CHINA MONEY-Junk bonds to widen investment options, funding

Fri Mar 16, 2012 12:49am EDT

Related Topics

* Launch of "junk" bonds on Shanghai bourse expected in H1

* Investment limited to institutions in trial period-sources

* Brokers, funds, asset managers to be primary investors

* Bonds issued by small firms to add to market depth

By Lu Jianxin and Kazunori Takada

SHANGHAI, March 16 (Reuters) - China's plan to introduce high-yield corporate bonds on the Shanghai stock exchange will create a new class of investments in its capital market, bringing in new investors who have not been active in the country's corporate debt market so far.

The move will also widen credit channels for small, private firms now largely shut out of China's state-dominated financial system and offer alternative funding to bank loans and equity fundraising.

Analysts say the longer-term challenge of riskier instruments may also step up reform of China's ratings system, transparency and regulations to better protect investors.

The so-called "junk" bond market is expected to open soon on a trial basis, offering high-risk, high-return corporate debt products to investors, including brokerages, asset managers, and hedging funds, sources with direct knowledge of the matter said.

The market may later open to private equity (PE) funds.

These institutions have so far mainly focused on China's relatively mature stock and government bond markets as a lack of liquidity in the corporate debt market has constrained demand.

Allowing small private companies to start issuing bonds will help deepen the corporate debt market, where issuers have so far been dominated by large state-owned enterprises, listed companies and local government investment vehicles.

The high-yield bond market could be launched in the first half of this year, top securities regulator Guo Shuqing said last week. Traders and analysts believe the market could start with an experimental period for six months to a year.

"High-yield bonds are particularly important for asset allocations of financial institutions which have proprietary securities trading, such as brokerages and mutual funds," said Li Jieming, bond analyst at Sealand Securities in Shenzhen.

"Those firms need to take risks for profits," Li said.

But such risk factors will likely mean that banks and retail investors may be barred from entering the market at least during the experimental period, Li added.

A trader at a Chinese PE fund said he believed that such "risk considerations" may also prevent PE funds from trading "junk" bonds during the trial period.

But once allowed entry, risk-oriented PE funds would become primary traders of the high-yield bonds, the trader said.

HIGH RISK, HIGH RETURN

Debt issuance by China's non-financial firms accounts for around 10 percent of total corporate financing in recent years, with firms mainly relying on bank loans as the primary source of funding and the equity market to a lesser extent.

In comparison, debt financing typically accounts for 60 to 70 percent of total corporate financing in mature economies such as in the United States and in Europe.

Last week, Guo said on the sidelines of a parliamentary session that China's high-yield bonds will be called "privately placed small- and medium-sized enterprise bonds", hinting that "junk" bonds will be issued via private placements.

That means sellers will directly discuss coupon rates with underwriters and buyers, who may seek rates of more than 10 percent, more than double the usual cost of corporate debt.

Traders estimate underwriting fees and such high coupon rates may cost the issuer as much as 20 percent of the fundraising amount.

For investors, such high rates mean they will have to conduct a more careful analysis of each individual seller, a practice many may not be used to since macroeconomic prospects are often enough to judge the health of major companies, analysts said.

Sources said the new bonds will be initially traded on the Shanghai exchange's fixed income platform, which is open to institutional investors only.

China's top policymakers have been trying to expand access to funding for small enterprises, considered key to technical innovation and job creation, in a financial system dominated by large state-backed banks that lend mainly to big state firms.

Attempts to create a working bond market have so far led to a less-efficient, fragmented regulatory system.

The Chinese Securities Regulatory Commission now approves bond issues of listed firms, while the top economic planner, the National Development and Reform Commission, regulates non-listed companies issuing bonds with maturity of one year or more. Shanghai Stock Exchange Chairman Geng Liang has said the market is hammering out details for setting up the new market, including approval procedures.

Sources said authorities are considering letting "junk" bonds be supervised by the securities regulator, with only a registration required to issue the bonds as opposed to a lengthy and often cumbersome approval process presently.

"Junk" bonds are a step in the right direction for the development of China's capital markets, many analysts say, although a lot more needs to be done.

"A mature junk debt market requires an objective rating system, and transparent information disclosure and law-protected liquidation mechanisms," said a bond trader at a Chinese brokerage in Shanghai.

"China will have a long way to go in fostering a real high-yield market even after the official launch." (Editing by Jacqueline Wong)

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