Much of the volatility that has recently shaken China’s credit markets has been associated with government interventions. For investors who are worried about the risk implications, fundamental analysis can provide a guide to how the country’s regulators think about companies and sectors.
China’s policy agenda involves a delicate balance between opening up its economy and capital markets and maintaining social stability. The first of these policy strands includes allowing more companies to default on their debt, as a way of enabling risk in credit markets to be priced more accurately—a reform generally welcomed by global credit investors.
The second strand was apparent recently in a crackdown on the education and tech sectors where business practices conflicted with the government’s social aims. The move led to a dramatic sell-off in stocks and in the offshore Chinese currency and credit markets.
Consequently, many investors in Chinese credit are wondering how to assess the risk implications of government interventions. Our research into two under-pressure credits—asset manager Huarong and property developer Evergrande—has yielded some insights.
Which Companies Are Systemically Important?
Huarong, which is majority state-owned and has assets of RMB 1.7 trillion (US$262 billion), alarmed bondholders in April when it failed to announce its 2020 results. The sell-off in its bonds was made worse by investor uncertainty about whether the company would be allowed to default in line with the government’s market liberalization aims.
We don’t think it will because, in our view, the company is systemically important.
Understanding which companies are systemically important is the key to understanding risk in Chinese credit markets. While it’s generally assumed that the government will support state-owned enterprises, the government doesn’t publish a list of systemically important companies or sectors. Fundamental analysis, however, can help in this respect.
In the banking sector, for example, it’s relatively easy to determine which entities are systemically important. The top three tiers of banks—three policy banks and the first- and second-tier commercial banks (respectively, six state-owned banks and 12 joint-stock banks) collectively account for between 60% and 70% of the banking system’s balance sheet.
On size alone, they are systemically important, but there are other factors. These include state ownership, interconnectedness with the financial system (such as borrowing in the interbank market), the banks’ importance for social stability and their access to international capital markets.
The last consideration is significant for China’s national agenda. An asset-manager default in offshore bond markets—a concern of some investors—might limit Chinese issuers’ access to foreign capital. That would run counter to Beijing’s policy of internationalizing the renminbi (RMB).
Huarong and other asset managers meet four of these five criteria (Display).