VSB — TECHNICAL UNIVERSITY OF OSTRAVA FACULTY OF ECONOMICS
DEPARTMENT OF FINANCE
Posouzení dluhopisového trhu v Číně Assessment of Bond Market in China
Student: Mengran Qin
Supervisor of the diploma thesis: Ing. Kateřina Kořená, Ph.D
Ostrava 2017
Content
1 Introduction ... 3
2 Characteristic of Bond Market ... 4
2.1 Characteristic of bond ... 4
2.2 Bond valuation ... 4
2.2.1 Bond valuation on a coupon date...5
2.2.2 Bond valuation during two coupon dates... 5
2.3 Definition and structure of bond market ... 6
2.4 Types of bond market ... 7
2.4.1 Government bond market ... 7
2.4.2 Municipal bond market ... 8
2.4.3 Corporate bond market ... 10
2.5 Main functions of bond market ... 12
2.5.1 Financing function ... 12
2.5.2 Capital flow oriented function ... 12
2.5.3 Macro-control function ... 12
2.6 Bond balance ... 13
2.7 Turnover rate ... 13
2.8 Main risks of investing in bonds ... 15
2.8.1 Credit risk... 15
2.8.2 Inflation risk ... 16
2.8.3 Liquidity risk ... 16
2.8.4 Reinvestment risk... 16
2.9 Bond rating... 17
3 Structure of Bond Market in China ... 20
3.1 Overview of China’s bond market ... 20
3.2 Structure of the bonds in the market ... 24
3.2.1 Main issuers in China’s bond market ... 24
3.2.2 Market structure analysis of China’s current bonds ... 26
3.3 Main participants in China bond market ... 26
3.4 The trading mechanism of China’s bond market ... 27
3.4.1 Market structure in China ... 27
3.4.2 Trading mechanism of China’s bond market ... 28
3.5 The China’s bond market regulation ... 30
4 Assessment of Bond Market in China ... 32
4.1 The development of China’s bond market ... 32
4.2 Bond market trading activity ... 35
4.3 Situation of bond market in China ... 35
4.4 The relationship between interest rates and credit rating ... 43
4.5 Comparison of the most important corporate bonds and government bonds ... 44
4.5.1 Government bond “2002 book-entry treasury bonds” ... 45
4.5.2 Corporate bond “2002 China Mobile Communications Corporations” ... 45
4.5.3 Comparison of “2002 China Mobile Communications Corporation” and “2002
book-entry treasury bonds” ... 46
4.6 Comparison of China’s and USA’s bond market ... 50
4.6.1 Bond market in USA...50
4.6.2 Bond market in China...52
4.6.3 Types of bond in China bond market and USA bond market ... 53
4.6.4 The regulation and supervision in China bond market and USA bond market .. 54
4.6.5 The comparison of China’s and American corporate bond rating ... 56
4.6.6 The comparison of China’s and American market participants ... 57
4.6.7 The comparison of China’s and American secondary market liquidity. ... 57
4.6.8 The comparison of China’s and American bond’s custody agency ... 59
4.7 The weaknesses of government bonds and corporate bonds in China bond market . ...61
4.7.1 Disadvantages and problems of government bonds in China ... 61
4.7.2 Disadvantages and problems of corporate bonds in China ... 62
4.8 New trend in China bond market ... 63
5 Conclusion ... 66
Bibliography ... 67
List of Abbreviations ... 69 Declaration of Utilization of Results from a Diploma Thesis
List of Annexes Annexes
1 Introduction
A bond is one of the financial instruments which helps deficit units borrow money from the surplus units. It is usually considered as a part of the portfolios which designed by insurance companies and banks. The aim of the thesis is the assessment of the bond market in China, the main goal is the analysis of China’s bond market through the bond trading activities and comparing with American bond market, and finding the disadvantages of China’s bond market, then get some lessons.
Generally speaking, this thesis has five chapters. The first chapter introduces the main goals and the structure of the thesis.
In the second chapter, we will introduce the basic information of bond market, the type of bond and main functions of bond market.
The third chapter of this thesis is the structure of bond market in China, first, it introduces the overview of bond market in China, then introduces the structure of bond markets in China, main participants and trading mechanism and regulation.
In the fourth chapter, it introduces the development of China’s bond market, trading activities and current situation, the relationship of interest rate and inflation, comparison of the most important corporate bonds and government bonds in China.
Then we compare the development, type, regulation and supervision, credit rating, market participant, secondary market liquidity and custody agency of China and American bond market. Finally we get some weaknesses of China’s corporate bond and government bond, and give new trends of China’s bond market.
And in the last chapter of the thesis, it is a conclusion of thesis. This part sums up differences with American bond market and draws a conclusion of China’s bond markets.
2 Characteristic of Bond Market
In chapter 2, we will introduce the main characteristic of bond and bond market which includes basic information of bond market, the main types of bond market, bond valuation and main function of bond market. Bond market is a part of financial market which allows capital deficit units to obtain funds by promising a regular coupon payment to creditors. In the trading of bond, there are a lot of creditors and only one debtor. Because the coupon payment is a kind of liabilities, the cost of bond is tax deductible which encourage the deficit unit to issue bond.
2.1 Characteristic of bond
When a bond issuing, there must have an issuer who obtain funds and some bondholders as creditors. In general, the bond issuers could have be several parts:
national government and its agencies, municipals and its agencies and corporations.
The face value or par value is the amount of principals which bondholders lend to issuers. The issuers promise to return these amount of money back to the creditors when bonds mature. Face value is a given sum of money and is different with its market price. Market price is always fluctuating because of inflation, interest rate and other factors.
The coupon is amount money that issuers promise to give to creditors every coupon date. It is kind of interest of bond. The coupon is computed by face value times coupon rate. Some bonds have no coupon such as zero-coupon bond, it is a kind of discounted bond. The interest of these bonds is paid as a discount of face value when purchasing.
