Chinese regulators are well known for their conservative approach, which has led to them keeping a tight grip on capital controls and using a slow and careful approach when it comes to opening up the onshore bond market.
It's hard to blame them. In 1997, the Asian financial crisis unfolded on China’s doorstep, showing how emerging economies could fall like dominoes if capital accounts open too fast, and global investment floods in and then rapidly out again.
The global financial crisis a decade later only reinforced the message that 'sophisticated' international banks might have little to teach China after all.
As the developed world still struggles with post-crisis slow economic growth and low interest rates, China’s prudence is rapidly transforming into assertiveness on the merits of its own development model — a halfway house between a restricted market and the free-wheeling economic liberalism of the US.
China’s defiance was evident in the recent issuance of a sovereign dollar bond, the first since 2004.
In the marketing documents, the Ministry of Finance (MoF) emphasised that the bond was not rated by any credit rating agency, taking a swipe at Moody’s and S&P, which downgraded the country’s rating earlier this year. A MoF spokesperson criticised the rating agencies' decision for what it considered inertial thinking, meaning a failure to understand China’s unique development path.
MoF’s view is shared by some in the market, with one senior DCM banker at a leading state-owned bank telling GlobalCapital Asia's sister publication GlobalRMB that the sovereign issuance shows there is no universal model of capital markets development. Another Shanghai-based banker quipped that international investors, not Chinese issuers and underwriters, should adjust the way they do business — such as accepting Chinese standards of credit rating — if they want to make money in China.
Dangerous thoughts
Yet this attitude could lead to the dangerous conclusion that many traits of China's market —from 100bp wide guidance used when syndicated bonds are being sold, to the overwhelming number of AAA ratings given to issuers — are somehow special characteristics of Chinese capital markets and not simply signs of the market’s immaturity.
To think that ultra-wide coupon ranges can somehow be helpful in guiding international investors entering the onshore market, or to suggest that China’s credit rating regime is in good health, when its domestic ratings do not distinguish between quality sovereign issuers in the Panda bond market and local corporates, is difficult to swallow.
Some Chinese regulators seem aware of how much work is still needed. In July, also as a result of pressure from the US, China opened the door to foreign credit rating agencies to launch a business in China without joint venture partners, although little progress has been made in getting the international rating agencies to set up wholly foreign-owned enterprises so far.
The launch of Bond Connect also suggests that regulators remain active in seeking foreign participation in the onshore market, but issues around taxation and hedging continue to delay widespread interest from global investors.
Right lessons
The unique features of China’s capital markets actually mask the ways in which their development is running in parallel with that of developed economies.
One example is the upcoming implementation of Europe’s Markets in Financial Instruments Directive II (MiFID II). When those rules come into force in January 2018, they will make it mandatory for all market participants, whether they are trading in the exchange or over the counter market, to acquire the Legal Entity Identifier — a 20-digit code that allows regulators to identify the legal entities behind trades.
While this level of scrutiny was only deemed necessary in the West after the global financial crisis, it has long been a feature in the Chinese market.
The China Securities Regulatory Commission and the People’s Bank of China already require investor identification from all market participants — institutional and retail, in both the exchange and interbank market. With the help of Hong Kong’s Securities and Futures Commission, it is now extending that oversight, albeit in a watered-down manner, to northbound Stock Connect investors.
But while China should be pleased with the increasing sophistication of its capital markets regulation, that should not breed complacency.
The less that developed markets can act as a guide for China, the more the local authorities will need to be vigilant in deciding independently where and when to tighten or loosen their grip if they are keen to avoid their own financial meltdown.
China may no longer be a student of the West, but it is certainly not ready to be a teacher.