Deacons
  August 1, 2005 - Hong Kong

China: China’s Central Bank Releases Rules Governing the Issuance of Financial Bonds
  by Philip Gilligan

On 27 April 2005, the People’s Bank of China ("PBOC") promulgated the Measures Governing the Issuance of Financial Bonds on the National Inter-bank Bond Market ("the Measures"). The Measures entered into force as of 1 June 2005 and represent an attempt by China’s central bank to standardise the activities of issuing financial bonds on the national inter-bank bond market. What are financial bonds? Generally, financial bonds mean securities issued, with principal redemption and interest payments effected by financial institutions. Financial institutions in the PRC include policy banks, commercial banks, financial companies of enterprise groups and other financial institutions. Why are the Measures needed in the PRC? There are two reasons for the formulation of the Measures. First, the Measures aim at ensuring the smooth issuing of financial bonds by standardising their issuance on the national inter-bank bond market. Second, it is desirable to have unified regulatory measures on financial bond issuance given the rapid development of the inter-bank bond market and the increase of issuers in the PRC. Moreover, a set of unified rules will serve to facilitate the improvement of a market-based framework as well as the fairness and effectiveness of market supervision. The Requirements under the Measures Under the Measures, financial institutions are required to submit an application to the PBOC and obtain its approval if they wish to issue financial bonds. Financial institutions should also submit specified documents, including financial reports, an explanatory memorandum for fund raising and underwriting agreements, alongside with the application report for the issuance of financial bonds to the PBOC. Moreover, issuers are expected to meet certain requirements, such as sound corporate governance, minimum capital-adequacy levels and absence of violations within the latest three years, before they can issue financial bonds. Financial bonds may be issued publicly or to targeted clients on the national inter-bank bond market. The issuance of financial bonds could be conducted in two ways. It could either be undertaken in one go or be conducted in stages within the total amount allowed. An issuing party, if it chooses to issue financial bonds in stages, must explain in the explanatory memorandum for fund raising the arrangement for each issuance. The Measures also require the issuance of financial bonds to undergo credit rating by a credit rating agency. After the issuance of the financial bonds, the credit rating agency shall conduct follow-up credit rating over the financial bonds on a yearly basis. The Measures provide that it is compulsory for the issuing party to form an underwriting consortium. The underwriter may then sell the financial bonds it underwrites to other investors. It should be noted that the underwriter has to be a financial institution and should satisfy the terms and conditions stipulated under the Measures. What are the effects of the Measures? First, promulgating a unified set of measures to regulate the issuance of financial bonds will enhance the asset and liability management capability of financial institutions and produce a long-term stable funding source. In light of the maturity mismatch between assets and liabilities, deposit-taking financial institutions have always lacked active liability tools and are weak in assets and liabilities management. As a result, their operating initiative and risk-bearing capability have largely been restricted. It is therefore hoped that the Measures will serve to change the passive liability-holding status of deposit-taking institutions and reduce financial risks. Second, the Measures will facilitate the expansion of direct financing and the optimisation of the structure of financial assets. Currently, there is a shortage of direct financing channels for enterprises in the PRC. This has led to a low proportion of direct financing, an unsuitable structure of financial assets and an over-concentration of risks on banks and the government. Hence, the issuance of financial bonds by finance companies will be effective in promoting the development of the financial bond market. Third, the Measures will lead to an increase in the variety of investment products with different credit levels. In China’s current bond market, securities backed by corporate credit only account for a small proportion, and market credit levels and bond products are limited. As a result, investors have limited investment choices, and the development of the financial bond market has been negatively affected. Hence, the enactment of the Measures is desirable to increase the number of issuers from different classes so that more types of investment products with different credit ratings could be provided to investors. Nonetheless, there is speculation that the Measures will harm the bond market in the short run due to worries over an excessive supply of bonds. Supplementary Information The Measures provide that its provisions shall apply to the issuance of subordinated bonds by commercial banks and assets supporting bonds in the national inter-bank bond market. Under the Measures, the Interim Administrative Provisions on Issuance of Financial Bonds by Policy Banks ("Interim Provisions") released in 1998 shall be abolished at the time when the Measures enter into force. This is probably because the Interim Provisions have become too detailed and out-dated to adapt to the current market situation. Conclusion On the whole, the Measures are largely welcomed because they serve to improve the asset and liability management capacity of financial institutions, expand direct financing and increase the number of investment portfolios available for investors. It is therefore hoped that the Measures will facilitate the healthy development of the financial bond market in the long run.