The maturity date is a specific date which issuers promise to pay back the principals. Generally speaking, the longer the maturity is, the higher the risk and yield are.1
2.2 Bond valuation
Bond can be exchanged in secondary market, different from it issuing in primary
1 http://www.investopedia.com/university/bonds/bonds2.asp
market, the price is usually fluctuating based on the remaining days before maturities.
Therefore, it is significant to establish a common way to evaluate the remaining value of the bond and price it. There are two different ways to calculate the market price based on two different situation.
2.2.1 Bond valuation on a coupon date
In this situation, bond can be purchased by its remaining value which is calculated by discounting the further coupon payment and principals. If the present value is higher than the face value, we say that the bond is purchased at a premium. If the present value equals to the face value, we say that the bond is purchased at par. If the present value is less than face value, we say that the bond is purchased at a discount.
C = r×F (2.1) PV = C
1+y+ C
(1+y)2+ ⋯ + 𝐶+𝐹
(1+𝑦)𝑛 (2.2) Where r is coupon rate per coupon payment period, y is yield to maturity per coupon payment period, C is coupon payment, F is face value, PV is present value, n is the total number of coupon payment periods remaining.
2.2.2 Bond valuation during two coupon dates
When bond is purchased during two coupon dates, it is difficult to assume n if we use the formula 2.2 to price a bond. It is strange when we assume both n is calculated by last coupon date and n is calculated by next coupon date. The interest during the last coupon date and the settlement date belongs to sellers and it belongs to buyers during the settlement date and next coupon date. We use accrued interest (ACCI) which is the amount of money which is owned by the sellers.
ACCI = (1 − w) ⋅ C (2.3) Where w is the proportion of the first coupon payment period remaining when bond value is calculated, C is coupon payment every coupon date.
Then we calculate the dirty price and clean price. Dirty price is the full price in which price the bond should be sold. After deducting the accrued interest, we get clean price which is the net price of the bond.
In actual, bond trading is either ex-coupon or cum coupon. The different of these two basis is who get the next coupon payment. We assume ex-coupon date is the first day the bond starts to trading without a coupon attached to it. If the business occurs during the ex-coupon date and next coupon date, buyers receive the next coupon payment and the accrued interest is positive. If the business occurs on or after the ex-coupon date, it is no coupon payment during these period which means that it is sellers who get the coupon. However, the accrued interest calculated the valuation that sellers give up the next coupon payment if they sell the bonds. in that case, we will have negative accrued interest.
If the settlement date is before the ex-coupon date, then we have:
pvd = c
(1+y)w+ C
(1+y)1+w+ ⋯ 𝐶
(1+𝑦)𝑛−2+𝑤+ 𝐶+𝐹
(1+𝑦)𝑛−1+𝑤 (2.4)
pvd = pν0⋅ (1 + y)1−w (2.5) pvC = pvd− ACCI (2.6)
If the settlement date is after the ex-coupon date, then we have:
ACCIneg = w ⋅ C (2.7)
pvd = pv0 + (1 − w) ⋅ (𝑝𝑣0 − pv0) − w ⋅ C (2.8) pvC = pvd+ 𝐴𝐶𝐶𝐼𝑛𝑒𝑔(2.9)
2.3 Definition and structure of bond market
A bond is a debt instrument of capital markets. It is a long-term debt obligations which allows issuers such as governments, municipals and corporates to satisfy its long-term capital shortage. “From the bond issuers’ point of view, they prefer to issue bond to finance its long-term obligation comparing equity financing. It is mainly because that the coupon payment is tax deductible and it will not lose control of the company. From the investors’ point of view, the interest rate on bonds is relatively higher than it on saving accounts”(Fabozzi, 2015).
A bond market is a very important part of the financial markets to issue and sell bonds. The bond market is an indispensable part of a country's financial system. A well-performing bond market can provide low-risk investments and financing tools
for investors and debtors. The yield curve of bonds is the benchmark of the level of all financial products in the social economy.
Generally speaking, bond market can be divided into primary market and secondary. market. Primary market is where the deficit units first raise funds by issuing bonds and it usually used by the private company first issuing IPOs or large company issuing additional bonds. Secondary market is where participants can sell and buy those bonds which is already issued in primary market. Usually the company can just get the funds which they get from an issue manager who underwrite the bonds in primary market regardless appreciating of bonds in secondary market.
The bond market is also a part of the credit market. The global credit market in aggregate is about 3 times the size of the global equity market which means the debt-financing is a popular way for debtors.2 When investors buy a bond, there is usually not a collateral which means that the bond rating is very significant.
2.4 Types of bond market
There are three basic bond markets, government bond market, municipal bond market and corporate bond market. In addition, there are also zero-coupon bond market and foreign bond market.
2.4.1 Government bond market
Government bond can be divided into Treasury note whose maturity is from 1 to 10 years and Treasury bonds whose maturity is more than 10 years. It is issued by government to finance the long-term national debt and other government expenditures.
2 http://bbu.yolasite.com/resources/An%20Introduction%20to%20Bond%20Markets.pdf
Chart 2.1 U.S. Treasury yield curve (nominal rate June 20, 2017)
Source:https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Page s/Historic-Yield-Data-Visualization.aspx
According to the Chart 2.1, we can see when the maturity is less than 1 year, there has lowest nominal interest rate. This rate is the most free risk rate in the economic. However, these treasury bills are not bonds because of short maturities.
And with the maturity longer and longer, the yield is higher and higher.
There is another government bond which is agency bond. These agency bond is issued by a government agency such as Fannie Mae and Freddie Mac and it is not fully guaranteed by government like T-notes and T-bonds. These agency bonds are mainly used for home mortgage financing and the cost of financing is relatively low.
