The National Development and Reform Commission’s notice two weeks ago limited the use of offshore bond proceeds to only refinancing existing bonds due within one year. These notes should also have mid- to long-term maturities, the regulator said, effectively excluding first-time issuers from tapping the offshore market.
Since then, more than 20 issuers have raised over $4bn from dollar bonds, making this one of the busiest periods the sector has ever seen since taking off in 2015. Apart from those with offshore debt coming due, these issuers also include many debut names rushing to the market to get at least something — however small and whatever the price — printed before their quota expires at the end of June. A lot of them are high yield, or even unrated.
The ballooning local government debt burden has always been a key concern for market participants and the latest regulatory development is definitely a step in the right direction as China attempts to rein in the risks. But a lot more needs to be done.
While the new rules may seem strict, there is some good news. Many LGFVs, especially the ones with decent credit quality, have already issued in dollars or even euros in the past, and will be allowed to continue doing so when refinancing needs come up. This means the material impact on the sector could be limited, as only the weaker entities are excluded from coming offshore for funding.
But while China has in recent years lifted the ban on local governments directly issuing bonds, the quotas assigned to local governments — albeit larger in 2019 — are far from enough to close a funding gap between their spending needs and revenue sources. As the country faces a slowing economy and the need to maintain infrastructure spending, local governments are only going to increase their reliance on LGFVs to fill that gap, despite China’s continuing effort to separate LGFV debt from that of their governments.
That means these entities face a dilemma. On the one hand there is the push from local authorities to continue raising funds but on the other, the central government is trying to limit their ability to do so.
While the new measures are helpful in curbing local government debt risks in the long run, they have at the same time created problems for the offshore market.
Under the local government mandates, some LGFVs would look to issue wherever they can, and could potentially resort once again to issuing bonds with tenors of less than one year, which do not require regulatory approvals from the NDRC. But a resurgence of the so-called 364-day bonds could lead to higher refinancing risk and default risk for the sector — exactly what China is trying to reduce.
While issuing 364-day bonds is a grey area that needs to be addressed, more clarity is also needed about which entities should qualify as LGFVs instead of SOEs. Many policy-driven LGFVs have taken on commercial businesses over the years and no longer function purely as financing arms for the governments, although they still rely in varying degrees on the support from the governments due to their weak revenue generating abilities. Issuers and bond investors both need to be clear on whether the new rule applies.
As China has grown to be one of the biggest dollar bond issuer bases, even in the global context, there is a lot at stake. When it comes to LGFVs, now a key sector for the offshore market, regulators must be prepared to make tough decisions.