Markets get wake-up call from China’s deleveraging moves

HONG KONG: The pace at which Beijing is announcing deleveraging reforms following last month’s Communist Party Congress is a wake-up call for investors in Chinese markets: risk just got real. Sweeping new rules for the asset management industry, a crackdown on micro loans and losses imposed on the creditors of the state-owned Chongqing Iron & Steel are not yet a “Big Bang” of reforms.

Some of the measures were well flagged and will only kick in 2019. But they are sending a signal to markets that policymakers are serious about deleveraging, something that has been urged by the International Monetary Fund and ratings agencies for years and flagged as a top priority by President Xi Jinping at the party congress. Debt markets reacted first, with benchmark 10-year borrowing costs hitting three-year highs above 4 percent and yield spreads between government and corporate debt widening as policymakers appear more tolerant of defaults.

Last week, the debt sell-off spilled over into equities, which saw their worst day in 19 months, and markets have since weakened further. “The pace of new regulations” being announced “does look somewhat surprising,” said Alexander Wolf, senior emerging markets economist at Aberdeen Standard Investments. “It might have caught some people off guard.”

But, he said, policymakers were ultimately trying to reduce risks in the system. “So I think that’s positive even if there’s some shortterm volatility.” Two weeks ago, the central bank and the top regulators for banking, insurance, securities and foreign exchange announced unified rules covering asset management. The aim was to close loopholes that allow regulatory arbitrage, reduce leverage levels, eliminate the implicit guarantees some financial institutions offer against investment losses and rein in shadow banking.

Last week, a top-level Chinese government body issued an urgent notice to provincial governments urging them to suspend regulatory approval for new internet micro-lenders in a bid to curb household debt, which is currently low but rising rapidly.

In the meantime, creditors of Chongqing Iron & Steel Co took a 70 percent loss in a debt-to-equity swap restructuring of nearly 40 billion yuan ($6 billion) of debt.

It’s not the first time the authorities have tried to get markets to price risk. In March 2014, Shanghai Chaori Solar Energy Science and Technology Co Ltd missed a bond interest payment, marking China’s first domestic bond default. But about six months later, domestic bondholders were bailed out after the default caused a jump in corporate bond yields. Debt-to-equity swaps are complex operations that are harder to undo than a