This implicit relationship with the branch of federal branch cause to a high credit quality which is seen as second only to the US government bonds.
In China, the agency bonds can be divided into government-backed bond which is issued by Ministry of Railway and government-backed agency bond which is issued by Central Huijin Company.
2.4.2 Municipal bond market
Municipal bonds are issued by state and local government to finance the state expenditures such as construction of highways, bridges and schools. Potential issuers of municipal bonds include states, cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned
0.85% 1.02% 1.13% 1.22%
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YIELD
MATURITY
airports and seaports, and other governmental entities (or group of governments) at or below the state level and having more than one of the three sovereign powers: the power of taxation, the power of eminent domain or the police power.
Chart 2.2 Proportion of Municipal Bond Trading Summary by Sector (2012-2016)
Source: http://www.sifma.org/legal/
Illustrated on Chart 2.2, we can see housing is a big part of it which including single-family housing neighborhoods, multi-family housing complexes. These housing-related municipal bonds are backed by property taxes which are prepaid by developers and it will be shared by residents who move into these completed communities. Other sectors is as important as housing which including general obligation, advanced refunded, appropriated tobacco and so on.
Fabozzi (2015)pointed out that the municipal bonds can be roughly classified into general obligation bond (GO) and revenue bond based on the source of its interest payments and principal repayments. A general obligation bond is rather backed by any specific revenues from a given project than the credit and taxing power of the issuers.
On the contrary, a revenue bond provide the coupon payments from a profitable project. And there is a combination bond of both general obligation and revenue pledges which is called double-barreled bond. The municipal bond is usually used to finance an income-producing projects such as highway and local stadium.
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PROPORTION
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Education Health
Utility Various Purpose
Housing Industrial Development Revenue
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Chart 2.3 Proportion of source of repayment 2012-2106 (percentage by $ amount)
Source: http://www.sifma.org/legal/
According to Chart 2.3, we can see that a large part of municipal bonds is backed on revenues which is 70% on average and it is about 25% on average of GO bonds.
When investors consider to buy a municipal bond, they have to take the credit risk into account because it is not that much free risk like government bond. Obviously, the default risk of revenue bonds is relatively lower than it in GO bonds and we also need to consider the issuer is municipal side or non-municipal side such as conduit borrower.
At the end of 1980s and the beginning of 1990s in China, lots of local governments issued municipal bond to raise funds for construction of bridges and highways with no interest rate. And even compulsive apportion it to every agency or offset a part of salaries in the name of supporting the construction of the state.
However issuing municipal bond was strictly forbidden in 1993 by the state council because there is doubt for the ability of redemption of the local government. This rule is abolition in 2009 and total amount of issuing reached to 200 billion RMB.
2.4.3 Corporate bond market
A corporate bond is a claim issued by industrials and companies which promised to repaid the principals and coupons in a given period time. The default risk of corporate bonds is relatively higher than municipal bond and government bond and it partly
72% 74%
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Revenue General Obligation Double Barrel
depends on the credit of the issuing company. In the meanwhile, the corporate bond has higher yield with this higher default risk.
When it is related with credit risk, the bond rating is important for investors to make their portfolios. It is evaluated by rating agencies such as Standard & Poor's, Moody's Investors Service based on the credit quality of the corporations. Usually, high-rating bonds, also called investment grade bonds, are issued by good-financing-performance companies and have relatively low interest rate than junk bonds (whose bond rating is BB to D or even no rating).
Chart 2.4 U.S. Corporate Bond Trading Volume during 2012 to 2016 (USD Billions)
Source: http://www.sifma.org/legal/
Illustrated on Chart 2.4, investors prefer to buy the bonds whose rating is A and BB which is the last two level of investment grade bond. These bonds have relatively higher rating and average interest rate. Some speculations would like to buy some no-rated bonds to seek higher interest rate.
Issuing corporate bonds is commonly used by the corporations. Companies can set up the elements of bonds such as size of bond, coupon rate and maturities itself comparing financing with bank loans. And the interest rate of bank loans could be different every time corporations apply for a loan. And the coupon payments can be a part of liabilities which is tax-deductible and will have no impact with the
AAA AA A BBB BB B CCC CC C D NA/N
R
4Q'12 0.5 1.4 5.6 5.7 1.8 2.6 1.1 0.1 0.0 0.1 2.4
4Q'13 0.4 1.6 5.6 6.4 2.6 2.2 1.4 0.1 0.1 0.0 2.5
4Q'14 0.3 1.8 6.3 7.0 3.2 3.1 1.3 0.1 0.1 0.0 2.9
4Q'15 0.2 1.9 5.6 7.6 3.3 3.2 1.4 0.1 0.0 0.2 2.2
4Q'16 0.3 2.1 6.3 8.8 2.9 3.1 1.5 0.1 0.1 0.3 2.3
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decision-making of the companies, however, the dividends cannot decrease the tax and issuing shares will increase the numbers of shareholders. Therefore, corporations prefer to issue bonds to finance its long-term projects in some aspect.
2.5 Main functions of bond market
Throughout the mature financial markets all over the world, we should admit that these mature financial markets can exist because they have a developed bond market.
The bond market occupies such an important role in the social economy because it has the following important functions:
2.5.1 Financing function
The bond market, as an important part of the financial market, has the function of raising surplus funding to the people who demand for funds which can raise funds for the this group. Chinese government and enterprises have issued a number of bonds to make up for the budget deficit and raise money for many key construction projects.
During the "Eighth Five-Year Plan" period, Chinese enterprises raised a total of 82 billion yuan through the issuance of bonds, focusing on supporting the Three Gorges Dam Project, Shanghai Pudong New Area, Beijing-Kowloon Railway, Shanghai-Nanjing Expressway, Jilin Chemical industry, Beijing Metro, Beijing West Railway Station, Transportation, important raw materials and other key construction projects and urban public facilities construction.
