China’s bond market is the third largest in the world (behind the United States and Japan) and has an estimated market size of US$11.8 trillion (as at the end of 2017). China’s bond market comprises:
the Interbank Bond Market (“Interbank Market”), which is regulated by the People’s Bank of China (“PBOC”) but administered by the National Association of Financial Market Institutional Investors (“NAFMII”); and
the stock exchange bond market (“Exchange Market”) which is regulated by the China Securities Regulatory Commission (“CSRC”).
The Exchange Market
In contrast to the Interbank Market, which is regulated by the PBOC, the Exchange Market is regulated by the CSRC, the relevant securities exchange (mainly, the Shanghai Stock Exchange and the Shenzhen Stock Exchange) and the China Securities Association (being the self-regulatory body for the securities industry in China). Public offerings of bonds on the Exchange Market must be approved by the CSRC (Article 16 of the CSRC Corporate Bonds Measures).
China Securities Depository and Clearing Corp. Ltd. acts as the central securities depository for the Exchange Market, whereas China Central Depository and Clearing Corporation, Limited and Shanghai Clearing House serve the Interbank Market.
The major types of products traded on the Exchange Market are treasury bonds, local government bonds, enterprise bonds, corporate bonds and convertible bonds. The Exchange Market is a retail market that targets small and medium-sized institutional investors and individuals. To protect investors' interests, the CSRC established the bonds trustee system and so a trustee must be appointed for all bonds offered on the Exchange Market (whether they are public offerings or private placements) (Article 48 of the CSRC Corporate Bonds Measures).
The Interbank Market is an over-the-counter wholesale market that targets institutional investors. The Interbank Market represents more than 88% of China’s bond market (as at the end of 2017).
Market participants in the Interbank Market primarily comprise domestic commercial banks (by far the largest participants), asset managers, insurance companies and securities firms. Overseas investors can access the Interbank Market directly through three programmes:
The internationalization of RMB and recognition of the scale and sophistication of the Interbank Market has encouraged increasing numbers of overseas issuers to issue RMB denominated bonds in China (“Panda bonds”). As at 30 June 2018, the Interbank Market had issued 23 Panda bonds with a total issued amount of 412.60 million yuan (accounting for 80.13% of the Panda bond market) and the Exchange Market had issued 8 Panda bonds with a total issued amount of 102.30 million yuan (accounting for 19.87% of the Panda bond market).
So, what’s new?
On 25 September 2018 the PBOC and the Ministry of Finance (“MOF”) issued the much anticipated “Interim Measures for the Administration of Bonds Issued by Overseas Issuers on the National Interbank Bond Market” (“2018 Measures”). The 2018 Measures have immediate effect and officially abolish the “Interim Measures for the Administration of RMB Bonds by International Development Institutions”(“2010 Measures”). The 2018 Measures “open up [the Interbank Market], regulat[e] bond issuances by overseas investors and [protect] the legitimate rights and interests of investors”.
The 2018 Measures contemplate that “NAFMII will strengthen the self-regulatory supervision on bond issuances by overseas issuers in the [Interbank Market]”. The aim is to offer a clearer regulatory framework and standardise issuance procedures for the issuance of Panda bonds by all overseas issuers. We expect NAFMII will produce guidelines (“Guidelines”) which will complement the 2018 Measures.
The 2018 Measures and the Guidelines (when issued) must be read together. Overall, there is no dramatic change to what has been the practice to-date in relation to the issuance of Panda bonds. The 2018 Measures relate largely to publicly issued Panda bonds. The provisions that refer to private placement helpfully confirm that an overseas issuer is permitted to agree disclosure requirements and accounting standards with its investors.
What is a private placement?
Generally, issuers may not offer privately placed bonds to more than 200 persons (Article 10, Securities Law of the People’s Republic of China). This restriction also applies to privately placed notes (“PPN”) issued in the Interbank Market, which are issued under the “N+X” system adopted by NAFMII (Provisions for the Selection of Specialized Institutional Investors of Private Placement Notes, adopted on 29 October 2015, NAFMII, available at: http://www.nafmii.org.cn/english/lawsandregulations/selfregulatory_e/201706/t20170623_61897.html.
Under the N+X system, investors are classified as special institutional investors (N) and specific institutional investors (X). The Issuer and underwriters are able to determine the target investor base prior to registration, provided that N+X does not exceed 200 persons.
