Problems in the legal system for the administration of corporate bonds

By Li Yunhai, Zhonglun W&D Law Firm
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In the capital market field, there has been a steady stream of cases involving corporate bonds, reflecting the fact that problems exist in the legal system governing the administration of corporate bonds in China. There are areas worth discussing in all of the legal systems that govern the administration of the issuance, trading and issuers of, investors in, and the coupon rates on, corporate bonds.

Administering the issuance

In terms of the authorities responsible for administration, one sees multi-institutional oversight that is in need of co-ordination with respect to regulatory policies. For the administration of corporate bonds, the total scale of corporate bond offerings nationwide each year, and the various targets within that total scale, are drafted by the National Development and Reform Commission (NDRC) in concert with the People’s Bank of China (PBOC), the Ministry of Finance, and the China Securities Regulatory Commission (CSRC). After approval by the State Council, they are issued to the relevant authorities of the governments of the provinces, autonomous regions, municipalities directly under the central government, and municipalities with independent development plans and of the State Council, for implementation.

李云海 Li Yunhai 中伦文德律师事务所 合伙人,金融委员会主任 Partner, Director of Finance Practice Zhonglun W&D Law Firm
李云海
Li Yunhai
中伦文德律师事务所
合伙人,金融委员会主任
Partner, Director of Finance Practice
Zhonglun W&D Law Firm

The NDRC approves limits and controls the total scale. This multi-organisational administration situation results in a complex corporate bond offering procedure, approval procedures with lots of red tape, and less than optimal bond offering efficiency that affects corporate bond offering timetables and fragments the corporate bond market, easily resulting in blind spots and loopholes in oversight.

With respect to the content of the administration of bond offerings, strict administration is mainly effected in respect of the types of bonds offered, offering limits and bond coupon rates. The restrictions placed by the state on the qualifications of enterprises wishing to issue bonds, and the types of bonds, are too numerous and overly strict.

Due to administrative regime-related reasons, the limits on bonds offered by enterprises are usually allocated by local governments, and that, together with a lack of soundness in the enterprise accounting standards and the lack of binding force of financial discipline on companies, makes it difficult to truly distinguish between high-grade bonds and junk bonds. Accordingly, bonds are less than attractive to investors.

Administration of bond trading

Corresponding to the multi-organisational oversight of the offering market is multi-organisational administration of the trading market. The central bank is in charge of the administration of corporate bonds traded on the interbank bond market or the over-the-counter market; whereas the CSRC is in charge of the administration of corporate bonds traded on stock exchanges. Currently, China’s corporate bonds are usually offered through the over-the-counter system by lead underwriters and sub-underwriters and if, after offering, the approvals of the CSRC and the stock exchange are secured, they may then be listed on the stock exchange.

However, the complicated procedures and stringent conditions ensure that the number of corporate bonds that achieve a listing on a stock exchange is very limited, and their daily trading volumes are extremely small. Numerous enterprises have begun to list on the New Third Board, and if these enterprises satisfy the listing conditions of the Shanghai and Shenzhen stock exchanges, they may then directly submit listing applications to the stock exchanges.

Administration of issuers, investors

In addition to state-owned enterprises (SOEs) organised as companies, SOEs not organised as companies may also issue corporate bonds. However, many restrictions still stand in the way of corporate bond offerings by compliant private enterprises. In accordance with regulations, financing proceeds derived from corporate bonds in China may only be used to make up funding shortfalls of investment projects. By contrast, financing proceeds from the offering of bonds in foreign countries can be used for a very wide range of purposes, including the repayment of bank loans. Particularly since the issuance of documents Fa Gai Ban Cai Jin [2013] No. 957 and Fa Gai Ban Cai Jin [2013] No. 1177, the NDRC has tightened its reviews of offerings of corporate bonds, making the issuance of corporate bonds even more difficult.

Investing entities are similarly subject to a host of restrictions. For example, the PBOC specifies that commercial banks may not invest in corporate bonds; and the newly amended Insurance Law specifies that the application of insurance capital is limited to bank deposits, trading of sovereign bonds, financial bonds and other applications of capital specified by the State Council. These restrictions are factors that will act as a brake on the trading of corporate bonds on the over-the-counter market by banks and insurance companies as trading entities. The lack of investing entities crimps the development of the corporate bond market.

Coupon rate administration

The coupon rate of a corporate bond reflects its market value as a financial commodity and the appropriateness of the rate which it is set, and the method by which the coupon is paid, directly affect whether the offering of the corporate bonds will proceed smoothly. The Administrative Regulations for Corporate Bonds specify that the coupon rate of a corporate bond may not be higher than 40% above the interest rate on bank savings deposits of the same term.

However, with the change in the economic situation and the development of the financial market, a considerable gap has opened up as compared to actual return rates in the capital market at present, affecting investors’ enthusiasm for investing in corporate bonds. In addition, setting the maximum coupon rate at “not higher than 40%”, regardless of the solvency and creditworthiness of the issuer, leaves no room for a risk premium in the coupon rate, raising the costs for high-quality corporate bonds and leaving average corporate bonds without risk returns. Lacking a risk mechanism and price flexibility, the coupon rate fails to reflect genuine changes in funding supply and demand, and the risk difference between different enterprises.

The standardisation and improvement of the legal system governing the corporate bond market is sorely needed, but this is a process of unknown length. Enterprises should seek financing through judicious use of non-corporate debt financing instruments on the interbank bond market.

Li Yunhai is a partner and the director of finance practice at Zhonglun W&D Law Firm

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