Junk bonds entering the market

The State's green light is on for small and medium-sized enterprises' junk bonds, synonymous with high-risk but high-yield and low credit ratings. SMEs are excited about the development but the market has mixed feelings. [Photo/China Daily]

Investors offered potentially higher returns but with far greater risks

China has for the first time added junk bonds - high-risk but potentially high-yield securities with low credit ratings - into the market in a move that has been met with a mixed response from investors.

Advocates say it diversifies China's financing channels and helps small and medium-sized enterprises break free from usurious loans made by both official and underground banks. Opponents, however, fear that lax regulations and law enforcement combined with under-educated investors could cause turmoil in a fledgling bond market.

Regulators said the country will launch its first high-yield bond market on the Shanghai and Shenzhen stock exchanges by mid-June as a way to expand funding access for SMEs.

Small domestic companies which are not listed on the stock exchange are eligible to participate. Issuance will be conducted through private placement. Regulators say they didn't opt for public offerings because only selected investors are able to take on the high levels of risk involved with the bonds. Investors deemed qualified are required to have a paid-in capital of no less than 10 million yuan ($1.59 million). Property and finance companies are excluded from the scheme.

Maturities must be longer than one year and the coupon rate should not exceed three times the central bank's benchmark interest rate. That means rates must be lower than 19 percent, based on the benchmark interest rate on June 8.

Regulators did not set any requirements on issuers' net assets or revenues, making the threshold low for issuers and the risk high for investors.

"The move is in line with the State Council's decree to expand financing channels for small companies to boost the real economy," the Shenzhen stock exchange said in a statement.

It's a fact that a monochrome bond market muffles the vigor of the country's real economy, said Wang Jianhui, an economist with Southwest Securities. But whether a more versatile one will do better is still open for debate, given that the memory is still fresh about how bond derivatives such as credit default obligations caused an implosion in the United States and global financial markets in 2008.

One of the direct aims of allowing SMEs to issue bonds is to deal with the credit crunch in China's private economy and rein in underground banking, said Zhao Xijun, a finance professor at Renmin University of China.

The bond market is underdeveloped in China, although it became the world's second biggest economy after the US last year. Data from regulators show 80 percent of bonds issued are based on State credit and most of the rest are from AAA or AA-rated large enterprises, which are also effectively risk-free. China's total bond balance, at 22.1 trillion yuan at the end of 2011, is only one-tenth of the $36 trillion in the United States.

In 2011, new issuance of enterprise bonds - issued by State-owned enterprises and government agencies - was 247.3 billion yuan, according to the People's Bank of China, the country's central bank. The volume of corporate bonds, issued by listed companies and State-owned companies, was 124.1 billion yuan. Bonds issued by SMEs account for a mere 5.2 billion yuan.

China's corporate and enterprises bond market has risen 20 times since 2005, mainly in a risk-free way. Analysts say the introduction of junk bonds will diversify China's fledgling bond market.