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China moves to check inflated ratings, allows issuers to opt out

(ATF) China has proposed scrapping corporate obligation to obtain a credit rating, in a sign the world’s second biggest bond market is maturing and investor scrutiny has improved.

It will also help end the practice of rating shopping – where issuers pick to hire an  agency that gives them the best rating – and ensure the survival of the fittest.

The country’s securities regulator has put out draft guidelines for soliciting public opinion until September 6, to be followed by a decision impacting the country’s $15 trillion bond market, in which corporate bonds account for just over half.

“China’s move to make rating voluntary is a sign of a maturing bond market where investors are required to do their own due diligence with a fair share of major issuers already rated – a culture of appointing rating agencies is already in place,” Terry Zhang, Head of Global Strategy and Business Management at Pengyuan Credit Rating (Hong Kong) Co Ltd, said in an interview with Asia Times Financial.

Pengyuan is one of the six main rating agencies in China’s domestic bond markets, whose overall size has grown rapidly from just under $286 billion in 2000. 

Rating shopping

As foreigners start pouring in and opening up the bond market, the scramble among rating agencies for business has intensified. This has encouraged the practice of rating shopping with the result that ratings in China are skewed – more than 50% of corporate borrowers are rated AAA, compared with just 2% in the United States.

Besides the “issuer pays” business model, which has created a conflict of interest, a minimum rating threshold before borrowers can tap the market is also responsible for this imbalance. The China Banking and Insurance Regulatory Commission (CBIRC) directs banks and insurers to invest only in bonds rated AA and higher, which provides little incentive for domestic agencies to assign lower ratings.

In 2018, Dagong Global Credit Rating, received a one-year ban for doing consultancy work for companies it also rated.

“Rating shopping will also be discouraged by making ratings voluntary – ultimately it is up to the investors and regulators to determine who will survive and thrive and who will die,” said Zhang.

“The regulator has been talking about this for a while and the pandemic may have expedited the process from a policy standpoint. This will help to nurture a healthier competitive dynamic for the rating industry and players cannot adopt a box checker mentality.”

China’s corporate bond market has proved to be a challenge for rating agencies as domestic bond issuers are mostly state-owned or deemed to have government support. But with foreign money flowing in rapidly, the onshore markets should see greater credit differentiation, as discerning investors demand greater due diligence on the part of rating agencies.

This would make the latest move more relevant, Zhang said.

“Such a move is net positive for the credit ratings industry and capital markets in the long-term, as rating agencies will have to buckle up and prove their relevance,” he said. 

And while the proposal to make credit ratings voluntary may appear to be a threat to business prospects, that was not a cause for concern to Zhang.

“The utilities of credit ratings actually transcends far beyond the primary issuance and imbedded throughout the life cycle of a bond for a wide variety of stakeholders and this realisation is starting to dawn,” he said.

“Borrowers’ profile assessment are used by commercial banks, insurers and for cross-border transactions – rating agencies should look beyond the bond primary markets.”

Pengyuan International (Pengyuan Credit Rating (Hong Kong) Co Ltd), a fully-owned subsidiary of CSCI Pengyuan, has been granted a type-10 license (providing credit rating services) by the Securities and Futures Commission of Hong Kong and providing global credit rating services since 2012. Asia Times Financial agreed on a partnership with Pengyuan based on data provision and the joint hosting of global industry conferences.

Umesh Desai

Umesh Desai is the Executive Editor at Asia Financial. Prior to this he spent over two decades with Reuters News as Asia Pacific Chief Correspondent in Hong Kong and Bureau Chief in Bombay. Before becoming a journalist Umesh was a credit ratings analyst with Moody's arm in India - ICRA. A chartered accountant by training, Umesh began his career as an equity analyst. His Twitter handle is @umesh_desai

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