March 21, 2024 (MLN): China’s revised rules for securities companies’ debt underwriting signal regulators’ increased acceptance of bond defaults, which could elevate refinancing risks for issuers with weaker credit profiles, says Fitch Ratings.
The changes may benefit securities companies by clarifying credit intermediary responsibilities and encouraging a more market-oriented approach for risk resolutions, thereby potentially lowering contingent liabilities for securities companies.
The underlying asset-quality risk could increase for some trust products; these products have historically been a key funding source for higher-risk corporate borrowers in China.
Press reports suggest that the Securities Association of China has circulated a consultation paper proposing updated criteria for assessing securities companies’ bond underwriting and trustee operations on an annual basis.
Such regulatory scoring can influence various aspects of a securities company’s business, including applications for new business licenses.
The proposed amendments highlight the regulatory intention to promote more rigorous debt underwriting practices and foster market-driven solutions for distressed bond issuers.
A significant revision includes the expansion of penalty points for securities firms serving as bond trustees from the previous top 20 to the top 30 with the highest default rates on bonds they underwrote, suggesting a stronger regulatory push for stricter bond underwriting practices.
The new rules also eliminate the bonus points awarded previously to securities companies that avert defaults by helping extend maturities for bonds they serve as trustees, which Fitch believes the regulator views as merely postponing defaults.
The emphasis is shifting toward more sustainable risk-resolution strategies, such as debt restructuring and bankruptcy reorganization.
Under the proposed new rules, securities companies will be awarded bonus points if they achieve significant progress in major litigations and further help define the responsibilities of credit intermediaries through setting precedents.
These bonus points contribute to the overall regulatory score received by a securities company.
The agency believes the revised rules also represent increased efforts to steer capital markets financing towards sectors of strategic importance to government policies, particularly those related to decarbonization, science and technology.
Under the new rules, securities companies will receive more bonus points for underwriting bonds that support certain government policies, including green and carbon transition bonds and issuance by science and technology entities.
This will help to bolster securities companies’ role in directing capital allocation in the financial system and supporting the government policy priorities, further strengthening the expectation for securities companies to receive extraordinary support from their central and/or local governments, or strong state-owned enterprise shareholders.
Yet, any rating uplift is unlikely in the near term – given the rated firms’ commercially driven activities which are still substantial.
These revisions are positive for securities companies, as clearer credit intermediary responsibilities and a more market-oriented approach to risk resolution could mitigate moral hazard and reduce contingent liabilities a securities company might face when a bond for which it serves as a trustee defaults.
However, the new rules might discourage securities firms from supporting bond offerings or suggesting temporary risk solutions for struggling companies.
This will lower the asset-impairment risks if securities companies are required to hold committed shares under the underwriting agreement, but at the same time could intensify refinancing difficulties for these high-risk firms and raise default rates in the domestic bond market.
Some trust products in China may also face higher asset-quality risks as a result, which continue to be an important source of funding access for borrowers with weaker credit.
Trust companies typically offer financing either through direct loans or investments in corporate-issued financial instruments.
A possible uptick in corporate refinancing risks at weaker borrowers means that we expect some assets underpinning capital trust products could face an elevated risk of impairment.
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Posted on: 2024-03-21T09:58:20+05:00
