China continues to take on its domestic credit rating sector, with the nation’s central bank removing rating requirements for the issuance of debt financing tools by non-financial firms. The move gives firms that issue debt financing instruments more choice to use external ratings and promotes reform in the credit rating industry, the People’s Bank of China (PBOC) said in a statement on Wednesday. It follows the introduction of new regulations last week by five central government bodies, including the PBOC, that increased penalties for credit rating businesses that did not comply with best practice — for example, not scoring a company’s probability of default. Authorities have stepped up scrutiny of the credit rating sector and called for better guardianship of the world’s second largest bond market after a series of defaults from highly rated state-owned enterprises. China braces for another record year of bond defaults The defaults, which included AA-rated Yongcheng Coal & Electricity last November, rocked investor confidence and damaged the credibility of China’s rating businesses . In a joint regulation released last week, the central bank and four other regulators announced they would set up a quality appraisal system with a default ratio at its core by the end of 2022. “We’ll lower the regulatory demand for external ratings … and return it to the market,” it said. The proportion of AA ratings and above in China’s bond market, which generally represents investment grade in developed countries, was 98.49 per cent for non-financial debt instruments at the end of last year. It was lowered to 98.28 per cent by end-March, as 32 credit downgrades were reported, according to a quarterly report in June from the National Association of Financial Market Institutional Investors (NAFMII). In the American market, less than 10 per cent of bonds are rated AA and above. “Under the mode of issuers paying for the service, domestic credit ratings have significantly underestimated the risk of default compared with that of [S&P Global Ratings],” wrote Liu Shida and Wang Hao, two researchers from Tsinghua University, in an article published in June. Their quantitative research, based on data collected between 2005 and 2019, found domestic ratings have poor early warning capabilities ahead of defaults, and there is often a phenomenon of sharp downward adjustments immediately before one. An employee at one of China’s major rating agencies, who did not wish to be identified, said they did not anticipate any immediate impact on business or revenue. “Many state-owned enterprises may drop the service, but small and private companies tend to continue for the purpose of credit enhancement. After all, the charge of about 200,000 yuan (US$30,800) per service is pretty low,” the employee said. “The government wants to see further credit differentiation through ratings to facilitate the de-risking.” The country has 11 major domestic agencies and two entities run by S&P Global Ratings and Fitch Ratings respectively, with a market size valued at billions of yuan. China’s fiscal risks ‘extremely severe’, former finance minister warns ahead of key meetings China Chengxin International, in which Moody’s holds a 30 per cent stake, rated more than 30 per cent of bond issuances last year, followed by Shanghai Brilliance, Lianhe Credit Rating and Golden Credit Rating, which had a share of 10 to 20 per cent, according to data from NAFMII. Last year, China Chengxin International provided services for 1,534 non-financial debt instruments, with a combined value of 1.5 trillion yuan. Revenue generated from the business was 262.3 million yuan, or 32.1 per cent of the company’s total, according to its annual filings to the regulator. The new rules do not apply to corporate bonds, which are overseen by the National Development and Reform Commission, the country’s top economic planning agency.