2.5.2 Capital flow oriented function
Enterprises with good benefits are usually more popular with investors, so the interest rate is low and the financing cost is small for these enterprises. On the contrary, the risk of issuance of bonds is relatively large, which is less favorable to investors and the financing cost is higher. Therefore, through the bond market, funds can be concentrated to the superior enterprises, which is favorable to the optimal allocation of resources.
2.5.3 Macro-control function
As a national monetary policy formulation and implementation departments, the central bank of a country carry out macroeconomic control mainly rely on deposit
reserve, open market business, rediscount and interest rates and other policy tools.
The open market business is that the central bank sales the bond and other securities through the securities market, thus regulating the money supply which is an important means to achieve macro-control. When the economy is overheated and the money supply needs to be reduced, the central bank sells bonds to recover some of the currency held by financial institutions or the public to curb the overheating of the economy. When the economy is depressed and the money supply is needed, the central bank buys bonds and increases money supply.
2.6 Bond balance
The accumulated bond balance refers to the amount of bonds that have already been issued but not yet repaid, it can also be called outstanding bonds.In China, “The Securities Law” sixteenth rules that: "the cumulative balance of bonds can not exceed 40% of the net assets of the company. The purpose of implementation of the balance control is to protect the profit of bond holders, and facilitate the company to continue financing.3
In the company debt financing tools, there are some financing tools that are restrained by the securities law, they are short-term financing bonds, medium-term notes, corporate bonds, a collection of notes and collection of bonds, but private bond, asset backed securities are not limit by the rules.
The ratio bond balance of bond balance to GDP can shows the degree of importance of bond market, if bond balance divided by GDP is higher, it means that the bond market in this country is active, if bond balance divided by GDP is lower, it means the bond market poorly developed.
2.7 Turnover rate
The bonds turnover ratio is a measure of bond market liquidity. The ratio shows the extent of trading in the secondary market relative to the amount of bonds outstanding. The average amount of bonds outstanding is computed by determining
3http://wiki.mbalib.com/wiki/%E7%B4%AF%E8%AE%A1%E5%80%BA%E5%88%B8%E4%BD%99%E9%A2
%9D
the average amount of bonds outstanding at the end of the previous and current quarters. This ratio is computed separately for government and corporates, and excludes repurchase transactions. The higher the turnover ratio, the more active the secondary market.4 The formula is:
turnover rate = trading volume
circulation market value (2.10) This formula shows the trading volume take a percentage of total circulation market value, if the turnover rate is higher, it means the trading volume is relatively higher, liquidity of this bond is high, the trading of this bond is active, on the other hand, it shows that investors have strong will to buy this bond, therefore we can infer the bond is popular, and investors pay more attention to this bond.
Chart 2.5 Turnover rate in different Asia countries on December fist 2016
Source:https://asianbondsonline.adb.org/regional/data/bondmarket.php?code=Bond_t urn_ratio
From this chart, it show that China has the highest turnover rate in Asia, it’s turnover rate is 0.21, the second is Indonesia, the turnover rate is 0.2, in China, Hong Kong has 0.14 turnover rate , it’s relatively higher than average level, it means the secondary market in Hong Kong is active.
Example of turnover rate
The Dreyfus Appreciation fund has a strong buy-and-hold method of investing in mostly large blue chip companies with total market capitalizations of over $5 billion at the time of purchase. Those companies show sustained profitability, strong balance
4 https://asianbondsonline.adb.org/regional/data/bondmarket.php?code=Bond_turn_ratio 0
0.05 0.1 0.15 0.2 0.25
CN HK ID JP KR MY TH
Turnover rate in different Asia countries on December fist
2016
sheets, global expansion and above-average earnings growth. As of May 4, 2016, the Dreyfus fund’s turnover ratio was 29%.
In contrast, the Rydex S&P Small-Cap 600 Pure Growth fund invests in the common stock of companies within the capitalization range of the underlying index and derivative instruments. At least 80% of the fund’s net assets, as well as borrowings for investments, are invested in securities of companies in the underlying index and derivatives, and other securities whose performance should correspond to that of the underlying index. The Rydex fund is non-diversified and as of March 31, 2016, had an average turnover ratio of 309%.5
2.8 Main risks of investing in bonds
In this sub-chapter, we will discuss several main risk associated with investing such as credit risk, inflation risk, liquidity risk and reinvestment risk. Investors must take these risk into account when making portfolios.
2.8.1 Credit risk
Credit risk, also referred to default risk, is the possibility of loss from a debtor’s default.6 When issuers plan to use future benefits to pay current liabilities, no one could guarantee that borrowers will have money to repay these debts. This is where credit risk arises. Usually a good financial condition of a government or a corporate will decrease the credit risk.
Although the government bond is the lowest risk in the world, we need to evaluate the credit of the countries. For example, the government bond of Brazil whose yield of 10Y bond is 10.7% is definitely more risk than the U.S. treasury bond (10Y 2.14%) when the maturity is the same. According to the statistic of trading economics, 10 years Japanese government bond has the lowest yield which is 0.05%.7
As for corporate bond, it is usually not backed by a collateral, therefore, it is more risk than the government bonds and municipal bonds. However, higher risk means higher return. For making sure that the money we invest is safe, we need to
5 http://www.investopedia.com/terms/t/turnoverratio.asp
6 http://www.investopedia.com/terms/c/creditrisk.asp
7 https://tradingeconomics.com/bonds
think carefully when we buy corporate bonds. Credit risk is an important factors.
Credit rating agencies like Moody’s, Standard and Poor’s and Fitch will help a lot.
