Li Yongquan Director and Senior Advisor of China Chengxin (Asia Pacific) Credit Rating Co., Ltd.
China's credit rating agency breakthrough
In 2012, Director Li Yongquan assisted China Chengxin International Credit Rating Co., Ltd. (CCXI, headquartered in Beijing) in establishing a credit rating agency (CRA) in Hong Kong, named China Chengxin (Asia Pacific) Credit Rating Co., Ltd. (CCXAP).
After nearly 12 years of hard work, CCXI was recognized as an approved CRA by the Mandatory Provident Fund Schemes Authority (MPFA) of Hong Kong on March 31, 2023, and was recognized as an approved CRA under the Qualifying Debt Instrument Scheme (QDI Scheme) by the Hong Kong Monetary Authority (HKMA) on Wednesday. CCXI is the first Chinese CRA to [go global] through CCXAP and enter the international market with Hong Kong as its base.
There are currently five CRAs recognized by MPFA, including CCXAP, Fitch, Moody's, R&I, and S&P. The MPF can use the minimum credit rating requirements set by any one or more of the above CRAs as investments in long-term bonds and short-term debt instruments (hereinafter collectively referred to as debt instruments) in accordance with the MPF guidelines issued by MPFA.
The CRAs approved by HKMA are the same as the five approved by MPFA. Before 1996, Hong Kong institutional investors, such as banks and enterprises, had to pay Hong Kong profits tax on the interest and profits they earned from investing in debt instruments issued in Hong Kong. In 1996, the Hong Kong government launched the QDI program to attract overseas issuers to issue bonds in Hong Kong and better develop the Hong Kong bond market.
QDI Program
Under the QDI program, institutional investors holding eligible debt instruments can enjoy a 50% tax reduction or tax exemption. For newly issued eligible debt instruments held after April 1, 2018, interest and profits are all exempted from tax. In addition, under the Green and Sustainable Finance Funding Program, debt instruments rated by an approved CRA recognized by HKMA can be subsidized for issuance costs.
Global CRA Institutional Market
The development of Hong Kong's bond market can help stabilize the financial market, allow companies and institutions to raise funds, and provide investors with a variety of investment options. Before the outbreak of the Asian financial crisis, former HKMA President Joseph Yam had already made efforts to promote the development of Hong Kong's bond market. In a speech, he proposed that the development of the debt instrument market requires four conditions, including: interest rate benchmark (Benchmark), underwriter (Intermediary), credit rating (Rating), and demand (Demand). He referred to these four conditions as BIRD (bird). He may not have realized at the time that a bird does not build a nest, but a group of birds need to build a nest to reproduce offspring. If bonds lack a settlement system (Settlement), it is difficult for the bond market to develop effectively. In fact, before he gave his speech, HKMA had already accepted the suggestion of the Hong Kong Capital Market Association (HKCMA) in 1990 to establish the Central Uniting and Clearing System for Debt Instruments (CMU System). Therefore, BIRD should be written as the plural BIRDS.
Undoubtedly, credit rating is an important part of the development of the bond market. Therefore, China, Japan, South Korea, Thailand, Indonesia, Portugal, Russia, Argentina, etc. all have their own local CRAs. International financial centers such as New York, London, Hong Kong, and Singapore all have international CRAs stationed there. Although, in the future, debt instruments are not required to be rated before they can be issued. However, in order to expand the investor base, bond issuers are willing to entrust CRAs with ratings.
Each country's local CRA uses a local rating scale to assess the credit status of its own currency bonds. CRA rates the country's government bonds as AAA, the highest level, and rates other rated entities in order of credit status.
When an issuer "goes out" to an international financial center to issue international debt instruments in foreign or domestic currencies, they are rated by international CRAs using an international rating scale. In the absence of explicit market consensus, the country or international financial organization with the strongest debt repayment capacity, such as the United States and the World Bank, is rated as the highest level of AAA, and the credit status of other rated entities is rated from AAA to default level. An issuer and its debt instruments that receive an AAA rating under the local rating scale may only receive a BBB rating under the international rating scale. Therefore, when investors buy bonds, they must be clear whether the bond's credit rating is international or local.
Does the difference between local ratings and international ratings mean that local ratings are inflated and untrustworthy? Not necessarily. Local debt instruments are issued in the country's currency, and the government has policies or window guidance to prevent debt instrument defaults to a certain extent and protect investors. International bonds that "go global" may lack the above-mentioned special features.
There are currently 9 CRAs licensed by the SFC in Hong Kong, 4 in China, 4 in the US and 1 in Hong Kong, all of which use international rating scales to assess the rated entities (issuers, debt instruments). The three with the longest history, Moody's, S&P and Fitch, have the largest market share in Hong Kong, and CCXAP is already catching up very closely.
There are many rating agencies in Europe, and there are 28 credit rating agencies that have obtained licenses or certificates from the European Securities and Markets Authority (ESMA). The large number of rating agencies reflects the active European debt instrument market on the one hand, and the different licensing regulations for CRAs in European countries on the other hand.
The increase in the number of credit ratings in Hong Kong reflects, to a certain extent, that the development of Hong Kong's debt market has risen to a new level. In particular, since 2012, the entry of Chinese CRAs has reflected that more and more Chinese companies and institutions are going to the international market to issue bonds. In addition, when the US Federal Reserve implemented QE, the extremely low US dollar interest rate attracted many mainland companies and local financing platforms to come to Hong Kong to issue US dollar bonds. Investors who are greedy for high interest rates and forget about risks have suffered heavy losses in the domino-like default of Chinese real estate companies' bonds. Even if they are willing to reach a debt restructuring agreement with the issuer, the restructuring will take a long time. After the restructuring, whether the issuer can sell assets at a reasonable price and other risks that the issuer will face in the future may not allow investors to get back the interest and principal they deserve.
Therefore, when investing in debt instruments, it is advisable to buy investment-grade ones; when investing in unrated or low-rated ones, you need to be more aware of your risk tolerance.
