Chinese Fixed Income Markets Essay Example

fiat or possibly by its order.

It is against the law for loans to be given directly to onshore entities by a lender not registered with the Central Bank of China. Such protectionist laws ensure that "entrusted loans" are used, where Chinese intermediary banks are involved and a transaction fee is earned by the bank. Chinese banks do not conduct thorough credit analyses of potential borrowers, leading riskier firms to incur monitoring costs passed onto them through the lender. Borrowing from the bond market is preferable theoretically as it could convey information about management's view of the firm to the market, decreasing rent-seeking by banks. Chinese corporations are unlikely to increase debt issues until their financial system functions more competitively.

Chinese banks' insufficient credit analysis hinders firms from building creditworthy reputations, resulting in interest rates being insensitive to credit history. This prevents the bond market from efficiently pricing yields, failing to potentially reward creditworthy firms with a lower cost of debt capital, and discouraging issuers from entering the bond market. Additionally, many "pre-bankable" private firms are unable to participate in the bond market due to a lack of credit history. Inefficient commercial loan pricing by banks leads to a subpar bond market lacking competitive advantages over the credit market. The bond market can only benefit from market competition through a decentralized and privatized banking system. Therefore, China should allow commercial banks to set their own interest rates and employ market discipline to encourage critical evaluations of borrower's credit histories.

To attract foreign investors, Chinese fixed income markets must reduce barriers to entry, as local demand may remain insufficient for some time. Institutional investors with

an appetite to diversify holdings with corporate bonds need to develop, and statutory restrictions on corporate bond holdings, such as those binding the National Social Security Fund, are unhelpful in this regard. As China transitions to a market economy, institutional investors will likely develop and increase domestic demand for corporate bonds, making them more liquid. Nonetheless, legal protections must ensure confidence for foreign investors to recover some of their potential investments in liquidation or reorganization. Currently, under bankruptcy laws or the standards of local courts in enforcing those laws, foreign investors find it difficult to ensure equal protection relative to their local counterparts. This is especially true for foreign investors who are the driving force behind demand in the short-term.To mitigate recruitment risk, foreign investors have adopted the practice of buying notes from offshore parents of Chinese subsidiaries. However, this approach comes with its own set of problems. Under this arrangement, when foreign investors lend money to offshore parents, they receive the money back as an interception loan that flows from offshore entities onshore. This effectively turns foreign bondholders into equity holders of the parent company without the potential upside of equity ownership. Even if interception loans are registered with the State Administration of Foreign Exchange, domestic creditors still have the ability to obtain a lien to circumvent priority. To protect themselves, offshore creditors must create leverage ex ante, such as by mandating invoice accounts receivables through the offshore parent accounts as security for the bonds. Overall, this unfair balancing of risk leads to inordinate transaction costs, which hinder China's fixed income markets in protectionism's name.China's bankruptcy law may have a strong structure, but its

enforcement suffers from corruption and bias due to a single-party governance approach. Decisions are made in favor of the country's best interests rather than following consistent and fair application of existing laws. To improve, China's courts must enforce bankruptcy laws fairly, regardless of claimant nationality. An effective bankruptcy regime can reduce corporate borrowing expenses and increase capital allocation.