S&P resists mapping new China onshore ratings to global scale

Uncertainty over state support and accounting prompts agency to keep Chinese ratings separate

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Standard & Poor’s, which today (July 11) became the first international credit rating agency to rate a domestic Chinese bond issuer, will not provide direct mapping between local scores and its global scale in a move that could limit the usefulness of the ratings for fund managers.

S&P’s decision to follow a national ratings scale for China without giving parallels to its main ratings may be due to the expectation of government guarantees making it hard to model domestic debt, and a lack of transparency in Chinese corporate disclosure, market participants say.

“The standards and transparency of the Chinese market are improving all the time, and we felt that having a set of local methodologies – based on our global experience but tailored to the local market – would help us adapt and evolve and grow as the market adapts and evolves and grows, which we know happens very rapidly in China,” says Peter Eastham, head of analytics for S&P Global (China) Ratings.

One local fund manager supports S&P’s decision, saying a mapping table for China debt might cause confusion in a domestic market that is new to global rating agencies. S&P gained permission from the People’s Bank of China to begin rating onshore debt in January.

“This is a very pragmatic approach,” says the fund manager who works for a US firm in Hong Kong. “If they tried to provide a mapping now it may draw more questions and actually be more confusing. Right now [S&P] just need to take their first steps in the [Chinese] ratings market, try to do business here and later on provide the mapping as the market evolves.”

S&P’s first onshore rating was given to ICBC Financial Leasing, a subsidiary of state-owned megabank ICBC. The rating is AAA, four notches above what the company’s standalone rating would be, without the support of its parent company.

In its ratings report, S&P wrote: “As the biggest commercial bank in China, ICBC has a very strong business position and financial strength. It is critical to the central government, and we believe the likelihood of government support, in times of stress, is almost certain.”

The agency uses the same rating conventions for local China debt as its global scale, but ICBC Financial Leasing’s AAA rating is not meant to be equivalent to AAA for a global issuer. While in most countries S&P’s domestic ratings are directly comparable to the global ones, there are exceptions such as in India and Israel where the agency continues to employ a non-mapped national scale.

Global scale

The entry of global agencies was expected to provide succour to credit ratings reform in the $13 trillion China onshore bond market, the third largest in the world, and assuage the concerns of foreign investors who held 1.51 trillion yuan ($220 billion) in Chinese onshore bonds at the end of last year. An overwhelming majority of Chinese corporate debt is rated AA or above by local agencies and no company carries a rating below A+.

A local credit rated AAA in China may be ranked in the range between A and BBB+ in the overseas market, although there is no clear-cut scale, investors say. Still, fund managers that Risk.net spoke to are yet to firm up a mapping tool of their own. Eastham maintains that it was the right decision not to hard-code a mapping into its Chinese ratings.

“We thought we gave a better service to the market by having dedicated and tailored methodologies for the local credit opinions. Our leverage ratios in corporate criteria are based on global samples but locally calibrated,” he says. “We just didn’t think [mapping] was appropriate.”

Two factors in particular may have persuaded S&P not to introduce direct mapping between its onshore and offshore ratings. The first is China’s implicit government guarantee on debt, which makes it hard to assess creditworthiness and often forces analysts and investors to rely on qualitative judgment, Eastham says. The guarantee has become less universal since 2014, though: in the past five years defaults – once unheard of – have multiplied. There were 119 defaults worth a total of 117 billion yuan in 2018, according to Wind Information, a Chinese financial data provider.

At the same time, the government is showing more willingness to step in for an orderly unwind of the problem, as recent instances demonstrate. The latest was in May, when China suffered its first public bank default since the 1990s. While authorities ring-fenced most depositors and creditors, they also said a small number of creditors may have to endure losses. As such, it is not entirely clear what any future default may look like.

Growing uncertainty over whether the state will automatically bail out struggling companies would bring China more in line with other countries and could weaken the argument for a separate national scale. In the meantime, reduced state support bolsters the case for mapping, as China’s domestic ratings would be perceived as more comparable to global ratings.

It is difficult for global fund managers within their specific mandates to use ratings that do not use a global scale

Chia Woon Khien, ex-Nikko AM

Some market participants also point to another deterrent to mapping – that Chinese accounting practices do not always conform to global practices, giving rise to doubts over full disclosure on financial statements. In April, for example, Shenzhen-based Kangmei Pharmaceutical failed to properly account for 29.9 billion yuan on its balance sheet. The firm is currently being investigated by authorities.

“The Chinese financial report could be prepared to very different standards compared with [global ones] and the credibility of the financial report might also be less valuable,” says Aaron Ni, a Shanghai-based portfolio manager for Aberdeen Standard Investments.

Eastham recognises the difficulty of assessing Chinese financial reports, particularly in relation to accessing data, but says S&P may decline to rate any onshore Chinese bond that it cannot get fully comfortable with.

“So far with the testing, we have had to deal with some challenges in terms of trying to understand why a certain number appears in a financial statement and this can sometimes be hard to do in isolation,” Eastham says. “Our position is that if we can’t get sufficient quality information, or there are red flags that we are concerned about, then we are more likely to walk away than keep going.”

Fund managers hope the rating agency will eventually offer mapping, particularly global asset managers that may operate with a mandate from end-investors restricting their investments to debt with certain minimum ratings – on an international scale.

“No matter how objective or international the rating agency is, it is difficult for global fund managers within their specific mandates to use ratings that do not use a global scale,” says Chia Woon Khien, a former fund manager for Nikko Asset Management. “I remember saying [to one of the rating agencies], ‘Look, I’m telling you I need an international scale. You cannot expect me to do the mapping. I can’t do the mapping. You must do this for me, otherwise I just can’t [use] it’.”

Others emphasise that ratings are not supposed to be a substitute for in-house analysis by fund managers.

“A rating is just a reference given out by a third-party rating agency,” the fund manager at the US firm says. “Each company needs to establish their own credit research, credit process, investment process. That’s the key.”

Editing by Alex Krohn