The two faces of China's bond regulators

China’s powerful National Development and Reform Commission (NDRC), with authority over swathes of the domestic economy, has the job of traffic cop in the offshore bond market: it decides which companies can sell bonds and when. It has failed to win rave reviews for this particular role, and its workings in the bond market remain a mystery to many bankers and debt issuers.

“I hate the NDRC,” snarls one chief financial officer at a Chinese property company. 

It is an unusually strong condemnation of the regulator, but one that others across the bond market echo. The NDRC, the successor to China’s State Planning Commission, lost some of its power earlier this year, when president Xi Jinping’s government decided to transfer some functions to other agencies. But there is no sign it will lose its grasp over approving every Chinese issuer that wants to sell an offshore bond.

Few bond market operators understand the NDRC, but everyone has to deal with it. It is a contradictory, puzzling and sometimes frustrating institution that bankers and issuers are forced to consult carefully, somewhat like tea leaves.

The NDRC is a big headache for China’s bond issuers and the bankers they hire to execute those deals. The regulator’s hot-and-cold approach to allowing Chinese companies to sell bonds offshore, as well as its apparent unwillingness to let anyone know what it is thinking, makes it as unpredictable for issuers in China as it is for bankers outside the country.

That is a real problem. 

Chinese issuers now eclipse other Asian borrowers in the international bond market. Their $218.5 billion of G3 bond issuance last year accounted for just over 60% of the total in Asia ex-Japan, according to Dealogic, a percentage they have almost exactly matched so far this year already.

China’s dominant position among Asian issuers is even more pronounced in the high-yield market, accounting for 71.4% of the region’s issuance in 2017 and an even bigger share so far this year. This makes the NDRC’s unpredictability particularly troubling. China’s high-yield issuers are much more likely to get short shrift from the agency than the country’s well-connected state-owned enterprises.

In theory, the NDRC’s cautious ways should at least reduce foreign currency funding risks by ensuring that Chinese issuers are simply unable to overburden themselves with dollar financing. 

Instead, its approach to bond regulation has done just the opposite, increasing refinancing risks and adding a large dose of uncertainty to China’s funding landscape at a time when international investors are reluctant to come off the sidelines. 

Can anyone make sense of the NDRC?

There’s no rhyme or reason to what they’re doing,” laments one DCM head. 

The confusion about the regulator dates back to October 2015, when the NDRC declared it was no longer going to approve offshore bond issuance, moving instead to a system where deals only needed to be registered. This proved to be little more than a meaningless shift in nomenclature. 

“They call it registration, but they won’t allow an issue unless they acknowledge it has been registered,” explains a syndicate head. “That means it’s basically the same thing as an approval process.” 

A few issuers have called the NDRC’s bluff. At least five companies – China Water Affairs Group, China South City Holdings, Mingfa Group (International) Company, Ping An Real Estate and China Mengniu Dairy Company – issued bonds without hearing back from the regulator. But these issuers were named and shamed in an NDRC statement in June last year, and the regulator has made clear in private meetings that a repeat will not be tolerated, bankers and funding officials say. 

So for the rest of this article, Asiamoney will use ‘approval’ as convenient shorthand for ‘acknowledging registration in a way that is totally, completely different from approval’. To be clear: the NDRC even gives out specific quotas to each issuer, after asking them to apply for a desired amount.

The uncertainty about the NDRC even extends to what sources of funding it actually regulates. When Asiamoney sits down with two senior debt capital market bankers in Singapore at the end of May, we ask if offshore loans also had to be registered with the regulator. The two bankers answer simultaneously, then laugh when they realize that one had confidently said: “Yes” and the other had categorically stated: “No”.

After a quick email to an overworked junior staff member, one of these bankers clarifies the point. 

“The current interpretation of the rules is that you don’t need to register loans,” he says.

China is certainly not the only country where financial regulations are subject to interpretation, but the fact that a critical part of its offshore funding rules is subject to fundamentally different readings shows how far the NDRC needs to go to communicate its policies to bankers and issuers. Even more confounding is that the interpretation is less about what the rules say and more about what borrowers have been able to get away with.

“Technically, you’re supposed to register loans with the NDRC, but no one does,” says another DCM banker in Singapore. A Shanghai-based lawyer, asked for clarification, echoes this point. 

The bigger headache for debt bankers, though, is in the NDRC’s oversight of offshore bond issuance from Chinese corporations. There is neither any doubt that the regulator plays an important role in this matter, nor that it expects all deals to be registered: the confusion lies in everything else.

In 2017, the NDRC was incredibly hard on issuers, refusing to give out quotas to some and delaying the process for others. Bankers complained at the time that the registration process was a ‘black box’, although some bankers did admit China’s all-important 19th Party Congress, where president Xi consolidated his power, was always likely to slow things down.

This year has been dramatically different. Bankers talk about a seismic shift in the ability of their Chinese companies to get approvals. By the end of May this year, the NDRC disclosed it had approved 99 offshore bonds, compared with 44 during the same period last year, according to official data.  

This new, more liberal attitude has been welcomed by bankers and issuers, but has also had some unfortunate consequences. 

Bankers admit that corporations that previously needed to raise $500 million, for example, sometimes told the regulator they needed much more than that, perhaps $700 million, or even $1 billion. That way, they would be able to meet their funding targets even if the NDRC – as was its tendency – gave lower-than-requested quotas across the board. 

