The reliability of Chinese rating agencies has long been under question, at least for investors outside the mainland. At a time when bond investors have a degree of scepticism about the methodology and the reliability of the big three agencies, China credit assessing institutions come in for even greater cynicism.
A sense that China has a culture where transparency in regards to its corporates is not highly valued or regulated, feeds into doubts about the ability of its rating agencies to give an accurate assessment. That combines with the fact that Chinese rating agencies operate on a completely different scale to what to what is considered the market standard. For example a company which carries a triple-‘A’ rating from a Chinese rating agency may be rated anywhere between ‘AAA’ to ‘A’ by Standard & Poor’s.
This combined with seeming publicity seeking stunts from one of China’s biggest firms, Dagong Global Credit Rating, such as claiming the US dollar will be discarded by world and rating the US single-‘A’ give the impression that these institutions are more of a political tool than a system by which investors can make informed judgements.
But now criticism of China’s rating agencies has come from within the country and from one of the regulators of the interbank bond market.
The National Association of Financial Market Institutional Investors (Nafmii) has come out to say that it mainland ratings agencies are out of step with international firms and deliver too many upgrades, according to report from Caixin Online. In research published by Nafmii between January and June, 75 bond issuers in the interbank market were upgraded, but only seven firms experienced a deterioration in their rating. No firms with a rating of ‘AA’, ‘AA-’ or ‘A’ - which is the equivalent of ‘A’ to ‘BBB’ at international rating agencies – were downgraded to the research.
By comparison, in the second quarter alone, Moody’s downgraded six Chinese companies and upgraded only one with industrial and property developers accounting for the majority.
The figures might not be considered so erroneous if China was in a period of strong growth and credit expansion, but they appear against a backdrop when the country is experiencing an economic contraction with GDP growth in Q2 the lowest for 13 quarters at 7.6%. The slowing growth combined with government efforts to direct funding to certain sectors, has led new loans to fall to the 10-month low in July to Rmb540.1 billion (US$84.9 billion).
Yet the Nafmii research reveals that nearly 80% of the rating upgrades in the first six months of the year were for companies in energy production, real estate development and other industries which are normally considered susceptible to an economic downturn. No wonder the regulator has chosen to speak out.
And it is no coincidence that Nafmii has chosen now to make it opinions heard. China has moved quickly and comprehensively to develop a deeper and broader bond market this year. Initiatives include the launch of China’s first high yield bond market and allowing local municipalities to issue debt directly, which is a Nafmii plan.
As more bond products and issuers come online the investor base will expand and the need for ratings which more accurately reflect the credit quality of an issuer will be vital for the market’s credibility. The events of 2008 show just how damaging an overly bullish approach to credit ratings can be.
China is also opening its market up more to foreign investors. Revisions to the qualified foreign institutional investor (QFII) scheme introduced at the end of July gave greater access to the interbank market while the renminbi QFII programme, which came into force in December, is majority focused on fixed income.
With investors retaining a certain level of caution in regards to the large international rating agencies and the relatively small coverage they give to China due to regulatory restrictions, the opening up of China’s bond market presents an opportunity for domestic rating firms to gain market share providing they are viewed as reliable.
Of course, the fault does not just lie with the rating firms. China’s bond market is infamous for never having a default. Even when companies come close as in the case of Shangdong Helon or LDK Solar, the authorities step to rescue the company. No wonder the nation’s rating agencies tend to be more optimistic in their outlook. Whatever the credit merits of a company, if you know the government or one of its agencies will step in should the worse occur the ratings are likely to be more positive.
This reasoning was explained by the Philip Li, head of the Hong Kong bureau of China Chengxin Credit Rating Co who told Asiamoney PLUS in an interview that it’s very difficult to find an issuer that can’t pay back its bonds because they have an implicit guarantee from local banks and provincial governments.
The trouble is an implicit guarantee is not a guarantee at all.
China’s rating agencies need to be more transparent in their methodology. If they take into account implicit guarantees from banks and/or state authorities, this should be made clear to investors. In addition, they should publish a separate rating showing the issuer’s credit health without this backing.
Firms also need to avoid looking like the tools of the state, by avoiding anti-west propaganda and concentrating on well researched rating reports.
Until now, China’s rating agencies have be able to operate in a fairly benign and closed bond market. This is about the change for the better and so must they if they want to survive.