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China DCM scores: decent idea, poor execution

China stock crash PA 230x150
By Rebecca Feng
22 Oct 2019

Chinese regulators are planning to rate the bond underwriting ability of securities firms. That may appear a sensible solution to an exchange bond market that has become cutthroat and chaotic. But the proposed solution is too vague to have much impact.

The Securities Association of China (SAC) is planning to give every domesticsecurities firm with more than three years of experience in bond underwriting a score of ‘A’, ‘B’ or ‘C’. The process will start next May and the results will be made public. The scheme will cover all bonds issued by non-financial companies in the exchange market.

The evaluation will be based on five criteria: the number of people in a firm’s DCM team and their years of experience, the revenue from and volume of bonds underwritten in the past year, how well each firm complies with regulations, the quality of its risk control systems and finally (because why stop there?) how well the firms support “national-level strategies” such as the Belt and Road Initiative.

It makes some sense for regulators to try to clean up the market. Chinese banks have an all-too-familiar obsession with league tables, causing them to do anything ─ including abandoning such absurd notions as fees and syndication ─ to win business.

In April, Citic Securities and China International Capital Corporation acted as the joint lead underwriters on China National Nuclear Power’s Rmb7.8bn ($1.1bn) convertible corporate bond trade. The trade was one of the very few that disclosed underwriting fees. Together, the two joint lead underwriters charged the issuer only Rmb2.48m —0.03% of the underwriting amount.

By including bond underwriting revenue as a criterion, the new rating mechanism may help the regulator cool off the growingly fierce competition. But a crucial detail is missing from the new scoring guidelines. It remains unclear what disadvantages securities firms will face if they are rated ‘C’ and what preferential treatments they will receive if they are rated ‘A’.

It is not the first time Chinese regulators chose to not specify the consequences of the various ratings they assign to market participants. Since 2009, SAC has been giving a more general rating to each securities firm annually. The ratings range from triple-A to ‘E’.

On paper, these scores help the regulators provide differentiated treatment to securities firms. Those with higher scores will have an easier time obtaining licences and face fewer visits from the regulators. While those with low scores will have to go through more regular inspections and may have a harder time getting certain licences.

But three onshore DCM bankers told GlobalRMB that these ratings do not play much of a role when issuers hire securities firm to underwrite bond deals. One banker said that while issuers may care about their relationship with certain securities houses in the long-term, in the short-term, they only care about how cheaply a deal can get done.

As a result, some lower-rated firms have managed to grab more deals than their high-rated peers, Wind data shows. For example, Guorong Securities is ranked ‘C’, the lowest possible rating without being categorised as “at-risk”, and is number 34 of the volume league table. Immediately below Guorong is A-rated Caitong Securities, which has underwritten nine fewer bonds than Guorong. 

These rankings, since they are to be made public, only provide a “name and shame” effect on securities firms. Will they do any more than that? Will repercussions or fines follow? No-one knows.

Financial regulations should curb uncertainty, not create it. To make these ratings count, the Chinese regulators should give market participants a clear picture of how they are linked to concrete punishments or rewards.

By Rebecca Feng
22 Oct 2019