Fidelity sees necessity of state-controlled defaults

Added 14th July 2016

Onshore bond defaults controlled by Chinese authorities are welcome in principle, but in practice it is still unclear how the default process will work, according to Fidelity International.

Fidelity sees necessity of state-controlled defaults

Eric Wong

“More and more defaults are a healthy development in the market,” the firm’s fixed income portfolio manager, Eric Wong, told FSA.  

He estimates that the number of defaults is only 0.1%-0.2% of total onshore issuance. However, China has had more corporate bond defaults so far in 2016 than all of last year, FSA reported earlier. 

Considering the mounting pressure on many Chinese corporates, the very low number of defaults was not really realistic and it is good to see that the Chinese authorities are allowing more to occur, he said.  

But investors and creditors want to have clarity on how a state-controlled default process will work. “This is a relatively new bond market,” Wong explained.  

Bond defaults in China have become a top concern among foreign investors, while asset manager opinion has been mixed. Pinebridge said China offshore bonds may see defaults following their onshore counterparts, while Vanguard Investments in Hong Kong believes that the Chinese policymakers are capable of preventing a credit crisis from happening in the country. HSBC shares the view with Fidelity and believes that the defaults are healthy.

Recently authorities have taken another measure to control borrowing. On 8 July, the China Securities Depository and Clearing said it lowered ratios that determine how much investors can borrow to buy new notes using holdings of exchange-traded company notes as collateral.

Notes are issued in two-, three-, five- and 10-year terms, while bonds are long-term investments with terms of over 10 years. In China there is no difference between the terms "notes" and "bonds".  

Investors using securities whose bond and issuer ratings are AA can now count 50% of the value of those debentures as collateral, the China Securities Depository and Clearing said, which did not provide details of the previous percentage. However, a Bloomberg report said the figure had been 70%.

Borrowing costs will be increased in the primary bond market following the implementation of the new rules, and lower-rated issuers are expected to find it more difficult to sell bonds, the report said.

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