But since the NDRC has been much more willing to give full quotas this year, issuers have faced a dilemma. If they were to raise less than they were permitted, the NDRC might realize it had been duped. Instead, some are asking bankers to identify alternative funding sources, perhaps offshore renminbi bonds or equity-linked bonds.

This is an example of the law of unintended consequences in action. The regulator’s attempt to control offshore bond funding by Chinese companies has gone the other way, pushing some companies to lie about how much funding they need and some of those to take on additional debt, simply for fear of offending the regulator.

But an even more egregious example comes from the bonds that are being sold outside of the purview of the NDRC. By ignoring bond sales below a certain maturity, the NDRC is adding serious risks to the funding profile of Chinese debt issuers, particularly those high-yield borrowers who already have more than enough risk to deal with.

China’s bond market is haunted by the spectre of defaults. Eleven Chinese issuers have defaulted on a total of 18 bonds in China’s domestic market in the first four-and-a-half months of this year, according to Natixis. 

Tianfeng Securities, a local broker, has warned that Chinese companies are “flocking together to default”.

Where the domestic market goes, the offshore market follows. There have already been two Chinese defaults in the offshore bond market this year: China Energy Reserve and Chemicals Group’s failure to pay back a $350 million bond and a cross-default on CEFC China Energy’s $250 million deal after it failed to repay an onshore note. 

Several market participants say they expect more defaults on Chinese offshore bonds this year.

“It will happen. I really think it will happen,” says one chief financial officer with a hint of fear in his voice.

This, one might imagine, is where the NDRC comes in. Unfortunately, its involvement appears to be making default risk worse, not better.

The NDRC’s unpredictable registration system has raised refinancing risks for Chinese issuers, says Christopher Lee, chief ratings officer for Greater China corporations at S&P Global Ratings. 

But the issue goes beyond the delay in getting approval. 

The problem is simple: the regulator only approves deals with a maturity of one year or more. Any deals with maturities shorter than that can get through without NDRC approval, encouraging a swathe of issuers to resort to 364-day bonds to hit their funding needs. 

In 2016, not a single Chinese corporation sold a dollar bond with a maturity of less than one year, according to Dealogic data.

 

In 2017, 30 deals were sold, worth $6.66 billion in total. It seems inevitable that will be eclipsed this year. By early June, Chinese companies had done 23 deals with maturities of less than one year, raising just over $5 billion in total.

This national exercise in kicking the can down the road will ensure that the line between liquidity risks and credit risks becomes increasingly blurred. 

“Eventually, the move to short-term funding is going to shift from being a liquidity risk to a credit risk,” says Lee. “It will start to impact their ratings.

There is unsubstantiated talk among some market participants that the NDRC will soon start to regulate even bonds of less than one year in the offshore market. No one is quite sure what the regulator has planned. Some wonder whether the NDRC even knows itself.

Those who have met officials with responsibility for the debt market from the NDRC point to a sprawling regulatory body — with city, provincial and national levels — whose staff sometimes appear to have only a rudimentary understanding of offshore bonds. 

The regulator seems to be uncertain about exactly what its role in the offshore bond market should be. A property company executive tells Asiamoney that part of the NDRC’s hesitation comes from its sense that approving a bond is the same thing as vouching for the company behind it. She has urged NDRC officials not to think of their job in that way.

“No one else thinks that,” a senior debt banker agrees. “It’s just them.”

Bankers, issuers and other market participants speak of a regulator whose employees do not always know how to communicate even when face to face. One source told us he found NDRC officials “unimpressive” (and surprisingly young) when he met them in Beijing.

Chinese issuers raised $218.5 billion in the offshore market last year, but sold a whopping Rmb40.8 trillion onshore, according to data from Dealogic and Wind. In other words, offshore bonds represent just 3.3% of the total.

“They’re living in a mansion,” argues a DCM head. “It’s hard for them to care about the little hut next door.”

Furthermore, only a portion of the Chinese issuer base must tackle the NDRC maze each time it wants to raise money offshore. State-owned companies, with their national importance and their political capital, can be assured of much kinder treatment.

Perhaps the NDRC does think of the offshore bond market as a sideshow. But the little hut is the window through which much of the investment world views China. That makes the need for coherent regulations all the more urgent.

There are two tasks facing the NDRC, bankers and corporate executives tell Asiamoney. The first is the big one: reforming the registration process. The regulator needs to create a series of clear guidelines for bond issuers, making it transparent which industries will be favoured, how long the approval process is expected to take, what issuers can do to speed up the process and what exactly falls under the NDRC’s scope.

There is plenty of work to do here. It is striking how much the NDRC’s guidelines seem to be whispered from one source to another, changing from firm to firm and from person to person. One banker confidently tells Asiamoney the NDRC is only approving refinancings at the moment; another says his client just got approval for a deal that is not a refinancing. One DCM head says property companies were not getting approval in mid-May; a property company executive tells us she has heard there is no problem with new approvals.

Guesswork, conjecture and sheer hope remain the fundamental tools for dealing with the NDRC. 

The other hurdle for the NDRC, clearly related, is of communication. Not a single person interviewed for this piece disputed the idea that the NDRC is effectively a blank wall, leaving bankers and issuers clueless not just about when deals will be approved, but even if approval would ever come. Perhaps the NDRC does not think it needs to change its rules — but if not, it should let issuers understand how it comes to its decisions.

The NDRC acknowledged our attempt to seek comment, but did not make itself available for an interview or send a written response to our questions. 

Additional reporting by Morgan Davis, Addison Gong and Noah Sin.