China: Covid bonds are more bond than Covid

By Rebecca Feng

When one of the most powerful regulators in China’s domestic bond market introduced the ‘Covid-19 prevention and control’ bond label for Chinese companies at the beginning of February, bankers welcomed the news.

Companies selling bonds with the Covid-19 label were promised a faster registration process. The regulator – National Association of Financial Market Institutional Investors, or Nafmii – told banks and securities houses to provide services to Covid-19 bond issuers and encouraged a wide range of investors to buy the deals.

Better still, there was no need to go through any onerous qualification process. Instead, issuers were allowed to declare their own bonds as Covid-19 financing. Nafmii’s main demand was that issuers must use at least 10% of the financing from such deals for coronavirus-related causes, such as manufacturing medical devices, building hospitals, or scientific research.

The bonds were a success. In less than a month, 106 deals bearing the Covid-19 label were sold in the domestic interbank bond market, raising Rmb100.1 billion ($14 billion), Wind data shows. More than three quarters of them have tenors shorter than a year.

Domestic investors eagerly bought up the majority of these bonds, helping Covid-19 bonds to price inside conventional deals with similar tenors and ratings, Chinabond data shows.

“The Covid-19 label was a godsend for many companies,” a senior DCM banker at a large state-owned bank tells Asiamoney. “It also offered some patriotic elements to a financial product and made banks feel like we were joining the nationwide fight against the virus.”

A nationwide fight against the virus? Hardly. The vast majority of issuers used most of the proceeds to repay their existing loans and replenish their working capital.

In March, the busiest month for Covid-19 bond issuance, Chinese companies raised Rmb69.7 billion through public medium-term notes, short-term notes and super-short-term notes.

Asiamoney analysed 105 prospectuses for bonds sold during this period. The weighted average amount actually used for Covid-19 prevention and control causes was just 14% of the total raised.

The 10% minimum that must be used for Covid-19 responses is also rather general. There is no need for issuers to fund medical treatment, supplies of face masks, or anything else directly related to the virus. The money can just be used to help soften the blow of the pandemic on their businesses.

Take Yili Group, China’s leading dairy products producer. The company sold six Covid-19 bonds in March, raising Rmb3.5 billion in total. It vowed to use exactly 10% of the proceeds for coronavirus-related causes.

Yili said the money would be used to protect dairy farms from disrupted operations during the pandemic. It said the pandemic had hurt demand in the dairy market. To make sure that farmers did not have to let raw milk go to waste or kill their cows, Yili had not rejected even “one drop of milk that meets [the company’s] standards”.

As a result, 10% of the proceeds of these six Covid-19 bonds were used to purchase unpasteurised milk from farmers, as well as packaging materials.

Other issuers used a portion of their bond proceeds to make up for a shortfall in rent from small and medium-sized customers after the Chinese government asked landlords to reduce or scrap commercial rents for small and micro enterprises and mom-and-pop stores.

Some bankers admit that the standards for China’s Covid-19 bonds are too low, allowing issuers to attach a label without really contributing much to the fight against the pandemic or alleviating its economic impact.

“What is the point of calling these Covid-19 bonds?” asks a senior debt banker at an international bank. “These are just normal company bonds.”

Perhaps unsurprisingly, this view is not shared by many bankers in the onshore market, given that the Covid-19 bonds have generated plenty of new business.

They argue that setting the bar too high would scare away potential issuers, which would undermine the whole point of the market in the first place.

“In a crisis like this, every company needs money,” says a senior DCM banker at one of China’s big four banks. “After all, controlling Covid-19 does not actually require that much money from domestic companies. It is already admirable that companies would want to contribute any money at all.”

The banker was also quick to point out that Nafmii designed another label for bonds that dedicated 100% of the proceeds to coronavirus-related causes: Covid-19 prevention and control special-purpose bond. But there has only been one such deal so far, a Rmb300 million, 231-day note sold by Wumei Technology Group, a large supermarket operator.

The note was sold on February 7 and had a coupon of 2.95%. The company said it would use the proceeds for three main purposes. First, buying vegetables, meat, eggs, poultry and other living essentials to stock up its supermarkets’ inventories and help maintain stable commodity prices.

Second, buying masks, hand sanitiser and other sanitary products – and subsequently re-selling them in its stores.

Finally, the company said it would purchase technology for screening customers as they enter its supermarkets.

“Most companies that have issued Covid-19 bonds belong to those basic industries that are tasked with maintaining the stable operation of the society,” a senior DCM banker at Bank of China says. “To make sure that these companies are operating normally is in itself supporting the prevention and control of the Covid-19 pandemic.”

The regulator chose the 10% minimum for Covid bonds after careful consideration, says another senior DCM banker at a Chinese bank: it was the right figure to encourage investors to buy the deals while also motivating issuers.

“Many companies hit hard by the pandemic do not belong to one of those key virus prevention and control industries,” he says. “After all, Covid-19 bonds are something that needed to be launched in a very short amount of time in order to be relevant. It will not be able to have a very sophisticated and complete set of rules like the international social bonds.”

Although Chinese issuers were the first to issue Covid-19 response bonds – the first deal was China Development Bank’s Rmb8 billion, one-year note on February 6 – there has since been a wall of international issuance.

International Finance Corporation, the World Bank and African Development Bank are among the supranational issuers to have sold Covid-19 response bonds in the international market. Sovereign issuers include Austria and Indonesia.

The standards for international issuers are tougher, in part because Covid-19 response bonds are widely considered social bonds, slotting into an already-developed market. But international investors have also been forced to be more flexible.

“In the Covid-19 situation, they need to react quickly,” says Xiaofei Guo, director of green and sustainable finance for Asia-Pacific at Natixis.

“A second-party opinion is normally required pre-issuance by the investors in the social bond market,” she adds. “But for Covid-19-related issuance, the issuers have more flexibility. For example, if the issuer obtains a second-party opinion within 12 months post-issuance, investors are quite comfortable with that at the moment.”

Although it is difficult to compare the exact pricing levels of Chinese domestic bonds with and without the Covid-19 label, Covid-19 bonds have generally enjoyed a slightly cheaper funding cost than bonds without the label, multiple onshore DCM bankers tell Asiamoney. This is due to more publicity and onshore investors’ genuine desire to contribute to the cause, they say.

By the close of 2020, 136 or so Covid-19 bonds will come due, Wind data shows. More than half of those will mature in the months of November and December. The next question for issuers is going to be how to pay back those deals.

Bankers think there is unlikely to be a Covid-19 market when these deals come due. There were only six deals worth Rmb2.55 billion in May, compared to 37 deals worth Rmb28.3 billion in April. So it seems likely the market will fizzle out.

How should it be judged? There are legitimate questions about the use of proceeds, but whether China’s response was the right one or not, there is little doubt it was the quickest.

“I think every government has great Covid-19-related funding needs now,” says Linan Liu, head of Greater China macro strategy at Deutsche Bank.

“However, in terms of coming up with a dedicated bond format to channel these funding needs, China reacted faster than other countries.”