In the wake of the market-rocking bond default by state-owned miner Yongcheng Coal last November, one particularly unsettling fact stood out.
Just one month before the cash-strapped state-owned enterprise (SOE) revealed it couldn’t repay the 1.03 billion yuan ($159.5 million) in principal and interest due on Nov. 10, it had received the highest AAA rating from China Chengxin International Credit Rating Co. Ltd. — one of the country’s top ratings firms.
That fact raised an obvious question: Just how did a ratings company, which sells itself as an impartial evaluator of corporate financial health, manage to get it so wrong?
As more companies defaulted in the weeks that followed, China Chengxin and other Chinese ratings agencies came under fire for failing to give companies the ratings they deserved. On Dec. 29, a self-regulatory body banned China Chengxin from rating any new interbank bonds for three months over misconduct related to the Yongcheng Coal default.
Flawed rating methodology, conflicts of interest and corruption have all played a role in the industry’s recent failures, but structural problems in the bond market itself, including regulator meddling, are just as responsible for China’s ratings woes, according to multiple people familiar with the industry.
The ratings inflation problem exposed by last year’s wave of defaults presents a challenge for policymakers and regulators because of how severely it undermined investor confidence in China’s roughly 25 trillion yuan nonfinancial corporate bond market, triggering sell-offs and making it harder for many SOEs to raise money.
“We basically don’t trust other people’s ratings anymore,” a bond investor at one brokerage told Caixin.
Off a cliff
Yongcheng Coal and Electricity Holding Group Co. Ltd. was not the only company to hold a high rating from China Chengxin before defaulting. When another large SOE, Tsinghua Unigroup Co. Ltd., defaulted on a 1.3 billion yuan bond on Nov. 16, it had AA rating, only recently downgraded from AAA a few days earlier (link in Chinese).
These abrupt defaults of SOEs with high ratings sent shockwaves through China’s corporate bond market. In November, 100.4 billion yuan of corporate bond issuances were either canceled or delayed nationwide, up from 34.3 billion yuan the previous month.
“Domestic ratings firms have to some extent failed,” one bond market participant told Caixin. “They pretty much don’t lower an enterprise’s until it has already failed to repay its debt.”
The participant was alluding to a phenomenon in China known as the “ratings cliff” (评级悬崖). This is best described as rapid succession of downgrades that ratings agencies gives to a company — but only after it misses a debt payment. Investors and international ratings firms take a dim view of the practice, as the whole point of a ratings downgrade is to serve as an early warning for investors.
In the case of Yongcheng Coal,…
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