Special institutional investors (N) are determined and approved by NAFMII from time to time (currently approximately 120 institutional investors). Specific institutional investors (X) must meet certain qualification requirements stipulated in the NAFMII guidelines and will be selected by the Issuer and the underwriters. Institutional investors listed as “N” are not required to execute a private placement agreement for every subscription, or transfer, of bonds. Institutional investors listed as “X” are required to execute a private placement agreement in connection with every issue, or transfer, of bonds.
The N+X system is intended to boost trading volumes and increase liquidity in the PPN market.
The risks involved in the issuance (and the fact that such risks are borne by the investors) must (as has always been the practice) be fully disclosed.
The drafting of the 2018 Measures reflects the key regulatory issues encountered on issues of Panda bonds since the implementation of the 2010 Measures. The 2010 Measures only applied to international development institutions (who required approval by several PRC regulators), issues by other types of issuers were regulated on a case-by-case (or 'pilot') basis.
The 2018 Measures introduce a regime for the approval of issuance of Panda bonds by all types of issuers.
Who do the 2018 Measures apply to?
The 2018 Measures apply to all “overseas issuers”. These are classified as:
foreign governmental agencies (“foreign governments”);
international development institutions (“multilaterals”);
financial institutions (“foreign banks”); and
non-financial enterprises (“foreign companies”),
in each case that are registered outside China.
A “foreign governmental agency” means “the government of a sovereign entity, a foreign local government or an agency performing government functions”. This means analysis may still be required to decide how a particular issuer is to be assessed (for example, a corporatized governmental agency). We expect that the PBOC will continue to decide how to assess an applicant for the purposes of the 2018 Measures.
The 2018 Measures do not alter the way in which “international development institutions” are categorized. Under the 2018 Measures, multilaterals continue to be defined as “any multilateral, bilateral or regional international development financial institution that makes development loans and investments”.
Significantly, no criteria are specified for foreign companies. We expect that this means that applications by foreign companies to issue Panda bond will continue to be assessed on a case-by-case basis (at least until further rules are issued by NAFMII).
What are the material changes for overseas issuers under the 2018 Measures?
The 2018 Measures are not a comprehensive description of all the issues that need to be addressed when making an application to issue Panda bonds. The regulators will continue to exercise discretion when assessing the merits of an application.
The key aspects of the 2018 Measures concern:
accounting standards and audit;
the appointment of an independent entity to safeguard the interests of bondholders;
the language of the offer documents; and
the jurisdiction for dispute resolution.
In many respects, the 2018 Measures record what has been the practice for most recent issues of Panda bonds.
Eligibility criteria of overseas issuers to issue Panda bonds
For foreign banks the capitalization requirement is RMB 10 billion (or equivalent). Foreign governments and multilaterals must be experienced in issuing bonds. The 2018 Measures do not describe the eligibility criteria for the issue of Panda bonds by foreign companies.
Applications made by foreign banks are subject to approval by the PBOC but other applications are “subject to registration” with NAFMII. Our view is that the purpose of Article 4 is to simply to confirm (the existing understanding) that the PBOC directly supervises issues of Panda bonds by foreign banks but, as a practical matter, issues of Panda bonds by all overseas issuers are subject to the PBOC's approval (whether or not registration is required with NAFMII).
Accounting standards and audit
The most significant aspect of the 2018 Measures is the accounting and auditing standards which are subject to MOF oversight. There remains a possibility that MOF will issue its own guidelines on its requirements.
Article 15, 2018 Measures
A multilateral offering Panda bonds must include a prominent notice in its financial statements and the Offering Circular stating the accounting standards adopted by it. If its financial statements are not prepared in accordance with PRC Enterprise Accounting Standards (“PRC GAAP”) or equivalent accounting standards recognized by MOF (“Equivalent Standards”), the multilateral must also disclose a description of the key differences between the accounting standards adopted by it and PRC GAAP. Only EU-IFRS and Hong Kong Accounting Standards are regarded by MOF as equivalent to PRC GAAP. Bonds have already been issued in the PRC by a multilateral with a statement as to material differences.
Article 16, 2018 Measures
A foreign bank or foreign company offering Panda bonds must include a prominent notice in its financial statements and the Offering Circular stating the accounting standards adopted by it. If its financial statements are not prepared in accordance with PRC GAAP or Equivalent Standards then it must describe the material differences between the accounting standards adopted by it and PRC GAAP together with information on the reconciliation of its accounting standards with PRC GAAP.
Article 19, 2018 Measures
An overseas issuer that has adopted PRC GAAP as its accounting standards is required to engage a qualified PRC accounting firm to audit its financial statements.