2.8.2 Inflation risk
When investors buy a bond, they do receive coupons every coupon payment date, either it is semi-annual or annual. These coupons is kind of rate of return. But what if the inflation rate rises when investors buy a long-term bond. A increasing of inflation rate means an increase of cost of living. However, those coupon which is determined before is unequal to the expected return what we want before.
Puttable bond is a way to reduce the inflation risk. Puttable bond is a bond with a put option which allows bondholders can resell these bond back to the issuers usually in face value. When inflation rate increases, the bondholders can use this right to get principal back because of lower purchasing power of coupons.8
2.8.3 Liquidity risk
Liquidity risk occurs when investors convert their current assets to future income.
If the market is not that liquid, there is a risk that the investors might not be able to sell the securities quickly.
Liquidity risk is associated with bid/ask spread. If the spread is wide, the market is illiquid. If the spread is narrow, the market is more liquid.9 The spread measures the difference between the lowest price acceptable to prospective sellers and the highest price acceptable to prospective buyers. It means that the transaction size is very important for liquidity risk.
2.8.4 Reinvestment risk
When investors receive the coupons and principals, it is a big question if they want to reinvest their funds. Reinvestment risk is the risk of having to reinvest proceeds at a lower rate than the funds were previously earning.10
One of the most reason of reinvestment risk is callable bond. Callable bond is a bond which issuer has a call option and issuer has the right to buy the bond back from
8 https://en.wikipedia.org/wiki/Puttable_bond
9 http://www.investopedia.com/exam-guide/cfa-level-1/fixed-income-investments/liquidity-risk.asp
10 http://www.investopedia.com/articles/bonds/08/bond-risks.asp
bondholders at a call price.11 Usually when interest rate falls, issuer use the call option. They can save money by paying off the bonds and issuing new bond with lower coupon rate. Thus, investors is more risky when buying callable bond. This is why callable bond always have a higher interest rate which is to compensate for the risk that the bonds might be called back.12
2.9 Bond rating
Bond rating system is a process that a grade is given to a bond. It is usually expressed as letters ranging from “AAA” to “C” and “D”. Different rating agency has its own way to express the grade. There are 3 biggest rating agency in the USA:
Moody’s, Standard and Poor’s and Fitch rating. And below table will shows the different credit level of these three rating agency.
Table 2.2 Different bond rating scales from major rating agency in USA Bond Rating
Grade Risk
Moody’s S&P/Fitch
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative
Caa/Ca/C CCC/CC/C Junk Highly speculative
C D Junk In Default
Source:http://www.investopedia.com/walkthrough/corporatefinance/3/bonds/ratings.a spx
A junk-rating bond means that the issuers face a financial difficult and they have to offer a much higher yield than other debt. Junk bond is usually a symbol of speculation. Rating agencies regularly review bond rating every 6 to 12 months. Not only the institutional investors but also personal investors make decisions depends on
11 https://en.wikipedia.org/wiki/Callable_bond
12 https://www.sec.gov/fast-answers/answers-callablebondshtm.html
the investigate of rating agencies.
Table 2.3 The meaning of different rating degrees
‘AAA’ Extremely strong capacity to meet financial commitments. Highest rating
‘AA’ Very strong capacity to meet financial commitments
‘A’ Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances
‘BBB’ Adequate capacity to meet financial commitments, but more subject to adverse economic
conditions
‘BBB-’ Considered lowest investment grade by market participants
‘BB+’ Considered highest speculative grade by market participants
‘BB’ Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business,
financial and economic conditions
‘B’ More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments
‘CCC’ Currently vulnerable and dependent on favorable business, financial and economic
conditions to meet financial commitments
‘CC’ Currently highly vulnerable
‘C’ A bankruptcy petition has been filed or similar action taken,
but payments of financial commitments are continued
‘D’ Payments default on financial commitments
Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.
Source:http://lms.vsb.cz/pluginfile.php/593197/mod_resource/content/1/SP_CreditRat ingsGuide.pdf
Credit risk.
In Standard & Poor’s long-term rating scale, issuers and debt issues that receive a rating of ‘BBB–’ or above are generally considered by regulators and market participants as “investment grade”, while those receive a rating lower than ‘BBB–’ are
generally considered as “speculative grade.”13 The importance of credit rating
Credit ratings enable corporations and governments to raise money in the capital markets.and it plays a very important role in bond market. , these entities sometimes borrow money directly from investors by issuing bonds or notes instead of taking a loan from a bank. Investors buy these bonds , such as municipal bonds, expecting to receive interest plus the return of their initial principal when the bond matures or as periodic payments.
Credit ratings may improve the process of issuing and buying bonds and other debt issues by giving an efficient, widely recognized, and long-standing measure of relative credit risk. Investors and other market participants may use the ratings to choose the bond their want to match the relative credit risk of an issuer or individual debt issue with their own risk tolerance or credit risk guidelines in making investment and business decisions.14
13 www.standardandpoors.com
14 www.UnderstandingRatings.com
3 Structure of Bond Market in China
This chapter is about the whole structure of the Chinese bond market. Firstly, we are going to introduce the overview and development of bond market in China. Secondly, in the second part, we will introduce the structure of China's bond market, main issuer and types of bonds. Thirdly, we will describe the transaction mechanism in China's bond market. At last we will introduce the regulations and supervisions of bond market in China.
3.1 Overview of China’s bond market
As we all know that China’s economy has been developing rapidly in recent decades. China has become the world’s second largest economy. However, that is because our country tries our best to develop labor-intensive industries and extensive domestic investment. We lack depth in our financial sector, especially the underdevelopment of capital and bond markets. For continued growth, China needs more well-developed capital and bond markets.
Traditionally, China has focused on equity markets and bank loans at the expense of bond markets. But fully functioning, open financial markets and efficient capital allocation depend on the strong foundation of a liquid and transparent bond market. A mature domestic bond market offers a lot of opportunities for the government and the private sector to raise funds as an alternative to bank lending. And the government bond market typically creates opportunities for other issuers. However, there are a lot of problems existing in China’s bond market. We will discuss them later.
