A private affair

New bonds could help smaller firms get access to cash

Financing small and medium-size companies is a longstanding problem in China.

To put the issue in perspective, you just need to look at the distribution of outstanding loans in 2010: loans to small companies amounted to Rmb7.5 trillion ($1.15 trillion), medium size companies had Rmb10.1 trillion, while large companies took Rmb13.4 trillion, according to the People’s Bank of China.

This might seem like a fairly equitable split, until you take into account that 99% of Chinese companies are SMEs, and that they create 60% of China’s GDP, according to Xinhua. Last week, Beijing introduced the latest measure designed to direct lending further down the corporate food chain – new rules that allow non-financial companies to sell bonds via private placements. This overturns older regulations that only permitted firms to issue debt in public bond markets. With this expansion of the corporate bond market, smaller companies may be able to find new sources of capital.

“Allowing such firms to enter the domestic bond market can promote depth and diversity in the market, boosting the development of a high-yield corporate bond market,” Wang Yingfeng, a bond analyst at Shanghai Securities, told the Wall Street Journal.

Smaller companies find it difficult to issue debt in public markets because of the high rating requirements. In the private markets however, the criteria will be less strict.

“Privately-placed bonds allow companies to be introduced to investors with a risk appetite to resolve the plight of SMEs,” an official from the National Association of Financial Market Institutional Investors told 21CN Business Herald. After the private placement, the bonds can only be traded by sophisticated institutional investors.

But despite all the talk about helping small companies, the first batch of privately-placed bonds was very much an event for the larger state-owned firms. A total of Rmb13 billion was issued by China Minmetals, China Guodian and AVIC.

Mao Hongling, a fellow at Renmin University, told 21CN that it is best to test the new rules with large companies first, because smaller businesses might not have the same level of recognition in the market. The big SOEs are very interested too; a rule that forbids a company’s debt exceeding more than 40% of its net assets does not seem to apply to private placements.

It is not obvious when SMEs will start to take advantage of the new rules: “The first issuers are all state-owned. We had applications from several private enterprises, but they may be pushed back,” an insider at a major state-owned bank told 21CN.

But a source at ICBC told Shanghai Securities News that the bank is actively promoting private placements to SMEs.

No matter what kind of company ends up accessing the new financing options, the introduction of private placements is a significant advance for China’s capital markets. Not only should it increase the proportion of direct financing, and disintermediate banks; for investors, it is also a further addition to the increasing range of products that are on offer.

Private placements are regularly used in international financial centres such as the US and Japan. In 2010, $295.2 billion worth of privately-placed bonds were issued in the US, for instance, representing 30% of the country’s total bond issuance.

Finally, why now? Experts say the government sees the privately-placed bond market as another way to fight inflation – thanks to the way it disintermediates banks. Unlike new bank lending it has less of an impact on the money supply.

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