China's local govt bond market to develop further in 2015: Moody's

The China Securities Depository and Clearing Corporation, the nation's clearing agency for exchanges, said on Monday it will not allow bonds rated below AAA to be sold by issuers graded lower than AA, or to be used as collateral for short-term loans obtained through repurchase agreements.

The ruling sparked a retreat from lower-rated bonds and contributed to shares in Shanghai tumbling as note holders reassessed the appeal of owning such debt.

The CSDC is the clearing house for bonds that are traded on China's exchanges, which account for less than 10 percent of all outstanding notes in the country.

There were 1.03 trillion yuan ($166 billion) of outstanding corporate bonds regulated by the National Development and Reform Commission and traded on exchanges as of Oct 31.

The move means about 470 billion yuan of outstanding debt can no longer be pledged for repos, according to Haitong Securities Co.

Although the affected number is relatively small, and the new rule is only being applied to the secondary market, CSDC's move still affected the main market with yields of several bonds issued by the local government financing vehicles, or LGFVs, rallying more than 100 basis points on Tuesday and Wednesday.

"What the government is trying to do is repress the liquidity of riskier bonds, raise borrowing cost for lower-quality issuers and widen the yield differentiation among bonds," said Xu Gao, chief economist with Everbright Securities.

In the short-term it is hoped that LGFV borrowing could be curbed but in the long run, Xu said, that would only happen if the government significantly boosted its on-budget spending, thus reducing incentives for local government to incur off-budget spending through LGFV financing.

Sun Binbin, a bond analyst with China Merchant Securities, said that the new AAA-or-nothing rule is not targeted at debt products issued by the local government financing vehicles, widely known as chengtou notes.

General corporate bonds that are usually given a lower rating were more affected, marginally improving the popularity of chengtou notes.

"But I would still suggest the price of chengtou notes is overvalued by investors as they blindly assume all of the notes were granted implicit guarantees from local governments," Sun said. "This has nothing to do with the latest CDSC move as we held that view even before this move."

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