China’s corporate bond market looks set to see a record in missed repayments this year, surpassing last year’s 143.6 billion yuan (US$21.8 billion) in defaults and heightening concerns about issuers’ credibility and compliance.
Bond defaults had already topped 104 billion yuan between the start of this year and late November, according to Bloomberg data. Delinquencies on the mainland, the world’s second-largest bond market, have exceeded 100 billion yuan for three years running now.
“Rising defaults were expected as economic fundamentals this year are not strong enough to support company growth due to the coronavirus outbreak,” said Wang Feng, chairman of Shanghai-based financial services company Ye Lang Capital. “Investors are increasingly concerned about issuers’ misbehaviour and are urging regulators to tighten oversight on the market.”
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Two defaults involving state-owned industrial juggernauts have raised eyebrows recently. Last week, Hong Kong-listed Brilliance China Automotive Holdings, BMW’s Chinese joint-venture partner, said its parent, Huachen Automotive Holding Group, was being investigated by the mainland Chinese securities regulator for the alleged breach of information disclosure rules after it failed to repay interest and principal on a 1 billion yuan bond.
The announcement followed an investigation in early November by the interbank bond market regulator into Yongcheng Coal & Electricity Holding Group and its three underwriting banks, Industrial Bank, China Everbright Bank and Zhongyuan Bank, for suspected irregularities.
China has been conducting a market-based reform of its bond market since 2014. It was not until March the same year that the country reported its first default, when Shanghai Chaori Solar Energy Science & Technology failed to make an interest payment. Before that, the authorities had stepped in to bail out struggling corporate borrowers with cash injections or restructuring plans.
And the number of defaults in China’s bond market have been growing since. For instance, delinquencies in 2018 were valued at 122 billion yuan, more than quadrupling the levels seen a year earlier.
Officials at the People’s Bank of China said Beijing will control the amount of bond defaults this year, using both legal and market means.
The pandemic has prompted Beijing to support companies in the private sector by easing monetary policies, including loosening regulations on bond issuances. In August, it announced a plan to remove mandatory credit ratings for companies to help issuers sell debt on the country’s stock exchanges. The latest in a series of market-based reforms by Beijing, the move is also aimed at pushing bond investors to develop their own risk-assessment capabilities in the US$13 trillion onshore market.
But analysts said loosening regulations will result in irregularities that will hurt small investors. “There remain lots of uncertainties in China’s economic recovery, and there are chances that defaults will arise in the recovery process,” said Noelle Chiang, a senior investment strategist with AllianceBernstein. “Investors need to be cautious.”
The recent spike in bankruptcies among Chinese state-owned enterprises, however, is also being viewed as a positive sign in some quarters.
“This is a natural evolution of a bond market, and it actually shows the maturation and the sophistication of the Chinese fixed-income market generally,” said Martin Dropkin, Fidelity’s head of Asian fixed income.
Fidelity is, in fact, recommending that investors add China government bonds, which provide significantly higher returns than bonds issued by every other major country, especially the United States, to their portfolios.
“China government bonds, for investors looking for a bit of diversification, offer a good deal of that, and we think that will continue,” Dropkin said. Facing an environment of sustained, historically low interest rates, investors will need to rethink how they structure their defensive portfolios, he said.
There remains room for the addition of China government bonds in foreign portfolios. “The allocation of international investors to China government bonds, and broadly speaking, across the whole China fixed-income universe, still remains very low if we compare that to other major economies,” Dropkin said.
Foreign ownership rates of the bonds remain in the single-digits, he added, well below the 15 per cent to 20 per cent rate for other countries’ bonds. Other Chinese fixed-income assets have also yet to be fully tapped by international investors, including its US$4 trillion corporate bond market.
Although this market tends to be more opaque than what investors are accustomed to, it is showing signs of improvement, Dropkin said. “Management teams within China are just getting used to talking to investors like us, answering questions. Data flow is improving.”
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