The Middle Kingdom’s property companies have taken advantage of the dollar bond market in the past few years, funding break-neck expansion plans and becoming the biggest and most frequent base of corporate bond supply across Asia. They dominate the high yield market and offer plenty of investment grade supply, too.
Their importance brings extra oversight from regulators. The NDRC’s latest move to restrict the use of proceeds from foreign currency bonds issued by Chinese property companies did not blindside issuers or investors. There was limited immediate reaction in both the primary and secondary markets.
While Chinese policy makers are renowned for their unpredictability, they have been consistent (in recent years, at least) in their attempts to cool down the real estate market, as well as curb credit risk in the offshore market. In June 2018, the NDRC said that it wanted property companies to use offshore bonds for refinancing instead of funding land acquisitions. The latest move merely formalises that guidance.
Only a few weeks ago, the NDRC warned against risks stemming from another large segment of the offshore bond market, issuing a similar restriction on the use of proceeds for local government financing vehicles (LGFVs). LGFVs are supposed to look offshore only for near-term debt refinancing, despite many of these issuers have used dollar and euro bonds to support the construction of local projects.
It is easy to conclude that the regulator is going too far. Liquidity has already been tightened onshore, where policy makers are cracking down on domestic bonds issuance from the sector, and the new regulations appear to deny hemmed-in property companies their best alternative to onshore funding.
The NDRC’s move also penalises younger companies, as well as discouraging more careful issuers. Not only are developers late to the party denied the chance to establish an offshore curve, but repeat issuers will not be at liberty to sell opportunistic deals to refinance onshore debt, or prefund dollar maturities further down the road and save costs.
There are also potential unwanted side-effects, already familiar to Asian bond investors. Chinese companies with limited funding channels are likely to print deals with a maturity just below one year, since these bonds do not require NDRC approval. That will lead to an increase in short-term refinancing pressure, in turn raising the risk of defaults.
These are all relevant points that should be carefully weighed up by regulators, issuers and investors. But China’s onshore and offshore bond markets are still young. European and US bankers are typically correct to dismiss overregulation; they have a rich enough base of issuers, investors and hedging tools to stand alone. China’s dollar bond market, which often relies on friends and family investors or short-sighted underwriters happy to load up their balance sheets, is at an earlier stage of development.
While the new regulation will inevitably hurt issuance volumes and dent banks’ revenues, it should result in a much-needed credit diversification. Chinese property companies will be forced to reconsider their financing models, while those in other sectors will see a boost in demand. The market will move away from riskier credits, with more established players encouraged to borrow long and improve their debt maturity profiles.
The process will be painful and there could be defaults along the way. But the NDRC’s tough stance is the correct one to take with a sector that’s fueled China’s economic growth, but is now the source of much of its worries.