Chinese securitisation issuance surged to a record high in 2017 but significant challenges remain. Overseas ABS market participants point to the need to develop the investor base and deepen market expertise, but are also showing increased willingness to dip their own toes in the water.
The Chinese securitisation market is now the second-largest in terms of issuance, hitting CNY1.495trn in 2017. However, it remains a young market and investors are concerned by the perception of misaligned incentives among participants in the securitisation process, a lack of transparency regarding underlying assets and heavy reliance on credit ratings.
The credit assets securitisation (CAS) scheme has accounted for around half of all Chinese securitisation issuance since 2012. Last year it accounted for almost CNY600bn, with RMBS the single largest asset class.
The asset-backed specific plan (ABSP) accounted for around CNY840bn last year. The asset-backed note (ABN) and asset-backed plan (ABP) programmes both remain small.
China’s regulators first opened the doors for ABS in 2005, but the market was still in its infancy when the global financial crisis led to a total shutdown. Asset securitisation was reinstated in 2012 but its phase of explosive growth began two years later, in 2014, when market needs aligned with benign regulatory policy.
“The government is very supportive to the securitisation market and understands the benefits of such financial tools, but there have still been many obstacles and inefficiencies in growing this new market. For instance, the investors are less sophisticated and the market needs more long-term investors and investors who can take junior or subordinated risk,” says Raymond Chen, co-secretary-general of China ABS Forum-100.
The government’s role cannot be overstated. To whatever extent hurdles stand in the way of the market’s development, the government’s continued favour should be sufficient to see those hurdles overcome.
“In China the government can make things happen or make them stop happening on a dime. There is always the possibility that there could be a moratorium overnight, but this market has grown so much and is developing critical mass. Additionally, because it is such a diverse market with distinct sectors, the regulators could be very surgical in fixing issues if any trouble does develop, rather than having to shut the whole sector down,” says Richard Mertl, counsel, King & Wood Mallesons.
Despite government support and the market’s impressive growth, there remain significant challenges. These range from a lack of professional managers to comingling risk, lack of transparency and over-reliance on ratings. The rapid growth also distracts from the market’s youth and the fact that structures remain untested.
“Any investor looking to the Chinese market must remember that it remains an emerging market; its sheer size encourages some investors to assume it also is well developed, but as of yet that is simply not the case. There are practices allowed in China which would not be allowed in the US, Europe or Australia, for example,” says Jonathan Rochford, portfolio manager, Narrow Road Capital.
The Chinese ABS market has traditionally relied on offshore investors to take most of the risk. This is “because domestic investors do not have a strong understanding yet of this product”, notes Julien Martin, general manager, Bond Connect.
Bond Connect, which launched last July, provides overseas investors with access to 30,000 Chinese securities, including ABS, and the entire primary market. Martin notes that 260 new issues have already been bought by investors.
The arrival of international investors and more professional investment managers, coupled with the continued regulatory support, is expected to fuel a new phase of growth for the market. Great strides have already been made, although there are still concerns.
“There has been considerable debate that some Chinese securitisations have not achieved true sale and been off balance sheet. The market has now become more comfortable with the credit asset securitisation originated by financial institutions regulated by bank regulators and so-called standard structures, but less so for non-standard transactions,” says Jian Hu, md, structured finance, Moody’s.
Comingling risk, where originators are also servicers, has also been cited as a concern. There have been cases where originators have misused payments due to the securitisation for other purposes instead, thus disrupting cash to noteholders. The development of professional servicers is therefore keenly awaited, along with other similar infrastructure improvements on investors’ wish lists.
“The biggest hurdle to the market’s development is arguably regulatory caution, but mark my words, foot-dragging is not an issue; Chinese regulators are keen to see securitisation markets form. But to get comfortable they need to understand the market dynamics. To their credit, Chinese regulators have generally been proactive about monitoring and keeping abreast of developments in the marketplace,” says Mertl.
A full discussion of the challenges and opportunities presented by China’s ABS market appears in the Summer 2018 issue of SCI’s print magazine. This is available to subscribers and will also be distributed at Global ABS. A digital version is available here.-