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Ratings, RMB impair China's bond market

A stabilised currency, improved liquidity and a more mature credit culture are what will attract investment in onshore Chinese bonds, industry sources said.

Pheona Tsang, head of fixed income at BEA Union Investment Management, said the firm’s funds are currently not invested in onshore bonds due to worries over the RMB.

“We are taking a closer look at onshore Chinese bonds as the yields are turning more attractive,” she told FSA. “The key concern is the currency factor.”

When assessing the onshore market, the team will focus on government-backed bonds or listed companies bonds with a large market share in the industry or those that already have offshore issuances, she noted.

According to China's onshore “national scale” bond ratings, 51% of bonds are rated AAA and less than 1% of bonds are at A+ or below, according to BNP Paribas.

“It’s not meaningful to look at onshore ratings as too many are AAA-rated," Tsang said, adding that the same AAA bonds could be rated by international rating agencies with grades from AA to BBB.

“We rely on our internal ratings. However, we do take reference of the onshore ratings as local investors use them,” she added.

Even for some debt offshore, such as local government financing vehicles (LGFVs), the price level they are trading at does not match their corresponding credit ratings issued by external agencies, she noted. LGFVs are state-owned companies that raise funds for local government.

BEA's internal system also gives lower ratings for these LGFV issuances. “They usually have a price uplift due to implicit government support. But we are more conservative in rating these companies, as they might not actually be guaranteed by the government.”

Warut Promboon, credit analyst at Boncritic, a Hong Kong-based independent credit research provider, pointed out that an over-concentration of AAA ratings together with inconsistent official data makes it difficult to accurately price the risks for onshore bonds.

The issues are part of an undeveloped credit culture that “leads to China's poor capital allocation where capital does not translate into productivity and poorly-run entities are allowed to be in business,” he wrote in a report on research portal Smartkarma.

A notable example is developer Evergrande, where the rating is AAA onshore and about B- offshore. “Even if the Chinese ratings agencies wanted us to interpret Evergrande as a BBB- [offshore rating], there is no differentiation between BBB- and AAA in an onshore AAA rating,” he told FSA.

“Because many of the Chinese issuers are either government-owned or government-influenced, it is difficult for Chinese rating agencies to turn negative on China, let alone state-owned enterprises and local governments," said Promboon, who was formerly chief rating officer at the Hong Kong office of Dagong Global Credit Rating, a leading mainland agency.

“The Chinese government should let international rating agencies operate in China sooner rather than later. But it won’t happen overnight,” he added.

Earlier this month, Chinese regulators allowed US credit rating agencies to open wholly-owned operations onshore. Meanwhile, a recent working paper from the People’s Bank of China suggested that domestic investment grade for onshore bonds graded AA- or above are comparable to BBB- or above for international ratings.

Ken Hui, COO at Fullgoal Asset Management in Hong Kong, told FSA that data transparency and trading liquidity are also unresolved issues.

Most information about onshore bonds are available in Chinese only, making it difficult for foreign investors to access.

Moreover, trading bonds in the China Interbank Bond Market (CIBM), which has opened to foreign investors, requires RMB 10m ($1.5m) per trade and liquidity tends to be low, he added. Funds with small assets under management might find it difficult to achieve diversification among holdings.

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