Corporate bonds calls for acceleration

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Last updated at: (Beijing Time) Monday, October 13, 2003

Corporate bonds calls for acceleration

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In mature securities markets, the size of the corporate bond market typically is similar to that of the stock market. But in China, the corporate bond market is simply insignificant when compared with the stock market.

System-derived factors are the primary cause for the lagging development of the corporate bond market.

Firstly, during the process of developing China's securities market, there has always been a "stocks first, corporate bonds second" mentality, which has resulted in the corporate bonds market being treated as merely a supplementary funding source for central government-affiliated as well as local enterprises, not a key capital market tool.

Secondly, the planning of corporate bond issues has a strong tint from the planned-economy era. Every year, State planners distribute corporate bond issue quotas, which are approved by the State Council, among central and local governments or among industries.

Thirdly, the complicated management system - with the planning commission approving quotas, the central bank approving issuing applications and securities authorities overseeing trading qualifications - spells many artificial barriers for bond issuers, which is detrimental to the healthy development of the market.

Besides the system-derived reasons, many enterprises are embarrassed with poor credibility, which directly leads to the lagging growth of the corporate bond market.

According to a survey published in the Shanghai Securities News journal on September 9, only 50 companies out of the 160 listed companies that were polled have an investment-level credit rating.

And a distorted stock market (with high price-to-earnings ratios) fuels business enthusiasm about stock offerings rather than borrowing debt.

A lack of liquidity in the market is an important factor hampering the healthy growth of the corporate bond market. The market is mainly consisted of individual investors, and there is just a very limited selection of products.

The trading costs are the key factor in determining liquidity, but the trading costs in China are excessively high, and it is even difficult for investors to complete transactions at the time they desire.

At present, only a few central government-affiliated enterprises have their bonds traded on the Shanghai Stock Exchange, while most local enterprises have no place to trade their bonds, which considerably constrains investment opportunities and the possibility to hedge risks, and therefore is detrimental to the healthy growth of the market.

And there is the problem of an incomplete bond market credit rating system. China's corporate bond credit rating system still has many weaknesses: the management at many credit rating firms is still not standardized; there is a lack of uniform regulation; and the ratings are sometimes not credible or convincing.

In order to accelerate the development of China's corporate bond market, there must be a changed mentality that puts stocks and Treasury bonds over corporate bonds to provide a good policy basis.

The regulation that interest rates on corporate bonds should not be more than 40 per cent higher than the equivalent rates on bank deposits should be cancelled to allow a gradual liberalization of corporate bond interest rates.

The interest rate on corporate bonds should instead be decided by the issuers and underwriters according to the issuer's credit rating and market conditions.

On the part of the regulators, the government needs to improve management methods.

Firstly, quota-based management should be phased out to help enterprises learn to decide the scale of the issues under market rules in accordance with their funding needs. As long as it is needed by the issuer and recognized by the market, the issue plan should be approved.

Secondly, the government needs to loosen controls on the use of proceeds. While making sure the proceeds are mainly invested in fixed-asset projects, the government may allow them to be used to restructure debts and assets among others.

And building a complete credit rating system has a great significance in boosting the development of the corporate bond market. Credit ratings directly influence interest rates, maturity and redemption, and therefore determine the borrowing costs.

In developing an independent credit rating system, regulators need to break away from local protectionism and strengthen rating firms' efforts to keep track of the enterprises and upgrade ratings promptly.

As for investors, promoting risk awareness among individual investors and helping them learn how to choose the corporate bonds with affordable levels of risk are necessary.

And more efforts need to be made to foster more institutional investors (mainly social security funds and securities investment funds) so that they play a leading role in the marketplace.

For that purpose, not only the various funds and other existing institutional investors should be allowed to trade corporate bonds, but the government needs to usher in foreign institutional investors at a proper time.

In terms of building a marketplace for corporate bonds, we should learn from developed countries and promote the establishment of an over-the-counter market and a market-maker system, and then create a trading system that centers on exchanges and is assisted by the over-the-counter market.

Large and regular issues can be traded on the exchanges, while other corporate bonds can be traded in the over-the-counter segment.

In summary, given the restraints of incomplete market infrastructure and the lack of a social credit system, the time is not yet ripe to push for a corporate bond market liberalization. But we should strive to establish necessary systems that will promote the healthy development of China's corporate bond market and solve the possible financial risks resulting from the funding dependence on the banking sector.

The author is an analyst with the State Information Centre

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