The Chinese onshore bond market and why you should care about it

Why is the Chinese onshore bond market important and what differentiates Chinese and international bond markets?

Original news

Report on Chinese and international primary debt capital markets 

The first report of the ICMA/NAFMII Working Group, consisting of the International Capital Market Association (ICMA) and National Association of Financial Market Institutional Investors (NAFMII), aims to give policymakers and market practitioners a useful outline of the way in which bonds are sold through the primary capital markets in both the cross-border international debt market and the onshore Chinese interbank bond market.

What is the report about?

The report compares practices and procedures in the international investment grade public bond markets with those in the Chinese onshore interbank bond market and focusses on three key aspects of bond offerings:

  • due diligence—the process of identifying, processing and validating the information about the issuer which is provided to prospective investors to enable them to make an informed decision whether or not to invest in the bonds
  • disclosure—the overall composition of the information which issuers are required to provide to prospective investors (a description of the issuer and its business and the market in which it operates, based on the information gathered in the due diligence process, together with other information such as a the terms and conditions of the bonds and risk factors), and
  • bookbuilding—the process by which bond underwriters assess market demand for the bonds and fix the price at which they will be offered

Why is the Chinese onshore interbank bond market important?

The Chinese onshore bond market is now the third largest in the world, with total bonds outstanding of about $4.7trn at March 2015 according to figures published by the Bank of International Settlements. The interbank bond market represents more than 90% of the total Chinese onshore bond market.

Access by foreign investors to the Chinese bond market is restricted but being eased progressively as part of China’s push to promote the yuan as a reserve currency and have it included in the International Monetary Fund’s (IMF) special drawing rights (SDR) basket—in July 2015 new rules were issued making it easier for foreign central banks, sovereign wealth funds and global financial organisations to invest in the interbank bond market.

Foreign investors considering whether to participate in the Chinese bond market need to understand how it functions and how its processes and procedures compare to those of the international market.

Also, although nowhere mentioned in the report, the crash of the Chinese stock market (which is separate from the bond market) in the summer of 2015 will have raised doubts about Chinese capital markets in general—the ICMA/NAFMII report may provide a measure of reassurance, at least at a technical level.

What are the main differences between the international and Chinese bond markets?

Although the international bond markets have developed piecemeal since the 19th century and the Chinese market has grown explosively in a little over ten years, processes and procedures are quite similar—the rules governing the Chinese interbank bond market have clearly been drawn up with international best practice in mind.

The report highlights the following differences:

  • the lead underwriter of a Chinese bond issue is required to monitor the financial performance of the issuer as long as the bonds remain outstanding, whereas in the international markets the due diligence obligations of the lead underwriter cease when the bonds are issued
  • in the Chinese market the role of lawyers is limited to legal due diligence and the issuer’s auditors are not required to give a comfort letter, whereas in the international markets lawyers have a wider role in due diligence and in the preparation of the offering document and the auditor’s comfort letter is one of the key transaction documents
  • an issuer in China will effectively represent to investors that the information contained in the prospectus is accurate and the individual directors and the chief financial officer of the issuer will have personal legal liability for the information contained in the prospectus—by contrast, in the international markets, the representation by the issuer is made to the managers of the issue, not the investors, and there is no equivalent individual liability for the directors or chief financial officer
  • the full Chinese due diligence and disclosure requirements apply regardless of whether the issuer is well known to the market or a first-time issuer and regardless of the type of investors for whom the bonds are offered, whereas in the international markets due diligence is generally reduced for frequent issuers and a simpler disclosure regime applies to offers made to institutional investors
  • bookbuilding in the Chinese market is based on a transparent and mechanical auction system, whereas in the international markets bookbuilding depends on more informal soundings made by the lead manager and the lead manager’s judgment of the market

What recommendations does the report make?

The report recommends that the following should be considered:

  • adoption by the Chinese market of reduced due diligence requirements for frequent issuers and simpler disclosure requirements for offers to institutional investors
  • greater involvement of lawyers and auditors in due diligence in the Chinese market, and
  • more transparent bookbuilding processes in the international markets, drawing on the Chinese model

Tony Smith, solicitor in the Lexis®PSL Banking & Finance team.

First published on LexisPSL Banking & Finance. Click here for a free trial.

Relevant Articles
Area of Interest