Suisse.
“The whole financial system has been highly skewed towards banks. The government itself has realized that a lot of risk is concentrated within the banking system and they want to diversify the risks,” said Daisy Wu, an analyst with Credit Suisse.
“They have found that both from the issuers’ perspective and the investors’ perspective, bonds are something they really can do. There is both a big potential supply and demand.”
A series of China’s biggest state-owned companies, from oil giant Sinopec to China National Nuclear, have taken advantage of the appetite for bonds to issue debt with coupon rates below bank lending rates. Private companies such as Goldwind and Chang’an Automobile, which traditionally have had a slightly harder time getting bank credit, have also met strong demand in the bond market.
Total debt issuance by Chinese non-financial corporations was Rmb853bn ($134bn) in the first half of 2012, the most on record and up from Rmb530bn during the same period last year, according to Wind, a Chinese data provider.
Moreover, the funds that companies have raised through bonds this year equate to about a third of the total that they have borrowed from banks, versus a quarter last year. This indicates that while bank financing is still dominant, its grip on Chinese corporate balance sheets is diminishing.
The major reason for this has been regulatory reform, with officials clearing away some of the obstacles that have stood in the way of the development of the bond market.
China’s corporate bond market has long been divided into three separate fiefdoms. The National Development and Reform Commission, a central planning agency, controls enterprise bonds, which are issued by state-owned companies. The China Securities Regulatory Commission manages bonds that are issued by listed companies and traded on a public exchange. And finally, the central bank oversees commercial paper and medium-term notes, which are traded only in the interbank market.
Each regulatory regime has different approval requirements, some truly arduous. The NDRC has traditionally made companies wait up to a year while it vets their application, while the securities regulator has also been notorious for long delays.
But the situation began to improve in 2008 when the central bank injected vigor into China’s sclerotic bond market with its promotion of medium-term notes. It greatly simplified the issuance process, opting for a registration system rather than an approval system – a move that forced investors, not regulators, to assess credit risks.
The relative ease of issuing made a huge difference: the volume of medium term note issuance was nearly twice as large as that of exchange-listed bonds over the past two years.
The central bank’s success has, in turn, prodded the other regulators to follow its example. The securities regulator has made especially big strides this year. It has started to fast track issuance approval, cutting waiting times to just over one month. And in June it launched a new high-yield ‘junk’ bond market, adopting a registration, not an approval, system, just like the central bank.
These initiatives have had an immediate impact. Exchange-listed bonds have clawed their way to be about level in issuance volume with medium-term notes this year, according to data from Thomson Reuters.
Just as vital for the development of the Chinese bond market, secondary trading has increased dramatically. Many bonds used to be held by banks to maturity, making them little different to loans. But with the increase in exchange-traded bonds, a wider variety of institutions plus retail investors have been clamoring to add fixed-income securities to their portfolios.
“Liquidity used to be extremely weak, but market infrastructure has now improved, the investor base is bigger and liquidity has increased quickly,” said Shi Lei, a senior bond analyst at Ping An Securities.
But despite its speedy growth, this year has also served up a reminder that China’s bond market still has a lot of maturing to do.
Shandong Helon, a rayon maker, was on the verge of defaulting on Rmb400m in commercial paper in April. It would have been the first major default in China’s corporate bond market, teaching investors a lesson about risk. But instead, the local government intervened and ensured that state- owned banks would bail out the company.
“There have been no defaults, so everyone thinks that bonds cannot default,” Mr. Shi said. “Investors are far too relaxed about credit risk.”