Few were surprised when China’s Anhui province unveiled plans in April for a 25.8 billion yuan ($4.2 billion) debt sale, part of the ruling Communist Party’s widely publicized effort to jumpstart a municipal bond market.
The deal was shocking, though, for market insiders because of what they found in the fine print: Anhui will pay just 50,000 yuan for a credit rating on the bonds. That fee, from Beijing-based Golden Credit Rating International Co., is a fraction of the 250,000-yuan price floor that rival China Lianhe Credit Rating Co. says was agreed by major ratings companies under the guidance of the central bank about eight years ago.
Golden Credit, a state-owned company that started issuing debt rankings in 2012, says it isn’t concerned with profits and low prices are part of its “social responsibility.”
For industry critics, however, lower fees reflect an intensifying fight for business among Chinese ratings companies that threatens to erode their credibility. Standard & Poor’s, the world’s biggest ratings firm, charged the state of Texas about 20 times more to assess a December debt sale than what Anhui agreed to pay Golden Credit.
“There’s vicious competition,” said Yang Feng, an analyst in Beijing at Citic Securities Co., China’s biggest brokerage. “Some graders compete by charging low prices and granting inflated rankings, which hurt the ratings’ trustworthiness.”
While the potential for conflicts in the industry isn’t unique to China and there’s no evidence that price cuts have eroded the quality of assessments, questions over the veracity of ratings could hardly come at a worse time for the nation’s
35.6 trillion yuan onshore debt market.
To start, the grades are becoming entrenched in the regulatory system, with authorities using them to decide which debt is suitable for individuals and certain types of funds. There’s also a newfound need to assess credit risks after China had its first onshore default in March 2014 and an unprecedented non-payment by a state company last month.
Perhaps most importantly for policy makers, trustworthy ratings will help China boost confidence in its corporate debt market and lure more foreign funds -- a key to making the yuan an international currency.
“We are faced with huge pressure and so-called moral risks,” Mao Zhenhua, chairman of China Chengxin International Credit Rating Co., said in a forum in Beijing on May. 9. “Rating companies are eager to give issuers AAA ratings, and some are not charging anything for rankings.”
Data on ratings fees in China are elusive as most issuers don’t publish the information and graders have refused requests for detailed figures. Only recently have some local authorities started disclosing the charges on government websites.
It’s also difficult to gauge the accuracy of assessments because there have been so few defaults in China. Baoding Tianwei Group Co., the power-transformer maker that became the country’s first state-owned company to renege on a domestic bond last month, was rated the equivalent of investment grade by China Lianhe less than five months before its non-payment.
Guan Jianzhong, the chairman of Beijing-based Dagong Global Credit Rating Group, said in an interview in March that some rivals are compromising standards to win business.
“The real concern is that price competition degrades the quality of the initial ratings and subsequent surveillance,” Todd Ely, an assistant professor at the School of Public Affairs at University of Colorado Denver who has studied ratings fees in municipal bond markets, said April 22.
China’s biggest ratings companies signed an agreement on the price floor for rankings in 2007, Rebecca Yan, the chief executive officer at China Lianhe, said in an April 1 interview in Beijing. Dagong Global confirmed there was such a deal, while declining to give details.
The nation’s securities laws don’t specify what are acceptable prices, saying that graders should charge fees in line with standards set by regulators. The China Securities Regulatory Commission and the People’s Bank of China didn’t reply to faxed requests for comment.
Golden Credit, which is authorized by bodies including the CSRC and the PBOC, said it signed an agreement with the central bank in 2011 that set minimum prices for bond assessments. It didn’t disclose the amount. The grader is charging Shanxi, a coal-rich province in central China, 80,000 yuan to rate a 24.5 billion yuan bond this year, according to government websites.
Anhui, a 139,400-square-kilometer province in east China, is paying the equivalent of $8,052 for its rating, versus $161,054 charged by S&P for a Texas bond issue that was less than half the Anhui note’s size. Moody’s Investors Service, which owns 49 percent of China Chengxin, charged Maryland $136,000 for a rating on $883.36 million of debt in March, according to the state’s treasurer.
“We advocate greater competition in our industry, as long as that competition occurs on the basis of credit ratings quality,” Michael Adler, a Moody’s spokesman, said April 22.
Skepticism over the standard of debt rankings in China has prompted many institutional investors to conduct their own assessments, according to Citic’s Yang. At Guangzhou-based E Fund Management Co., there’s a team of about 10 analysts in Beijing dedicated to bond assessments.
“We trust our internal ratings more because we are not sure if outside ratings companies are doing enough due diligence,” said Jeffrey Qi, who helps oversee about 30 billion yuan as a money manager at E Fund’s Hong Kong unit.
It’s getting more difficult for investors to ignore credit rankings as they become more intertwined with the regulation of China’s debt markets. The CSRC said in January that companies need a top AAA rating to sell exchange-traded bonds to public investors -- individuals with less than 3 million yuan of financial assets.
The China Securities Depository and Clearing Corp. said in December that exchange-traded notes rated lower than AAA can’t be used as collateral for short-term loans because they’re too risky. All government issuers that plan to sell debt in 2015 must get ratings and the government requires corporate pension funds and social security funds to only buy investment-grade securities.
The risk of defaults in China has increased as the nation’s economy heads for its slowest expansion since 1990 and the government shows an increased willingness to let companies renege on their obligations. Seven-year AA- rated corporate bonds yield 6.28 percent, 150 basis points higher than their record low in December 2008, ChinaBond data show.
China’s onshore debt market has grown 37 percent in the past two years and local governments are planning to sell more than 1.7 trillion yuan in municipal bonds in 2015, up from 400 billion yuan last year. The CSRC said in March it may give overseas investors greater access to local capital markets.
The central bank cut its one-year deposit and lending rates 0.25 percentage points from Monday after consumer prices in April rose at half the pace the government is targeting for
2015. More monetary easing is necessary to provide an increased supply of funds and lower financing costs, as demand for local government bonds remains weak amid high yields, Barclays Plc strategists led by Chang Jian wrote in a note Sunday.
“In the absence of reputational constraints or effective regulation of rating agencies, ratings will lack credibility in China and could over time become a meaningless rubber stamp,” said Jeffrey Manns, an associate professor of law at George Washington University. “That will hurt the range of market actors that rely on ratings as proxies of creditworthiness and stunt Chinese debt markets.”
— With assistance by Tian Chen