Caixin reports that China is set to allow private placement of corporate bonds on the inter-bank market. If so, this will allow for a further expansion of the bond market and pluralization of financial instruments available to issuers and investors. In terms of financial reform, this is a positive development, since it should make it easier for all types of firms to issue debt instruments. This should be of particular benefit to private firms.
But this could also introduce some new dangers into the market. The regulations (the Chinese text) on which this reform is based suggest that private placement of bonds will go through much of the same process as public placements, requiring audited financial statements, credit ratings, etc. If one has confidence in Chinese auditors and rating agencies, then no worries. But I don't have full confidence in them despite the fact that the people who created, run, and staff these organizations are likely upstanding and smart people. We also know that in the Chinese context, although publicly issued corporate bonds are just supposed to be priced based on the credit risk of the specific issuers, investors may assume there is an implicit government guarantee for these bonds. And that, in fact, may be the case if any of those bonds ever were in danger of default.
I think this presumption is less likely to hold true in the case of private placements. Hence, we should see lower credit ratings and higher interest rates on these bonds. And institutional investors, in China that means mainly banks, should be more wary of these bonds. The question is whether the market will actually price these bonds credibly and will institutional investors account for this pricing in determining whether to take a chance on these bonds. It is likely that a portion of corporate bonds already issued by investment "platforms" created by local governments are relatively risky; these new bonds will likely add to the risk.
In the medium to long term, permitting more varied corporate bonds is critically important for the maturation of China's financial system. But it will require introducing some potential for additional volatility that may make Chinese issuers, investors and the Chinese government more uncomfortable. Reform of the bond market will be "mature" not just when anyone with a pen can issue bonds, but when there are defaults and they don't cause a panic and are accepted as necessary and reasonable risks. This new liberalization is a small step in that direction, but we need to carefully watch where everyone is stepping.