Have mainland regulators banned the standby letter of credit-backed bond?
Confusion reigns on this issue, even for banks that have recently sold deals using the structure.
"One has to be humble and admit no one understands what is happening on this issue," said Yves Jacob, the Asia-Pacific head of debt capital markets at Societe Generale, referring to the mooted SBLC ban.
Another banker involved in a recent SBLC-backed bond said: "The status of the SBLC structure is an ongoing question. Everyone is curious about it."
According to widespread reports at the end of last year, the People's Bank of China told the mainland's Big Four banks to stop issuing letters of credit backing offshore bonds issued by mainland companies.
There was concern that state banks' SBLC-backed deals crowded out demand for their own bonds, as issuers perceived them as all coming from the same credit.
The PBOC also did not want the state banks piling on credit risk when they were already struggling with growing volumes of bad debt.
"It defeats the purpose of derisking the Chinese economy. Regulators wanted issuers to use the offshore market because it pushed lending risk offshore. However, with the SBLC-backed bonds, the risk comes back to the banks' balance sheets," Jacob said.
The SBLC structure involves a large state bank promising to repay investors if a mainland issuer defaults on a bond. Unknown and often unrated mainland issuers with no offshore track record typically use the structure. Offshore investors who buy such bonds are essentially taking the risk of the bank that issues the letter of credit.
Since the ban supposedly took place, at least three SBLC-supported bonds have hit offshore markets, including one that arrived last week - a US$300 million three-year bond from Beijing Energy Investment.
Some believe the recent deals were done off legacy approvals - that is, permission was granted before the ban was implemented - while others contend that no such ban was ever implemented.
"We have seen bank-guaranteed bonds recently completed despite the rumour that the use of SBLC by [mainland] banks to credit enhance the bonds has been banned. We understand from [mainland] banks that deals are still being prepared using letters of credit to back these bonds and have no reason to believe they have been told to stop," said David Yim, the Asia managing director of debt capital markets at the Royal Bank of Scotland.
The mainland banks like to issue letters of credit. They see the instruments as good fee-payers, generating annual income of about 50 to 100 basis points. The letters of credit count as a contingent liability on their balance sheet, which ties up less capital than, for example, a straight loan.
"It's very lucrative for the bank," said the banker involved in the recent SBLC-backed bond.
As an added incentive, the bank that issues a letter of credit backing a bond is all but certain to get a bookrunner role on the bond itself.
The SBLC-backed bond is similar in concept to keepwell agreements, liquidity support covenants and deeds of equity agreement - all are workarounds to the core problem mainland issuers have when they raise capital offshore: China's capital controls prevent them from pledging their onshore assets to their offshore bonds.
Offshore investors are asked to invest in bonds issued by offshore subsidiaries with few assets. To get investors comfortable with that arrangement, onshore issuers have offered various levels of support to their offshore issuing vehicles. But the enforceability of all these support arrangements have all been legally questionable because there is no clear way for offshore investors to lay claim on mainland assets in the event of a default.
However, the uncertainty - and the structures used to address it - may soon be eclipsed by another development in the mainland bond market. On February 13, the State Administration of Foreign Exchange launched a public consultation on letting mainland parents guarantee bonds issued by offshore subsidiaries.
Hu Kai, a senior credit officer at ratings agency Moody's Investors Service, said the onshore parent would be able to effectively pledge assets to their offshore debt. It would make offshore debt issuance much more straightforward for all involved, and it would eliminate the need for SBLC structures and their ilk. Thinking bigger, it would also mark a critical step to yuan liberalisation.
"This is the beginning of relaxation of capital controls … it's a big step," Hu said.