At present, the China’s bond market includes interbank market, exchange market and commercial bank counter market. In view of the total amount of trust, the inter-bank bond market is the main body of the Chinese bond market due to the participation of commercial banks. Its bond stock and trading volume account for more than 90% of the Chinese bond market. The exchange bond market is an important part of the Chinese bond market, and its participants cover both institutional investors and individual investors. The exchange bond market consists of two parts:
one is the retail market that focuses on matching transactions, and the other is the
wholesale market, which consists of fixed income place and trading systems.
Commercial bank counter trading market is an extension of the inter-bank bond market, also belongs to the bond retail market.
Table 3.1 China's bond market classification
Source: www.chinabond.com Inter-bank Bond Market
Stock Exchange Bond Market
Bank Counter Bond Market Market
properties
OTC transactions Transaction on exchange
OTC transactions
The types for issuing and trading
Treasury bonds, financial bonds, short term financing, medium-term notes, corporate bonds, asset securitization products
National bonds, corporate bonds, asset receipts
National bonds
Derivative trading instruments
Forward rate
agreements, interest rate swaps, etc.
Separable transactions Convertible bonds, ordinary convertible bonds Investors Institutional Investor All Investors
(except Commercial Banks)
Individual and Corporate Investors
Table 3.2 China's bond market classification Inter-bank Bond Market
Stock Exchange Bond Market
Bank Counter Bond Market Transaction varieties spot trading,
pledged repurchase,
pledged
repurchase, spot trading
spot trading
buyout repurchase, forward transaction Methods for
transaction
One-on-one inquiry transaction
One-to-one inquiry
transaction and automatic matching
bank counter offer
Settlement system by the full settlement
By the daily settlement of the net settlement
by the full settlement
Settlement time T + 0 or T + 1 T+0 T+0
Bond custodian Central Treasury Registration and Settlement Co., Ltd.
China Securities Departure &
Clearing Co., Ltd.
Commercial bank
Source: www.chinabond.com
After 10 years of development, China's bond market has formed a relatively rich product range, including treasury bonds, central bank bills, local government bonds, financial bonds, corporate bonds, medium-term notes, short-term financing bonds, corporate bonds, convertible bonds and other varieties. In the form of terms, not only has a period of only three months of short-term bond varieties, but also 30 years,
50-year long-term bond varieties.
China’s bond market development process
Since 1981, the development of China's bond market has gone through four stages of development.
The first stage was from 1981 to 1987, which was the embryonic stage of the bond market. In 1981, the national bonds regained to issue, marking the formal beginning of the Chinese bond market, corporate bonds began to appear since 1984, 1985 state-owned commercial banks have begun to issue financial bonds. However, at this stage, there was no legally formed bond trading mechanism or place of exchange, bonds cannot be transferred or traded, so it can be said that this stage of the bond market is very primitive.
The second stage was from 1988 to 1996, which was the bond market start and exploring stage. In 1988, the Ministry of Finance and the People's Bank began to plan the establishment of an open government bond market, in December 1990, the exchange bond market was formally established, and marking the development of China's bond market has entered a new historical stage. Since then, the issuance of bonds began to be marketization, transferred from the administrative assessment to the underwriting, the issuance of bonds was successful in 1995, and the success of the development of this stage is another major breakthrough in the bond market.
The third stage was from 1997 to 2002, during this stage: the inter-bank bond market has sprung up, the framework of China's bond market basically formed. In June 1997, the People's Bank of China requested all commercial banks to withdraw from the exchange market, and established a national inter-bank bond market. The foreign exchange trading center system was used as the quotation system. The central government bond registration and settlement company was used as a backstage settlement system, for transaction. Since then, the inter-bank bond market has gradually expanded into a bond market that all types of institutions can participate in, and eventually form a bond market system, mainly based on inter-bank bond market, minor for exchange bond market and commercial bank
The fourth stage was from 2003 to 2017, at this stage, the interest rate market
accelerated to run, system construction and market regulation gradually developed and improved. The most prominent is the large-scale development of credit products, such as short-term financing bills, medium-term notes, unsecured corporate bonds, separate trading convertible bonds (WB), corporate bonds and other varieties, the market size are from small to large, rapid development. In addition, derivative products made from scratch, achieved a breakthrough. Such as bond forward, interest rate swaps and other products, are beginning to appear at this stage. In particular, the interest rate swap market, since the official launch in 2006, the current monthly turnover is nearly 100 billion, become an important part of the bond market15.
3.2 Structure of the bonds in the market
This chapter is going to introduce the main issuers in China’s bond market. Then we will analyze the market structure in China’s current bonds.
3.2.1 Main issuers in China’s bond market
In order to clarify the relationship between creditors and debtors and protect the equity of investors, China has set up China Government Securities Depository Trust Clearing Co. Ltd(CDC), China Securities Depository and Clearing Co. Ltd(CSDCC) and Shanghai Clearing House(SCH), and carries out centralized and unified securities registration, custody and settlement system for different bond markets.
The CDC and SCH is jointly responsible for bond distribution, custody and settlement business in inter-bank bond market. In addition, the CDC is also the primary custodian of the bond business of the commercial banking counter market and the custodian of the treasury bonds held by the exchange. CSDCC is to undertake all the registration and settlement business which original belongs to the Shanghai.
