Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

A decade ago, China had one of the smallest corporate bond markets anywhere in the world. Since 2014, there has been more company debt issued onshore than in all of the U.S. The only thing missing was rules.

Now that they're coming, and because the growth was largely fueled by their absence, don't be surprised if China's corporate note market slows. Actually, it's some of the best news investors could get.

After a string of defaults, Beijing seems finally to have realized that big markets can't be centrally controlled. On Friday, China's National Association of Financial Market Institutional Investors said it intends to roll out a basic set of covenants that regulators expect issuers to start including in documents for bonds that will be sold locally.

Zero to Hero
China's local corporate bond market was three times the size of the U.S. domestic market last year
Source: Bloomberg
* U.S. domestic-market corporate debt doesn't include all U.S. dollar issuance, and excludes municipal and Treasury bonds.

Among the clauses to be included in bond-sale documents are change of control and asset sale restrictions. They allow investors to require immediate repayment if a company's owner changes or if a firm sells its main income-earning business. NAFMII is also considering minimum leverage metrics and cross-default triggers.

China is well behind on all counts.

About 16.5 percent of outstanding bonds in the U.S. domestic market contain a change-of-control clause, versus just 0.05 percent for corporate notes in China, data compiled by Bloomberg show. Clauses that limit a company's total debt apply to 27 percent of securities in the U.S., compared with 0.3 percent in Asia's biggest economy.

Misadventure
Investors still lack basic protection in China
Source: Bloomberg
* Data refers only to the outstanding debt of non-financial companies.

If adopted, the rules could see issuance fall off a cliff. To date, companies in China have relied on local ratings, which tend to overestimate their ability to repay. Should they have to comply with debt limits, many might not make the cut.

That could initially accelerate defaults and bankruptcies, considering some firms are probably papering over sky-high leverage ratios by issuing ever more debt. But rather than involving more and more investors, it's better these companies folded anyway.

China has been very good at adopting capitalist markets. Now it's time to adopt their rule of law too.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. China has two main bond markets: the interbank market, which is primarily regulated by the People’s Bank of China, and an exchange-based bond market, which is primarily regulated by the China Securities Regulatory Commission. The interbank bond market accounts for about 95 percent of total trading volumes.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net