1. Lecture 7 China’s bond market Capital markets of China Fall 2012 Qi Quan

2. The growth of China’s bond market over the last 10 years Now the third largest in the world in terms of total value traded

3. The structure of bond market in China  China’s bond market is composed of three parts: The exchange market  All the trades are carried out on the exchange  Centralized trading place and time  Shanghai and Shenzhen stock exchange  Qualified Foreign Institutional Investors (QFII) are presently only permitted to access the exchange market. The interbank market  Wholesale OTC market  Established after 1997  Currently, interbank bond market plays a central role, and is the largest in terms of scale

4. The main instruments in China’s bond market 1)  The treasury bond (T-bond) Certificate T-bonds  Like savings bond in U.S.; cannot be traded on the market, but can be discounted by the original seller before maturity Bearer-form T-bonds  Physical T-bond purchased in the exchanges or at bank counters Book-entry T-bonds  Electronic T-bonds  Financial bonds Policy bonds issued by the policy banks in order to finance large infrastructure projects in China such as “Three gorges dam”; the issuers are the China Development Bank, the Export-Import Bank of China and the Agriculture Development Bank of China Subordinate bonds issued by commercial banks after 2004  Central bank bill Short-term debt certificate issued by the central bank to the commercial banks Manage the excess reserve of the commercial banks  Corporate bonds Enterprise bonds are issued by institutions affiliated to Central Government departments, enterprises solely funded by the State, State controlled enterprises and other large-sized state-owned entities Issued by the corporations Both ordinary and convertible, fixed and floating rate

5. The main instruments in China’s bond market 2)  Spot trading  Forwards  Interest rate swap  Credit risk mitigation agreement (warrant)

6. The secondary market

7. The size of various sectors

8. Methods of issuing bonds  Bonds can be issued in two ways: Tender through the issue system of the People’s Bank of China (PBOC) Book building  Non-financial enterprises are allowed to issue bonds by public tender through the Issue System of the People’s Bank of China They need to satisfy the relevant provisions of the Notice of the People’s Bank of China on the Relevant Matters Concerning the Issue of Bonds by Tender

9. Credit-rating system  Eight rating agencies PBC is the main supervisor of credit-rating agencies The China Securities and Regulatory Commission (CSRC) supervises credit rating in the exchange bond market National Development and Reform Commission (NDRC) oversees the credit rating for enterprise bonds

10. Credit ranks for medium and long-term bonds in China’s interbank bond market

13. The investors in China’s bond market  Both institutional investors and individual investors Institutional investors dominate both the primary and secondary market  Types of institutional investors Banks  Big four banks; commercial banks; joint stock banks; foreign banks Insurance companies Non-bank financial institutions Securities companies Investment funds Non-financial institutions  Enterprises Foreign institutional investors (QFII)

14. The access of foreign investors  Qualified Foreign Institutional Investors (QFII) program Launched in 2002 to allow licensed foreign investors to buy and sell Yuan- denominated equities and bonds in China’s mainland stock exchanges QFIIs can transfer an approved amount of US dollars to a special QFII account in a qualified custodian account and convert to RMB under the supervision of the State Administration of Foreign Exchange (“SAFE”) As of May 2012, a total of 141 foreign institutional investors and US$26 billion quota have been approved under the QFII program.  A pilot program launched in 2010 to allow three types of offshore institutions to invest in China’s largely closed Inter-bank bond market Foreign central banks (direct access to interbank bond market) Lenders in Hong Kong and Macao that have already conducted renminbi clearing (direct access to interbank bond market) overseas banks involved in renminbi cross-border trade settlement (agent access by appointing a proxy)

15. The typical bond issuing procedure  The bond issuer selects the major underwriter →  Determines the issue scale and prices the securities →  Sets up underwriting syndication→  Sells bonds in the primary market →  Bonds are issued through bank branches and securities companies, the interbank bond market, the exchanges, and the bank OTC market.

16. Some new developments in the bond market  Municipal bond (200 billion was issued in 2009) Mainly used to finance social welfare projects, especially those unappealing to private investment, such as welfare housing projects, rural livelihood improvement programs, public health, education, cultural programs and eco-protection construction projects  SME collective notes Debt financing instrument collectively issued by 2 to 10 small and medium-sized non-financial enterprises on the interbank bond market  The take-off of “Junk-bond” market In June 2012, the Shanghai stock exchange approved seven Chinese companies to issue high-yield bonds via private placements to qualified investors First issuance: Suzhou Huadong Coating Glass offered 50 million RMB two-year bonds a a yield of 9.5% per year

17. The ratio of debt to GDP

18. Asset securitization  Transformation of banks’ illiquid assets into securities  Initiated first in 2005 and was suspended as a result of 2008 subprime crisis China Development Bank and China Construction Bank became the pilot institutions  Restarted again in 2012 An important move that would help banks diversify risk and increase the capital adequacy ratio

19. What drives the growth of bond market in China  Government’s incentives to diversify risk in the banking system  The growing need for direct financing from the private sector  The growing investment need from the general public  Obstacles Multiple regulators Underdeveloped credit-rating system Investor protection