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Issues beset China's onshore bond market, says rating agency​

HONG KONG -- Beijing's liberalization of the multitrillion onshore bond market was a vital step in the internationalization of the yuan but a local rating agency said technical issues are hampering the participation of foreign institutional investors.

"For the bond market to take off, investors have to price the bond correctly. Basically, you need to know how to assess the risks," Warut Promboon, chief rating officer at Dagong Global Credit Rating, told reporters at a panel discussion on Thursday. Dagong is a Beijing-based agency founded in 1994 upon the approval of the People's Bank of China and the former State Economic and Trade Commission to grade onshore debt instruments.

The onshore bond market still had to address issues around information disclosure, taxation, capital repatriation and credit ratings before institutional investors would take the plunge.

According to a July report by Deutsche Bank, Chinese bonds remain underweight in international bond portfolios, making up only 1.5% of such portfolios, while those from Japan and the U.S. accounted for 9% and 38% respectively. This is despite China being the third largest bond market in the world.

Promboon, who was previously a bonds analyst at Societe Generale, ING bank, and Standard Chartered Bank, pointed out the huge gap between domestic and international rating standards.

First, the former is based on comparisons between local peers, whereas the latter is between global counterparts. Second, "a lot of support mechanism" is factored in for any onshore triple-A rating.

"First of all, we look at the influence that the government has on the company's management policy.

[Then] we look at how systemically important the company is to the Chinese economy," said Promboon. "Triple-A rating onshore is pretty much an investment grade, anything below that, mostly are non-investment grades."

Promboon said Dagong was trying to match the national- and global-scale ratings. "We do have a mapping table already," said Promboon, "But the mapping table is a guidance. It's not set in stone. So, everything that can be translated has to be decided by the rating committee anyway. It's more like a roadmap."

About 28% of the 22,719 onshore Chinese bonds are rated "AAA-" or above at the end of July, based on data from China Central Depository & Clearing. About 60% of the bonds were given double-A levels. Only 86 offerings, or less than 0.1%, were rated BBB+ or below.

The official central depository said that 58% of their ratings were consistent with those of credit rating agencies, while 41% were assigned lower grades. In June, 62% of China's ratings were consistent with those of agencies.

The lack of information was identified by Promboon as the main reason overseas investors are holding back. For instance, some company information is only available on the homegrown financial terminal Wind, but not on global data providers such as Bloomberg and Reuters.

That also partly explained why foreign investments remain highly concentrated in government bonds and policy bank bonds, which altogether made up 50% of foreign holdings in August, data from China Central Depository & Clearing shows.

Murkiness surrounding the structure of China's bonds and issues such as withholding tax on coupon payments and capital gains tax also baffled investors. "These, actually, we are still discussing with the central bank as well as the taxation bureau in China to hopefully have a clearer guideline on how they'll actually be implemented," said Patrick Wong, head of China sales and business development at HSBC, one of the four foreign settlement banks that help overseas investors access the onshore bond market and register for trading.

Apart from central banks and sovereign wealth funds, Beijing has also allowed commercial banks, insurers, securities companies and asset managers to partake in the onshore bond markets since February. However, demand has mainly come from asset managers, according to Wong. In terms of geography, 40% was from the U.S., 40% from Europe, and the remaining from Asia.

Angus Hui, Asian fixed income portfolio manager at Schroder Investment Management, was sanguine about the Chinese bond market. He sees the attractive yields there compared with other markets, especially in the current scenario of near-zero to negative interest rates in Europe and Japan.

Hui expects China's $8 trillion bond market to displace Japan's $11 trillion one and become the world's second largest in five years. That would be supported by its likely inclusion into global benchmarks.

For instance, a 1-2% weighting in the J.P. Morgan Global Investment Grade Aggregate Bond Index would result in $40-60 billion flowing into China's bond market. He also believes the increased offerings of yuan-related hedging tools in the future would help offset bearish bias against a devaluation of the yuan, which is dampening demand for Chinese bonds.

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