An overseas issuer that has adopted accounting standards other than PRC GAAP is required to engage either a qualified PRC accounting firm or a well-known overseas accounting firm with an international reputation, to audit its financial statements. In the latter case, information on reconciliation to PRC GAAP must be attested by a PRC qualified accounting firm.
We expect that Article 19 only applies to overseas issuers which prepare “financial statements” and not, for example, to foreign governments which only prepare economic data.
Article 19 is not particularly onerous – we expect that any of ‘big 4’ accounting firms will satisfy this requirement.
Articles 20 and 21, 2018 Measures
Overseas accounting firms engaged to audit the financial statements of an overseas issuer relating to the issue of Panda bonds are required to accept the supervision of and make filings with MOF at least 20 business days before the issuance and thereafter annually during the tenor of the bonds in accordance with PRC law.
We expect that Articles 20 and 21 only apply to overseas issuers that prepare “financial statements” as opposed foreign governments (which only prepare economic data). Assessments will need to be made in respect of foreign governments which prepare public accounts (rather than economic data).
Nonetheless, Articles 20 and 21 are subject to further clarification.
In particular, as to whether the requirement that an overseas accounting firm:
“accept supervision” by MOF is limited to making representations to, and undertaking obligations with, MOF (see below); and
“make filings” with MOF means providing a standard form report to MOF.
Two forms of filing are contemplated. The first being provided at least 20 business days before the submission by an overseas issuer of an application for the issuance of Panda bonds. The second being provided annually during the tenor of the bonds and attaching the audit report and the financial report.
We expect that the overseas accounting firms will have views as to their ability to provide the forms, the content of which is not yet public.
This has been the position for some time. The 2018 Measures simply record what has been the practice encountered in recent applications.
The 2010 Measures required issuers to have received at least two credit ratings of least AA (or equivalent).
Under the 2018 Measures, it is not mandatory for an overseas issuer to obtain a rating by an onshore rating agency. It may however be necessary if required by onshore investors. Ratings may only be given by a rating agency that is “qualified to conduct rating business on the [Interbank Market]” which currently includes China Chengxin, Shanghai Brillance Credit Rating & Investors Service Co., Ltd and China Bond Rating Co., Ltd.
Information disclosure must be truthful, accurate complete and timely and must not contain false records, misleading statements or major omissions. Information that is disclosed in other markets should also be disclosed in the Interbank Market at the same time or as soon as reasonably practicable thereafter.
Issuers must be aware of the disclosure standards applicable to, and liability for errors or omissions in, an offering circular distributed in the PRC. Issuers and their joint lead underwriters must conduct due diligence in order to ensure the accuracy of the offering circular.
Panda bonds may be issued on a standalone basis or pursuant to a programme in series or tranches.
Appointment of an independent entity to safeguard the interests of bondholders
Information disclosure obligations in relation to Panda bonds apply both prior to issuance (i.e. disclosure in the offering circular) and throughout the life of the bonds (e.g. via the Chinamoney and Shanghai Clearing House websites). Overseas issuers are required to engage an “independent” onshore entity to “safeguard” investors’ interests. The entity is required to disclose information relating to material events and convene bondholders meetings.
We expect NAFMII will oversee the precise formulation of what constitutes a material event.
The appointment of a trustee, that is so familiar in offshore markets, is not the current practice in the Interbank Market. It remains to be seen whether that is what is contemplated or whether the lead underwriter (which his now appointed to act as the issuer’s “supervisor”) will perform that role.
Language of the offering documents
The information disclosure documents publicly disclosed by an overseas issuer must be in simplified Chinese or accompanied by a simplified Chinese translation.
Jurisdiction for dispute resolution
The 2010 Measures provided that Chinese law should be applied when a multilateral defaults under its bonds or for other disputes. The 2018 Measures do not specify any mandatory provisions in relation to the governing law for dispute resolution but the current practice is to submit disputes to onshore arbitration (for example, submission to the China International Economics and Trade Arbitration Commission (CIETAC) for arbitration in Beijing).
What is the impact of the 2018 Measures for the Panda bond market?
The bottom line is that the 2018 Measures do not materially change the existing practice for the issuance of Panda bonds. The 2018 Measures clarify and standardize issuance procedure for Panda bonds. Further guidance is required to address the supervision and filing requirements relating to overseas accountancy firms.
Anything else to consider?
Yes. The PRC continues to apply strict capital controls. This means that the opening of onshore accounts, the remittance of the proceeds from the issue of RMB bonds from onshore to offshore and the remittance of RMB from offshore to onshore to pay interest and redeem the Panda bonds, require approval.
The PBOC and SAFE will continue to exercise discretion in approving cross-border remittance.