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Asia CommentGC Asia View

China’s short-dated bonds are undermining the market


China’s regulators have left DCM bankers, issuers and investors befuddled this year, as they struggle to understand which companies will gain approval to issue offshore bonds and which will be rejected. In this environment it was only natural that sub-one year bonds, which don’t need approval, should become very popular, but a recent deal shows using the loophole comes at a cost.

One of the biggest complaints against China’s National Development Reform Commission’s approach to international debt issuance approvals this year is that it is not predictable. It never was, of course, but the sporadic nature of who gets a go-ahead has been very much on display in 2017.

Many high yield names have struggled to go offshore, and there is little consistency to the types of credits being delayed or rejected from selling a bond. Approvals, necessary for any Chinese issuer wanting to sell a bond dated longer than a year offshore, are patchy at best.  

Yet there is some sense in China’s efforts to filter offshore sales, particularly in the year of its national party congress, when the country is fixated on its international reputation. Many of the credits that have not been winning approvals would be considered risky investments.

In 2016 the market was inundated with bonds from local government financing vehicles (LGFV) but it began to baulk at some of the shadier LGFVs with questionable revenues. This year, LGFV issues have been few and far between, as the NDRC seems reluctant to allow feebler credits to affect China's reputation in international markets.

Short-term fix? 

Many borrowers have found a way out by selling bonds with tenors of less than a year — as they are exempt from the regulatory process.

But China’s HNA Group Co took things up a notch last week. Earlier this year, the group made headlines after Chinese banking regulators demanded an assessment of its lending banks' offshore loan exposure to the company.

The negative news hit HNA hard, damaging the performance of its existing paper. HNA previously had no concerns selling offshore notes, and was even included in an NDRC pilot programme last year, which allowed it to execute bond deals up to a certain amount without having to receive approval for each sale. This year the company had no such luck, and was cut from the pilot programme list.

But when HNA hit the debt market last week, it grabbed $300m from a 363-day bond — sold with a notably high yield of 8.875%. By comparison, HNA’s September 2016 trade, a $200m 2021, was sold at 6.25%.

Short-dated issuance this year has come at a price. More often than not, short notes have been priced close to where three year bonds by the same issuer should trade. But HNA’s bond, which made it one of the highest payers for short-dated paper this year, showed how borrowers facing immense funding pressure can use the NDRC loophole. 

It’s certainly a bad sign for the market. That's not to say all short-dated deals should be avoided though. Some companies, such as Oceanwide Holdings Co, issued short-dated bonds only to get NDRC approval a few weeks later, allowing them to revisit the market at more appealing terms.

But a short-term trade offers no long-term benefits for borrowers. That issuers have chosen tenors of less than a year to effectively bandage up their funding needs leaves little doubt that they will be back in the market as soon as they can next year to plug their funding gap again. But if a company did not receive approval to go offshore in 2017, there is little certainty that it will be approved in 2018. The short-term debt exercises at high costs are merely kicking the can down a dark road.

It’s also apparent that some banks are avoiding working on short-dated transactions just as they avoided lower-tiered LGFV supply last year. The risks associated with these credits will only grow if the companies are allowed to cobble together temporary, high yield fixes to their funding problems.

Investors may be keen to buy more Asian bonds, but they need to look at other options in the market and trust that, on occasion, the NDRC may filter out issuers for good reason. 

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