China probe into state miner's shock bond default reveals market defects

SHANGHAI, Nov 20 (Reuters) – China’s investigation into the shock bond default by a state-owned coal miner hit shares of its listed underwriters on Friday, while shedding light on the creaking infrastructure of the country’s $4.4 trillion corporate bond market.

Top-rated Yongcheng Coal & Electricity Holding Group defaulted on a 1 billion yuan ($152 million) bond on November 10, stunning investors.

Shares of Industrial Bank Co and China Everbright Bank fell in Shanghai on Friday after regulators said the two underwriting banks were suspected of misconduct.

Hong Kong-listed Zhongyuan Bank Co was also investigated.

Recent bond investors’ “flight to quality” exposes defects in China’s bond market infrastructure, said Wang Qian, financial professor at Tongji University.

More specifically, the scandal calls into question a popular model in China’s interbank market, where banks underwrite bonds for their loan clients, who then use the proceeds to repay loans or roll over debt.

In Yongcheng’s case, the three lead underwriters are also lenders to its parent, Henan Energy and Chemical Industry Group.

“Some banks even underwrite bonds for companies to which they’re no longer willing to lend,” a bond fund manager said on condition of anonymity.

Wang added that companies should sell bonds mainly to fund business operations, rather than to repay loans.

The default of the AAA-rated Yongcheng bonds further tarnishes China’s credit rating business. Over 90% of defaulted bonds had A, double A, or triple A ratings at the time of delinquency, which had helped inflate prices, Wang said.

If rating agencies fail to signal a borrower’s creditworthiness truthfully, “to some extent, they’re misleading investors,” said Ligang Liu, chief China economist at Citi Research.

That partly explains why global investors are rushing into Chinese sovereign bonds, while largely avoiding higher-yielding Chinese corporate bonds.

“We don’t invest in the onshore market, exactly for those reasons,” said Tiansi Wang, senior credit analyst at Robeco in Hong Kong.

“We think, so far, there’s no proper risk pricing in that market. For us, as fundamental investors, it’s not a market to play.”

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