Take Refuge in the Dragon's Lair

Prescient investors took note of the corporate bond seminar held in November 2009 in Beijing under the joint sponsorship of the British Embassy and the People's Bank of China. The conference welcomed the removal of restrictions on foreign participation in China's bond market and investors were encouraged to move in. The advice proved prophetic.

Where to hide?

Each day brings new reasons to shun over-commitment to the euro zone. The yield on medium term Greek Government bonds exceeds 15% and rates continue to rises on the debt of their PIIGS companions (Portugal, Ireland, Italy and Spain). The market in the zone's paper would reel under any default. Bloomberg recently reported that contracts to insure China's bonds are now less expensive than those for Greece, Spain and Italy. Coalition government in the UK hardly improves sentiment, and a final "Job's comforter" is Ernst & Young's latest global fraud survey, which reveals an increase to 21% in the number of European companies that have experienced significant fraud.

Chinese bonds

It is time to shed predisposition, check the facts and make more room for Chinese bonds in the portfolios of investment funds and treasuries of companies doing business with China. A range of collective investments including exchange traded funds (ETFs) and index-trackers is already dedicated to China's equities.

Bonds are a way of increasing commitment to the country's capital market without increasing exposure to the volatility of equities. The opportunity is enhanced by the low correlation of Chinese bonds with US and European bonds (less than 10%) and with the country's own equities (1.6%). China's $2tn bond market spans a spectrum of issuers, maturities and investors. It is Asia's largest fixed-income market outside Japan.

The market is open to foreign institutional and corporate investors by application to the China Securities Regulatory Commission (CSRC) for the status of Qualified Foreign Institutional Investor (QFII). This gives access to government and corporate bonds, convertible bonds, warrants and other instruments approved by the CSRC. Investors will find themselves in the company of leading banks, collectives, and corporate asset managers including Barclays, Schroder Investment Management, Prudential Asset Management and Shell Asset Management. Foreign investors can also invest through foreign institutions that already have the necessary status. For example investors can buy into appropriate international exchange-traded funds (ETFs). Currency ETFs are also available.

Goldman Sachs, UBS Securities, Deutsche Bank, Credit Suisse and others have engaged in numerous joint issuing ventures. Citigroup was attracted when the government increased bond yields to wean companies off bank loans and broaden the range of investors.

Corporate bonds are many. For example the holdings of the ChinaAMC Bond Fund C recently included:

• China Development Bank
• Tangshan Iron & Steel Co
• An Hui Shan Ying Paper Industry
• Guangxi Liugong Machinery
• Guangdong Greatoo Molds
• Haima Invest Grp Co
• Guangxi Wuzhou Comms Co
• Anhui Hengyuan Coal Industry and Electricity Power.

Another major corporate, Sinochem Fertilizer, made a large bond issue in November 2009.

Rating and regulation

Issuers are fully documented by international information services and are subject to bond rating, which now approaches international standard. A defining moment was the 2006 codification by the People's Bank of China entitled "Guidance for credit rating management". This set forth the factors determining credit ratings, definitions and the index system.

Moody's has an established alliance with the China Chengxin International Credit Rating Co (CCXI). CCXI was the first nationwide domestic credit rating agency to be created with the approval of the People's Bank of China. The alliance with Moody's pools management expertise, technical know-how on rating methodologies and analyst training. CCXI is a licensed domestic credit rating agency and continues to provide domestic ratings while Moody's role emphasises globally comparable ratings for cross-border financing. There are now more than fifty rating agencies in China of which five are certified by the regulators.

Regulation is strict. The CSRC regulates the market for listed companies. The National Development and Reform Commission regulates unlisted companies. The People's Bank of China oversees structure. The Ministry of Finance handles supranational issues and the State Administration for Foreign Exchange controls transfer of invested funds. Improved regulation and increasing absolute liquidity have attracted counterparties of global stature. UBS Investment Bank, CITIC Securities, Eyebright Securities and China Securities Corporation underwrote the recent issue by The State Grid Corporation of China of RMB20bn ($3bn) seven and ten-year bonds. 2009 saw over 300 deals amounting to more than $150bn.

Treasurers and fund managers that integrate China's bonds into their risk management and portfolio planning will find themselves in a good company of fellow investors, issuers, counterparties and regulators. Chinese bonds are an opportune antidote to uncertainties nearer home.