China Central Depository and Clearing (CCDC) published its biannual report on China’s asset backed securitization (ABS) market on August 8. It recommended regulators loosen up liquidity, provide incentives to attract more participants, and test the waters by opening an offshore ABS market. Here’s a quick guide to what CCDC said.
How big is China’s ABS market?
In the first half of 2017, ABS issuance was Rmb488.41bn ($73.3bn), marking a substantial year-on-year growth of 68.87%. Outstanding volume stood at Rmb1.22tr, up 39.06% year-on-year.
ABS backed by corporate debt — which includes micro credit, accounts receivables and income from leases — was the biggest slice of the market, with volumes of Rmb286.4bn, up 89.33% year-on-year and making up 58.64% of all issuance. Credit ABS — which includes collateralised loan obligations, residential mortgage-backed securities (RMBS) and auto loan-backed deals — recorded Rmb190.6bn of issuance, up 41.64% year-on-year with a 39.03% market share.
Is the secondary market liquid?
ABS liquidity was under pressure in the first half as regulators tightened liquidity across the onshore debt market, said CCDC. In the secondary market, the turnover rate, which represents the trading volume as a percentage of total issuance,fell 6.76% year-on-year to 8.72%.
Some parts of the market were hit harder than others. Within corporate ABS, for instance, RMBS suffered a 15.56% fall in issuance due to macroeconomic regulation and control in the real estate market, which shrank its share of corporate ABS to just 20.55%.
In contrast, auto ABS issuance grew by 62.28% in the same period, making up 22.04% of the corporate ABS market.
How can regulators do help the market develop?
CCDC recommended the government increase secondary market liquidity by introducing pledged repurchasing (repo) contracts — repos in which participants do not exchange ownership of the collateral — with ABS as collateral. It has also asked for a market maker mechanism and encouraged longer term investors such as insurance companies and asset managers to enter the market. CCDC argued this could break the pattern of banks holding each other’s securities, which would also promote greater activity in the secondary market.
What about China's deleveraging campaign?
The Chinese government, CCDC noted, is encouraging the use of securitization as a key tool in the economy-wide deleveraging effort, as premier Li Keqiang highlighted in March.
One way of doing this is through non-performing loan (NPL)-backed securitization, which banks are already using to get bad debt off their balance sheets. But CCDC also said the approval process for NPL-backed securitization is inefficient, limiting the market’s development.
As regulators draw up plans to put Li’s words into action, CCDC recommended they start with lowering the barrier for originators to enter the NPL securitization market, improve risk and value identification mechanisms, and strengthen the disclosure procedure, which would raise the standards and credibility of the market.
What does this have to do with foreign investors or originators?
CCDC believes there is scope for greater foreign investor and originator participation in China’s ABS market, although it did not provide data on current levels of foreign participation. Originators with foreign parents issued 12.4% of all ABS deals year-to-date, up slightly from 11.7% for the same period of 2016, according to Dealogic.
CCDC also said regulators should encourage more medium to long term investors — including foreign investor, insurance and pension funds — into securitization backed by debt derived from public private partnership (PPP) projects. CCDC recommended allowing PPP ABS deals to originate offshore or in free trade zones, which would also help attract international investors.
Since the launch of Bond Connect in July, international investors can trade cash bonds, including ABS, in the interbank bond market from Hong Kong.
What’s in it for investors and originators entering this market for the first time?
The yield movement in the market suggests conditions are more favourable for investors than originators at this stage.
The average coupon of senior tranche A of credit ABS was 4.73% in the first half, up 100bp, with the average coupon of tranche B at 5.16%, up 95bp, according to CCDC.
Corporate ABS tranche A had an average coupon of 5.21%, up 57bp, with tranche B’s average coupon at 5.91%, down 53bp.
CCDC said this phenomenon reflects the market’s demand for high yield asset allocation. AAA rated deals made up 82.26% of all corporate ABS issuance and 68.27% of all credit ABS issuance, according to CCDC’s data. But investors ought to take these figures with a pinch of salt, given the difference in standards between credit rating agencies in China and the international rating houses.
How else can regulators lure potential participants?
CCDC singled out credit ABS as a segment where regulators should consider introducing tax incentives.
It also suggested regulators should clarify rules on tax exemption for special purpose vehicles to avoid originators getting taxed twice, consider an exemption to risk self-retention — that is the need for originators to hold part of the ABS issuance on their own balance sheets — for high quality RMBS products, and expand this exemption to other areas of the market over time.
Originators are required to keep at least 5% of every ABS deal on their books — the so-called skin in the game. The People’s Bank of China and the China Banking Regulatory Commission introduced the rule in December 2013.