China Steps Said to Grow Bond Market, Add Issuer Scrutiny

China is allowing more companies to trade bonds and increasing scrutiny over issuers as the government seeks to ensure that the expansion of its nascent debt market isn’t derailed by defaults.

The top economic planning agency ordered local governments to examine the ability of companies to repay bonds maturing in 2012 and 2013, two people with direct knowledge of the matter said yesterday, asking not to be identified as they weren’t authorized to speak to media. China Securities Regulatory Commission began allowing mutual funds to invest in private placements by smaller companies, according to an agency document obtained by Bloomberg News.

Chinese companies sold more debt in the first five months of the year than in all of 2010 as the government encouraged companies to boost fundraising through sales of equity and bonds in a campaign to wean them off loans from state-owned banks and make their finances more transparent. The growth is spurring concern given that China has never had a domestic bond default, according to Moody’s Investors Service.

“It’s kind of a dilemma because for a bond market you must face default sooner or later,” said Ivan Chung, an analyst at Moody’s in Hong Kong. Chinese officials “worry that one default may cause a confidence crisis and people will lose faith in the bond market,” he said.

China’s 4.2 trillion yuan ($659 billion) corporate bond market is about 9 percent of its gross domestic product. In the U.S., the $7.9 trillion in fixed-income securities is equal to more than half the size of economic output.

Risk Monitoring

The National Development and Reform Commission ordered local officials to set up risk monitoring and forecasting mechanisms for debt maturing this year and next, the people said. Companies that violate the monitoring rules and default will be barred from selling more bonds, they said.

Local branches of the NDRC that submitted bond-sale applications to the central commission for companies that later default won’t be allowed to submit additional applications, the people said. It wasn’t clear if the bans would be temporary or permanent, the people said.

The main underwriters for defaulted debt will have their bond issuance businesses either temporarily or permanently halted as punishment, the people said.

The orders, outlined in documents issued by the NDRC and dated May 15, were received by local officials this week, the people said. They were issued because the risk of defaults is increasing as the bond market expands, they said.

NDRC spokesman Li Pumin couldn’t be reached by telephone at his office for comment.

‘Chain Reaction’

One source of concern has been the borrowings of local government finance vehicles set up by cities and provinces to sidestep rules that barred them from directly taking bank loans or selling bonds, Lion Fund Management Co. said.

China’s National Audit Office said in June 2011 that these financing vehicles had 10.7 trillion yuan ($1.7 trillion) of debt at the end of 2010, with 29 percent maturing in 2012 and 2013.

The NDRC is responsible for approving bond sales by these financing vehicles. Local authorities set up the vehicles to fund the construction of roads, bridges and stadiums, which helped stave off the effects of the global financial crisis in 2008 and 2009.

“Any default could possibly have some chain reaction in the system and I’m sure the government will take steps to preempt that,” James Zhou, a bond fund manager at Lion Fund in Shenzhen, said in an interview.

Innovation Needed

Guo Shuqing, chairman of the China Securities Regulatory Commission, said in a March interview with the official People’s Daily newspaper that the nation’s bond market needed innovation. China’s debt and equities markets still “seriously” lag behind the demands of the real economy, he said.

In less than two years, China has introduced junk bonds, municipal debt and credit default swaps. The China Securities Journal newspaper also reported in March that regulators were preparing for trading of government bond futures.

The securities regulator began allowing mutual funds to buy bonds sold by smaller companies with the provision that such debt doesn’t exceed 10 percent of the fund’s net asset value, according to the document obtained yesterday. Money-market funds, which mainly invest in short-term securities, are also excluded, according to the circular.

Funds that plan to invest in such debt should disclose the securities’ liquidity and credit risk in the prospectus, the CSRC file said. The rule takes effect June 15, it said.

Sales of corporate bonds surged to 511 billion yuan this year through June 18 compared with 206 billion yuan for the same period of 2011, according to data compiled by Bloomberg. Local government controlled companies sold 185 billion yuan of bonds in the first five months compared with 118 billion yuan a year earlier, according to Chinabond.

(Adds detail of source in fourth paragraph.)
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