15 Shanghai stock exchange report in 2015
Table 3.3 Major bond products in China (2015)
Inter-bank market Bank counter
market
Exchange market
CTBR Shanghai clearing house CTBR CSDCC
Government bonds
Short-term financing bonds Book-entry Treasury bonds
Government bonds Government
bank bonds
Ultra short-term financing bonds Policy bank bonds
Local bonds
Government agency bonds
Medium-term notes China Railway Corporation and Government agency bonds
Policy-oriented financial bonds
Non-commercia l bank bonds
SME collection bills Corporate
bonds Corporate
bonds
Non-public debt financing instruments
Convertible bond Asset-backed
securities
Financial corporate short-term financing bond
SME private placement bonds Non-financial companies of
asset-backed notes
Credit asset-backed securities Debt-financial assets management companies
Inter-bank certificates of deposit Government agency bonds
Source: https://www.licai.com/yanjiu/201512-95030.html
3.2.2 Market structure analysis of China’s current bonds
In 2015 bond market, government bonds account for 25% ,Debt-financial assets management companies account for 1%, government agency bonds account for 1%, Medium-term notes account for 5%, inter-bank certificates of deposit account for 21%, asset-backed securities account for 2%, financial corporate short-term financing bond account for 2%, corporate bond account for 5%, closed redirect debt financing instruments account for 4%, short-term financing bonds account for 5%, ultra short-term financing bonds account for 11%, capital instruments account for 1%,SME private placement bonds account for 1%,Others account for 1%.
Chart 3.1 Market structure analysis of China's current bonds by bond type (2015)
Source: https://www.licai.com/yanjiu/201512-95030.html
3.3 Main participants in China bond market
Bond market consists of OTC market and exchange market in China. OTC market includes inter-bank market and over-the-counter market. Exchange market includes Shanghai Stock Exchange and Shenzhen Stock Exchange. The main participants in inter-bank bond market are institution investors and it’s a huge market.
SME private placement bonds Capital instruments
Ultra short-term financing bonds Short-term financing bonds Closed redirect debt financing instruments
Corporate bond
Financial corporate short-term financing bond
Other
Asset-backed securities Interbank certificates of deposit
The main participants in OTC market are individuals and institution investors and the prices are negotiated by both parties. Exchange market provides various types of bonds listed on the Shenzhen Stock Exchange and the Shanghai Stock Exchange for investors. The total amount of bonds traded in the Shanghai Stock Exchange accounted for more than 90% of the total exchange market and it’s the chief exchange market in China.
Chart 3.2 Main participants in China bond market (2016)
Source: http://www.cnfinance.cn
The main participants in China’s bond market are institutional investors and the personal investors only account a few part and is concentrated on government bond.
From the holding amount of bonds' point of view, the commercial bank accounts 4.31% in total participants while holding almost 70.67% in total bond balance at the end of 2016. And the settlement of repurchase of bond stands 72.65% in total settlement which is the biggest providers of capital and the main body of trading.
3.4 The trading mechanism of China’s bond market
In this chapter, we will describe the market structure in China and then we will introduce the trading mechanism of China’s bond market.
3.4.1 Market structure in China
China's bond market formed a unified hierarchical market system, including the
Commercial bank Other
Security company Insurance company Fund
Credit union
Non-financial institutions Non-bank institutions National commercial bank Members of the special settlement
inter-bank market, the exchange market and commercial bank counter market. The following table is China's 2016 bond market trading pattern, it can be seen that the amount of inter-bank circulation and transaction is the largest share of the largest part and the commercial bank counter market is the smallest
Table 3.4 China's bond market trading pattern in 2015 (Trillions of Yuan)
Trillions of Yuan Inter-bank market Exchange market Bank counter market
Circulation 15.75 1.07 0.19
Trading volume 548.41 126.72 0.011
Managed volume 42.35 2 0.66
Source: https://www.haiyinhui.com/news/licaizhishi-wz1636
3.4.2 Trading mechanism of China’s bond market
China's bond market transactions are divided into floor trading market and OTC market, and the OTC market is the main place for China's bond trading, supplemented by the floor trading market.
The floor trading market is also known as the exchange market. There are varieties of bonds traded on the exchange including national debt, corporate bonds, convertible bonds, cross-market corporate bonds and so on. In addition to institutional investors, individual investors can also carry out investment transactions through the exchange market, you can sale the bonds like the sale of stocks. The number of bond transactions in the floor trading market is small, usually in hand (1,000-yuan denomination) as a unit. The floor trading market transaction is mainly use the competitive Price Transaction system for warranty.
OTC market is the main place for China's bond trading, that is, we usually say that the inter-bank market. The bond custody of it has more than 260 billion Yuan, accounting for 93% of the total bond stock. In other words, 93% of the bonds can only be traded through the inter-bank market.
The members of the inter-bank market mainly include banking institutions and non-banking institutions such as insurance company, fund company, securities
company, trust company and finance company. Institutional members use market admittance system, and they need to have a certain transaction settlement conditions to enter the market transactions. Individual investors are hard to get into this market.
There are thousands of professional traders in the inter-bank bond market, and the deal is usually negotiated by telephone and electronic inquiry between traders.
The inter-bank market use cash bond market market-maker system to standardize the market and promotes the market liquidity. The central treasury registration and settlement company will evaluate the bond price on each trading day; the inter-bank market traders' association will also price the valuation of the upcoming bonds on a weekly basis according to the quotation of each quotient, this price will affect the transaction price of the secondary market to some extent.
Chart 3.3 Inter-bank bond market bond transactions flow chart
Source: www.chinabond.com
3.5 The China’s bond market regulation
China bond market supervision has been in a situation of fragmenting regulation;
the following can show the regulation of different bond varieties.
|
ElectronicTrading System
Both parties to a transaction
Conclude the transaction China bond comprehensive business platform(client)
Both parties confirm it
Sufficient bonds
Sufficient funds momoneybo nds
Insufficient bonds
Insufficient funds
Waiting for the bonds
Waiting for the funds
When they are still insufficient by the end of the settlement date, the contract becomes invalid and a failure delivery order will be generated
CCDC book-entry system Send message
Payment system Crediting bond-paying party’s account
Debiting bond-receiving party’s account
Return the success order to the
CCDC book-entry system CCDC book-entry
system Bonds are transferred
The settlement contract is made successfully and a delivery order is generated
From the bond issuance, the government bonds are issued by the People's Bank of China, the Ministry of Finance and the Commission management. The corporate bonds are issued by the National Development and Reform Commission, the People's Bank of China and the Commission, the financial bonds’ issuance are managed by the People's Bank of China and the CBRC management.
