Monday Humor: China Will Bring In Moody’s, S&P To Make Bond Market Safer

If you read Heisenberg (either in these pages or elsewhere), you should be pretty well versed in China’s recent trials and tribulations.

The country has a tendency to move from crisis to crisis with remarkable rapidity as Beijing struggles to keep all of its many plates spinning.

There was, for instance, the stock market crash in the summer of 2015, when hordes of newly-minted day traders (who had managed to drive Chinese equity prices through the ceiling on the back of lunatic margin debt) found out that stocks can go down as well as up. Beijing ended up spending nearly CNY2 trillion to stabilize the market.

Then, just weeks later, the PBoC devalued the yuan, sending shockwaves through global markets and setting in motion a dynamic that has to date cost the country around $1 trillion of its FX reserves.

More recently, we saw how “fixing” one problem tends to create another (or two) when the PBoC’s efforts to rein in speculation in the bond market by raising short-term funding costs ended up contributing to what I’ve variously described as a mini-meltdown in mid-December. As WSJ notes, China’s bond market hasn’t learned “how to correctly price risk.”

But that’s ok. Because as the Journal goes on to report, Beijing is about to bring in the experts on risk pricing: Moody’s, S&P, and Fitch. Here’s more:

As Chinese bonds sold off sharply in December, Beijing quietly declared its intention to allow foreign credit-rating companies to rate local issues for the first time. This would be a step in the right direction for a market that has grown large without learning to correctly price risk. A bottoms-up approach by the likes of Moody’s, Standard & Poor’s and Fitch, in theory, could help investors better differentiate among companies, especially those with various forms of state support. In practice, it will be more complicated than that.

The status quo is that domestic bonds can be handled only by homegrown ratings companies, who have a reputation for grade inflation. More than a third of bonds get a top rating from local companies and another 60% of bonds are split over the next two tiers of ratings, also considered investment-grade.

Official numbers show more than 370 foreign institutions own a total of $150 billion Chinese bonds, tiny but the most in years. Deutsche Bank analysts expect bond investment inflows to reach as much as $800 billion over the next five years, with about $40 billion this year.

Foreign investors will have to contend with a lack of discernment between risk-free and high-risk bonds. The spread between five-year Chinese government bonds and the worst of locally-rated Chinese companies is near where it was in mid-2015, and well away from its widest. And, while not a like-for-like comparison, median spreads on global below-investment grade corporate bonds are close to 6 percentage points.

The stakes for China’s financial system are high. The bond market has become critical not just to companies and local governments, but for bank funding and heavily leveraged investment products. With unaccounted-for risk in Chinese bonds dispersed widely, investors should hope global rating companies are allowed to dig deeper.

I don’t know about you, but I’m relieved.

I mean, the great thing about bringing in Moody’s, S&P, and Fitch is that they’ve never been accused of demonstrating “a lack of discernment between risk-free and high-risk bonds” or of incorrectly “pricing risk.”

Indeed, when it comes to “digging deep” when risk is “widely dispersed,” the big three ratings agencies are second to none.

Oh, wait…