Bond Ratings Spur `Market Misbehavior' Unless Investors Pay: China Credit
China’s bond-market regulator said a new credit-rating agency it is establishing needs to be funded by investors rather than issuers to avoid conflicts of interest that erode confidence in existing assessments.
“The credibility of China’s credit-ratings agencies and their authority is not high,” Shi Wenchao, secretary-general of the National Association of Financial Market Institutional Investors, said yesterday at the launch of a committee to address ratings reform. “The inadequate set-up of the industry in China has imposed no effective external constraints, and has caused some misbehavior in the market.”
China has five credit-rating firms and bond sellers have an incentive to give their business to those that offer the highest grades, an outcome that may not be in the best interest of investors. Moody’s Investors Service Inc., Standard & Poor’s and Fitch Ratings assigned top rankings to U.S. subprime-mortgage bonds before that market collapsed in 2007, triggering a global credit crisis that led to $1.8 trillion of losses at financial companies worldwide.
NAFMII, which was set up by China’s central bank in 2007, is spending 50 million yuan ($7.5 million) developing a new ratings agency to help protect investors as private companies sell more debt. China has the lowest yields of the world’s four largest emerging-market economies. The local-currency corporate bond market expanded 54 percent to $546 billion in the year to June 30, the Asian Development Bank said this month.
The yield on 10-year notes issued by Chinese companies with top AAA ratings has dropped 50 basis points, or 0.50 percentage point, this year to 4.52 percent. Similar-maturity government bonds yield 3.64 percent, compared with 12.53 percent in Brazil, 8.15 percent in India and 7.70 percent in Russia.
The yield on China’s benchmark local currency 10-year bond held at 3.64 percent yesterday, following a 21 basis-point jump last week, when the central bank raised its benchmark interest rates for the first time since 2007 to help prevent asset bubbles. Similar-maturity bonds yield 8.17 percent in India, 7.7 percent in Russia and 12.53 percent in Brazil.
Twelve-month non-deliverable yuan forwards weakened 0.2 percent to 6.4576 per dollar as of 2:35 p.m. in Hong Kong, reflecting bets for a gain of 3.2 percent from the onshore spot rate of 6.6615.
Five-year credit default swaps on the nation’s debt declined to 55 basis points yesterday, from 57 on Oct. 22, according to data compiled by CMA and Bloomberg. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.
Corporate bond sales in China doubled to 1.96 trillion yuan last year as the government urged companies to reduce reliance on bank loans, according to data compiled by Bloomberg. This year’s tally has reached 1.58 trillion yuan, compared with a 7.5 trillion yuan ceiling the government set for new bank loans.
The increasing size of China’s corporate bond market and its importance to the financial system has highlighted the need for reliable ratings, said Ba Shusong, deputy head of the financial institute at the State Council’s Development Research Center.
“The impact of the international ratings agencies on the financial safety of capital markets has caused many policy makers in China to pay attention,” Ba, who sits on NAFMII’s new committee, said yesterday. “The most important thing to learn from the U.S. is to strengthen the internal mechanisms of the ratings companies and increase their transparency.”
Under the current system, issuers shop around for the best grades and assessments don’t adequately reflect risk, Guan Jianzhong, chairman of Beijing-based Dagong Global Credit Rating Co., said in July. Guan has been appointed to the NAFMII committee looking into ratings reform.
Two of the remaining four official ratings companies have overseas partners; China Chengxin International Credit Rating Co. is a venture with Moody’s and China Lianhe Credit Rating Co. is affiliated with Fitch. The others are Shanghai Brilliance Credit Rating & Investors Service Co. and Xinhua Far East China Ratings. All four were unavailable for comment earlier today, while Zhang Jun, Vice General Manager in the Planning Department of Dagong, said his chairman’s views have already been aired.
Moody’s Corp. Chief Executive Officer Raymond McDaniel said in June, in written testimony submitted to a U.S. Congressional inquiry into the credit crisis, that his company’s ratings of collateralized debt obligations and residential mortgage securities in the past several years have been “deeply disappointing.” Even so, the New York-based company is reluctant for the industry’s revenue model to change.
“The issuer-pay model is well understood and accepted by investors and other market participants,” said Michael Adler, a Moody’s spokesman in New York. “It has the added benefit of making ratings publicly available. Moody’s is keenly focused on making sure our analytical opinions and processes are of the highest caliber in every respect.”
Daniel Noonan, a spokesman for Fitch in New York, said potential conflicts in the “issuer pays” model are “far fewer and more transparent than those associated with alternative models.” David Wargin, an S&P spokesman in New York, referred to a report published by the firm in April 2009 that said “the global credit market is large and diverse enough to accommodate more than one business model” and “it is vital for investors and issuers alike to have confidence in ratings and ratings firms, and to have a range of options from which to select.”
Ping An Insurance (Group) Co., China’s No. 2 insurer, has built up its own team of credit analysts since 2003 and relies on its own rating system, Deputy Chief Investment Officer Timothy Chan last week in Shanghai. Many fund-management companies in China have had to do likewise “to compensate for the inadequacy of ratings from domestic agencies,” said William Hess, managing director at Beijing-based China Analytics Ltd., a financial research firm.
“Even some of the Chinese ratings agencies that are interested in the long-term development of their own businesses have publicly made very critical comments about the state of the ratings industry and the need to improve,” said Hess, who was formerly director for Asia sovereign ratings at S&P.
Demand for corporate debt is building as regulators let Chinese insurers buy more of the securities and overseas financial institutions are given greater access. Ping An is boosting the proportion of its assets in the securities, according to Chan, while Standard Chartered Plc and HSBC Holdings Plc won approval this month to invest in China’s interbank bond market.
The extra yield investors demand to hold 10-year notes issued by Chinese companies rated AAA instead of sovereign debt shrank 50 basis points this year to 88, the biggest annual drop in Chinabond data going back to 2006.
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