From the bond market circulation, the People's Bank of China and the SFC are responsible for regulating the inter-bank bond market and exchange bonds market.
From the table, a bond often corresponds to multiple departments, which means that in order to successfully issue, the entire bond issuance must meet the requirements of the three different departments, and because there is an internal link between each process, The division of the surface will only cause the overlap of operation, the communication between the issuer and the regulatory authorities are easy to have obstacles. On the one hand, it makes it difficult to divide the work between the regulatory authorities and regulatory efficiency is low, there may be a regulatory empty, on the other hand, also makes the bond market investors cannot get use to different requirement of different regulatory institution, it will influence their investment goals, the unclear regulation and the division of market are adverse to share information and communication, it not only limit China's bond market development, but also adverse to the coordination operation fiscal policy and monetary policy.
4 Assessment of Bond Market in China
This chapter is divided into 6 parts to evaluate the Chinese bond market. First of all, we introduced the development of Chinese bond market including bond market trading activity. Secondly situation of bond market in China was described. Thirdly we compared the amount and balance of bonds issued by 12 provinces in China.
Fourthly, we chose several bonds to do multiple regression, trying to analyze the relationship between each variable and the bond interest rate. Then we compared the Chinese bond market with the US bond market and briefed the shortcomings of Chinese corporate bonds and government bonds. At last, the new trend of Chinese bond market and green bonds were introduced.
4.1 The development of China’s bond market
We choose the data including bond balance and amount of bond from 2000 and every 5 years as one part to analyze the current situation of China’s bond market based on the table and chart. And trading activity, the volumes of trading. Amount of bond means the number of trading bonds, bond balance means the bond amount that have been issued but not yet repaid.
Table 4.1 Amount of bond in China (2000-2017)
2000 2005 2010 2015 2017
Government Bond 44 106 184 248 270
Municipal Bond 0 0 50 97 2,619
Central Bank Bill 1 59 107 9 10,376
Financial Bond 50 132 405 1,707 1,515
Corporate Bond 76 63 515 3,544 7,533
Medium-term Note 0 0 219 2,250 3,298
Commercial Paper 0 0 257 1,367 1,554
Private Placement Note 0 0 0 1,711 2,248
International Bond 0 0 4 3 8
Government backed agency bonds 7 5 33 84 125
Asset-backed Security 0 0 49 439 3,549
Convertible Bond 3 32 32 38 134
Total 181 397 1,855 11,497 33,229
Source:http://www.chinabond.com.cn/cb/cn/yjfx/zzfx/nb/20170109/146099051.shtml
Chart 4.1 Amount of bond in China (2000-2015)
Source:http://www.chinabond.com.cn/cb/cn/yjfx/zzfx/nb/20170109/146099051.shtml According to this table 4.1.1, in China every 5 years during 2000 to 2015 the amount of bond increase. For instance, in 2000, the amount of government bond is 44 and increase to 270 in 2017. The proportion of corporate bond and financing bond is 41.99% and 27.62% in 2000, however, the proportion of central bank bond occupy a large part which means the central bank bond developed rapidly during these years which increased from 181 to 33229.
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000
2000 2005 2010 2015 2017
Government Bond Municiple Bond Central Bank Bill Financial Bond Corporate Bond Medium-term Note Commercial Paper Private Placement Note International Bond Government backed agency bonds
Asset-backed Security Convertible Bond Total
Table 4.2 The Bond Balance in China 2000-2017 (100million RMB)
Bond Balance 2000 2005 2010 2015 2017
Government Bond 13179.99 31,261.90 61,516.77 95,908.93 123,394.36 Municipal Bond 0.00 0.00 2,000.00 11,623.50 123,251.57 Central Bank Bill 118.92 9,742.10 40,565.00 4,222.00 80,151.80 Financial Bond 8,756.43 18,140.87 50,459.66 127,293.71 168,945.85 Corporate Bond 250.22 1,153.50 9,215.78 36,985.02 77,034.12 Medium-term Note 0.00 0.00 8,649.65 33,900.29 46,491.47 Commercial Paper 0.00 0.00 4,501.05 17,637.43 16,773.70 Private Placement
Note
0.00 0.00 0.00 17,847.84 20,909.64
International Bond 0.00 0.00 40.00 31.30 200.00
Government backed agency bonds
106.32 119.00 2,930.00 10,175.00 13,955.00
Asset-backed Security 0.00 0.00 234.20 3,114.84 12,180.30 Convertible Bond 18.50 334.93 1,053.42 1,320.75 1,709.58 Total 22430.38 60,752.30 181165.53 360,060.61 684,997.39
Source:http://www.chinabond.com.cn/cb/cn/yjfx/zzfx/nb/20170109/146099051.shtml Chart 4.2 The Bond Balance in China (2000-2017)
Source:http://www.chinabond.com.cn/cb/cn/yjfx/zzfx/nb/20170109/146099051.shtml Illustrated on the table and chart, the bond balance of government bond is highest
0.00 100,000.00 200,000.00 300,000.00 400,000.00 500,000.00 600,000.00 700,000.00 800,000.00
2000 2005 2010 2015 2017
Government Bond Municiple Bond Central Bank Bill Financial Bond Corporate Bond Medium-term Note Commercial Paper Private Placement Note International Bond
Government backed agency bonds
Asset-backed Security Convertible Bond Total
