China debt: will self-disclosed scandal bring back ratings credibility after series of bond defaults?
- China has become the world’s second largest bond market after the US, attracting 600 billion yuan (US$91.7 million) of inflows in the first eight months of 2020
- But a series of recent defaults of several top rated state-owned enterprises has hurt the credibility of home-grown bond rating services
China’s authorities have renewed efforts to restore the credibility of home-grown bond rating services and rebuild the country’s credit culture with the previously rare public exposure of a string of scandals and punishments.
The market panic eventually forced the Financial Stability and Development Committee, the top financial regulatory body headed by Vice-Premier Liu He, to step in to anchor investor confidence, but questions over local governments would still honour the implicit guarantees of the debt of their SOEs and overly favourable ratings by domestic ratings agencies, remained high.
On Monday, state-owned Golden Credit Rating, which generated 263 million yuan (US$40.2 million) in revenue last year, was suspended from issuing new securities ratings for three months soon after the Central Commission for Discipline Inspection charged its general manager and another executive with taking bribes from firms in exchange for high ratings of their corporate debt.
It is another major punishment after Dagong International was suspended from conducting new securities ratings for a year in 2018 after it overcharged for providing counselling to rated companies.
“Bond ratings in China are highly skewed, reflecting both stringent issuance requirements and implicit guarantees,” Alfred Schipke, former China representative of the International Monetary Fund (IMF), wrote in his book, The Future of China’s Bond Market, published last year.
More than 95 per cent of bonds issued in China are rated AA and above, compared to less than 6 per cent in the US, Schipke’s research found.
The three main international bond agencies – Moody’s, S&P and Fitch Ratings – offer corporate bond ratings as low as C, which “are the lowest rated and are typically in default, with little prospect for recovery of principal or interest”, according to Moody’s.
Pan Gongsheng, deputy governor of the People’s Bank of China, said last week that rating agencies must do a better job in their role as a gatekeeper for bond investors.
China has become the world’s second largest bond market after the United States, attracting 600 billion yuan (US$91.7 million) of inflows in the first eight months of the year.
Beijing is trying to eliminate implicit government guarantees of financial securities as part of its effort to attract more international investors.
Chinese investors have long assumed that local governments stand behind – or implicitly guarantee – the securities issues by enterprises they own or control, bailing out investors in case the company defaults.
“In the rating system, we have to consider the financial condition of individual [issuers] and their backing institutions as well,” he said on Tuesday.
“It is hard to tell how this belief will evolve in the future … But it deserves reflection by the whole society.”
In a recent report, the National Association of Financial Market Institutional Investors (NAFMII) identified a series of credit rating problems, including that the ratings of 27 issuers, or 4.59 per cent of the total, were different in the interbank market and the exchange-traded market at the end of June. This figure had risen to 35, or 7.4 per cent, by the end of September.
The association also noted that 17 of the 136 issuers who changed their rating agencies in the third quarter of 2020 received a higher rating.
Meanwhile, credit spreads in China are much higher for AAA bonds, typically 50 basis points different in the US but 87 basis points different in China.
China has 15 credit rating agencies, with the market for interbank bonds, exchange-traded bonds and enterprise bonds dominated by domestic players.
The IMF said it hopes that international ratings giants, such as S&P and Fitch that already have wholly owned onshore entities and ratings licences, can help strengthen the credit culture and quality within the Chinese industry.
S&P Global China Ratings finished six ratings last year, rating four issuers and two mortgage-backed securities, generating revenue of 2 million yuan, according to its filing to the NAFMII.