China Emerging Markets Fixed Income White Paper

China Credit

A Guide to Investing in the Onshore Market

Nov 26, 2019
2 min read

What You Need to Know

Opportunities for foreign investors to participate in China’s onshore markets are exploding as major benchmark providers add the country to their global indices. Many investors are taking a close look at the country’s capital markets for the first time. From outside China, the view can be perplexing—both familiar and strange. While the markets superficially resemble their global counterparts, the institutions and conventions that underpin them have their own unique character. This paper provides a practical guide for understanding and navigating China’s onshore corporate-bond market and its evolving regulatory and legal landscape.

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7
Number of domestic rating agencies
in China
99.6%
Share of bonds rated AA or above
by China’s rating agencies
174
Number of corporate bond defaults
in China in 2018
Authors

As China’s stock and bond markets have become more integrated into the global financial markets, their distinctive character and features have begun to evolve. Understanding how they are changing—and in what ways they are likely to retain a local flavor—is essential for any investor making an allocation to China.

This is as necessary for China’s domestic credit market as it is for its other capital markets. Corporate bonds comprise 54% of the country’s US$12.5 trillion bond market, the rest consisting of government bonds and public-sector bonds issued by government-affiliated companies.

The credit market’s structure, which reflects successive phases in the market’s development and liberalization, is unique. Its most striking characteristics are diversity and complexity (Display): It includes four kinds of securities (enterprise bonds, corporate bonds, medium-term notes and commercial paper), two trading platforms (exchange and over-the-counter) and no fewer than three regulators. “Firms can issue instruments with similar characteristics and maturities in different segments, each governed by a different regulatory agency, subject to different issuance and rules, and traded on different platforms” (International Monetary Fund).

China’s Credit Market Is Diverse and Complex

Corporate Bond Market Characteristics by Sector

China’s Credit Market Is Diverse and Complex

As of October 31, 2019

CDCC = China Central Depository and Clearing Corporation Limited; CSDC = China Securities Depository and Clearing Corporation Limited; CSRC = China SecuritiesRegulatory Commission; NAFMI = National Association of Financial Market Institutional Investors; NDRC = National Development and Reform Commission

Source: IMF

Enterprise bonds are issued mainly by state-owned enterprises (SOEs), among which local government financial vehicles (LGFVs) are by far the biggest issuers, accounting for about 80% of the market. The sector is regulated by the National Development and Reform Commission (NDRC), and the securities can be traded on both the interbank market and the Shenzhen and Shanghai exchanges.

Corporate bonds, which are exchange traded and overseen by the China Securities Regulatory Commission (CSRC), were launched as a sector in 2007 as part of the government’s plan to open up and develop the capital markets.

The following year, China launched the medium-term notes sector, which is traded on the interbank market and regulated by the National Association of Financial Market Institutional Investors (NAFMII), a self-regulated agency under the People’s Bank of China (PBOC). The interbank market in China, unlike its counterparts elsewhere, is not limited to financial entities, and corporates and large institutional investors are able to participate.

Regulation, law and government policy—particularly in the areas of economic and financial-market reform—have been, and continue to be, important drivers of the market’s growth. So too is the increasing involvement in the market of global investors, credit rating agencies, law firms and other intermediaries.

Below, we look at how these agents of change are affecting credit ratings, covenants, bankruptcy law and defaults—four areas that are critical to the market’s future success.

Credit Ratings: The Dragon at the Gate

In any bond market, credit ratings are an important factor in an investor’s decision to buy a security. For investors in China’s onshore credit market, however, ratings present a challenge and are probably the one area in which the market differs most sharply from its offshore counterparts. In some ways, they stand as a forbidding dragon at the gate.

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