China Opens to Foreign Credit Raters to Boost Bond Credibility

(Bloomberg Businessweek) -- This should be a great time to get into the credit analysis business in China. Policymakers in what will soon be the world's second-largest bond market are inviting more international investors to pile in. And there should be plenty of demand for guidance now that authorities are allowing a record number of borrowers to default—a big change from just a few years ago. Yet foreign ratings companies may find China a tricky market to assess.

When it comes to the Chinese debt business, nothing is simple. Take the case of China Minsheng Investment Group, one of the country's largest private-sector borrowers. CMIG, whose interests span real estate to renewable energy, failed to make payments to bondholders at the start of February. While the group later made good on the payments, local media report that it's now in talks with creditors to maintain solvency. Shanghai Brilliance Credit Rating & Investor Service had CMIG's bonds at AAA before the missed payment and kept them at the top grade even after the fact. Shanghai Brilliance declined to comment on the rating.

Into this world steps S&P Global Ratings, which in January became the first foreign ratings company to get regulators' approval to set up a wholly owned unit to grade domestic bonds. While S&P and other major global ratings providers have had their legendary misses—remember subprime mortgages?—in China they'll face a market where common practice bears little resemblance to norms in developed markets. And they'll be competing with established domestic companies.

There are a half-dozen major local ratings companies, founded in a period when authorities in China's single-party system effectively prevented defaults. The Communist Party's top priority has long been stability, and corporate collapses could lead to job losses and social unrest, so the thinking was defaults would best be avoided. That helps explain why more than 40 percent of domestic corporate bonds get a top AAA rating from the four leading local agencies, compared with just 2 percent in the U.S., according to data compiled by Bloomberg. Investors in China consider AA and lower as a junk rating.

Local authorities have a record of pulling out the stops to aid some corporate debtors, including pressuring creditors into providing funding even after a company has defaulted. So it's hard to imagine they'd be patient with downgrades by a foreign ratings company that could make it difficult for a troubled borrower to refinance.

Yet regulators in Beijing recognize that allowing credit to be priced based on the risk of the borrower could make investment across the economy more efficient. The People's Bank of China says a certain amount of defaults can be healthy. And it sees foreign investors as a catalyst for reform. Given that those investors would prefer ratings akin to what they're used to elsewhere, China in 2017 opened the door to the big three global ratings companies to operate wholly owned units.

S&P has hired at least 30 analysts for its Beijing office, preparing to open for business soon, says Simon Jin, chief executive officer of the company's new China unit. The question on the minds of observers is just how S&P, along with Moody's Investors Service and Fitch Ratings—if and when they follow—will manage to produce ratings that enjoy the confidence of international investors while also expanding business in a market that may not welcome hard truths about creditworthiness.

Jin says “there is genuine demand for objective and reliable ratings in China” and that S&P plans “to provide Chinese market participants the same standards of transparency and independent analysis as we do anywhere else in the world.” At the same time, Jin says the company is tailoring its approach to the local market. S&P doesn't plan to spell out how that tailored scale would compare with those in developed markets.

Ek Pon Tay, a Singapore-based portfolio manager at BNP Paribas Asset Management, says he doesn't look at local ratings companies' assessments when considering Chinese bonds, and he'd prefer to use those of foreign providers. But he recognizes the challenges foreign companies will face. “International rating firms will have to walk a fine line between winning market share in China and having to maintain the same standards as their other ratings elsewhere,” Tay says.

Until now, foreign investors have mainly stuck to government bonds and notes sold by three key state-owned lenders. They accounted for more than 83 percent of holdings as of January. So the upside to a trusted system of credit ratings is clear: It would encourage greater consideration of corporate debt at a time when global funds are pouring record amounts into China's fixed-income market.

This year could prove pivotal. As Leong Wai Hoong, a senior money manager at Nikko Asset Management in Singapore, puts it: “If S&P lowers standards in rating Chinese local bonds, that will defeat the purpose of bringing in foreign rating firms.”

--With assistance from Yuling Yang, Tongjian Dong and Carrie Hong.

To contact the editor responsible for this story: Eric Gelman at egelman3@bloomberg.net