* 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 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
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
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,
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)