China `Overrated' Bonds May Challenge Foreign Rating Firms

  • Hard for foreign rating firms to expand in China, Bosera says
  • About 39% of local China bonds are rated AAA vs 2% in the U.S.

China has finally opened up its credit-rating market. But foreign credit assessors aren’t likely to waltz in, local money managers say.

The challenge for rating companies, which generally charge issuers for scoring them, will be to win business from borrowers used to getting high grades from local assessors. That’s key after Sunday, which marked the day by which China had agreed to allow foreign-owned firms to provide credit ratings in the country.

The tendency of Chinese rating firms to dish out stellar scores has caught the attention of the nation’s regulators, as they try to liberalize financial markets to better price risk. China’s biggest bond clearing house has said some onshore corporate notes are “overrated” and local firms are “seriously” late in adjusting ratings. Meanwhile, foreign companies must confront the reality on the ground, where about 39 percent of local company bonds are rated AAA, compared with less than 2 percent in the U.S.

“If foreign rating agencies adopt the same rating methodology as overseas, there may be huge differences from ratings given by local firms,” said Chen Zhixin, Shenzhen-based head of fixed income research at Bosera Asset Management Co. “Given that issuers generally want financing costs to be as low as possible, it will be difficult for foreign rating agencies to expand in China.”

While the big three foreign rating companies don’t yet rate local Chinese bonds, they do assess the country’s issuers in the international debt market. Moody’s Investors Service, S&P Global Ratings and Fitch Ratings haven’t given any Chinese corporate bond in the offshore market a top rating in the past five years, a period in which borrowers from the country increasingly went overseas to raise funds.

Divergent Views

Take China’s most indebted property developer as an example. The three main foreign rating firms gave China Evergrande Group a junk rating, while their local competitor China Chengxin Securities Rating Co. rated it AAA.

Moody’s, Fitch and S&P have downgraded 48 Chinese issuers so far this year and upgraded 19 while major local rating firms cut 15 companies’ ratings and raised 152, according to Bloomberg-compiled data.

S&P and Moody’s referred to previous statements when asked about their plans for the onshore market. Fitch declined to comment.

“We are reviewing the newly-released rules relating to the interbank bond market and will engage with regulators and other relevant stakeholders to determine how we can best serve the market,” S&P said.

“As a general matter, we are encouraged by the policies of the Chinese government to open the Chinese capital markets, including to the credit rating agency industry,” Moody’s said.

Kwong Li, Hong Kong-based head of Greater China at Fitch, said in May the firm is “excited” by China’s move to allow foreign-owned companies to provide credit ratings.

The presence of foreign rating firms has never been so important as China seeks to lure overseas investors to help counter capital outflows, and as rising corporate defaults fuel demand for risk assessments.

Leverage Crackdown

At the same time, Chinese borrowers are scrambling to hold down financing costs after a crackdown on leverage pushed onshore bond yields to the highest in more than two years last month.

Foreign investors hold only about 1 percent of the onshore Chinese bond market, and as they navigate the terrain they may find solace in familiar rating firms.

Such investors use local agencies’ scores mainly only as a reference because their rating scales are different from international peers, according to Raymond Gui, senior portfolio manager at Income Partners Asset Management (HK) Ltd.

“If the international rating agencies will rate more onshore bond issuers, it would attract more foreign investors to come,” he said.

Local money managers are often bound by mandates stipulating they buy only securities rated above a certain level. So they may continue to focus on domestic ratings, or it could necessitate changes if foreign rating firms were to offer lower grades, according to Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management Co.

“Our current contracts with investors are all based on the local rating mechanism and it’s hard to revise them,” Wang said. “It’s very likely that, in the short term, Chinese investors will mainly refer to local agencies’ ratings while foreign investors will rely on foreign rating agencies.”

— With assistance by Judy Chen, Vicky Wei, and Linan Bian

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