China’s Equity Market: Exposure, Access and Benchmarks
PGIM brings together a panel of thought leaders to discuss China’s rising role in the global economy and surrounding geopolitical tensions.
The first installment of PGIM's China Investment Symposium series focuses on China’s growing bond market. Our experts break down the investment opportunities available in the complex arena and examine how investors should think about the risk/reward tradeoffs.
This event aims to bring together a select group of global institutional investors, senior investment decision makers, and industry leaders to examine China's rising role in the world economy. To learn more, please contact PGIM’s Institutional Relationship Group.
[ Music ]
>>[DESCRIPTION:
The PGIM logo then appears with the following text "PGIM fixed income".
The Fixed income text then changes to "Global Partners", then to "Investments", "Private Capital" and finishes with "Real Estate".
The QMA logo replaces the PGIM logo on the screen, which is then replaced by "Jennison Associates".
The screen changes to the PGIM logo in the middle of the screen and below is the text:
"China Investment Symposium- Part 1: Risk, Reward, and Transparency in China's Bond Market".
In the center of the screen are fur circles with portrait style photographs of the following people:
"Cathy Hepworth, Managing director & head of emerging markets debt team, PGIM fixed income".
"Michael Chen, Managing director, Head of overseas Client Department, CCDC Shanghai headquarters".
"Peter Eastham, Managing director, S&P Global (China) ratings".
"Keshav Rajagopalan, Vice president and institutional client Director, PGIM".
To the right of these portraits is a small window that shows the speaker in a webcam view.
Music stops and Keshav Rajagopalan begins speaking.]
>>[AUDIO: Good morning, good afternoon and good evening.
We at PGIM continue to hope for the health and well-being of our colleagues, partners, clients and friends during this challenging time around the world.
Today, we have a truly global audience tuning in from four continents, over 12 countries and across 14 timezones.
A small silver lining that the situation we find ourselves in is to be able to get -- pulled together such a robust and wide ranging set of investors listen to and engage on interesting and important investment topics such as today.
My name is Keshav Rajagopalan.
And I will be your moderator for our virtual webinar hosted by PGIM.
At 1.3 trillion in assets under management PGIM, the investment management business to Prudential Financial is one of the world's largest money managers with global investment capabilities spending public fixed income, public equities and private asset, including real estate and other alternatives.
I want to personally extend a warm welcome to our PGIM China investment symposium.
The goal of this series is to have a multifaceted dialogue on the investment implications, including critically examining opportunities and risks that come with China's rising role in the global economy.
We'll also take a look at the effect that recent and growing tensions between China and other parts of the world will have on the investment [inaudible].
The majority of you are senior fiduciaries representing the largest pool of assets around the world.
You no doubt may already have investment exposure to China or you are now actively considering investment opportunities with realization that China is simply now too big to overlook.
The key question untangle is how.
How do you invest in China appropriately assessing risk and reward?
Today, in part one of our virtual series, we'll take a look at China's bond market and in subsequent sessions, we will take a look at public equities and private market investing as well.
For discussion now, I'm pleased to be joined by my colleague Cathy Hepworth, Managing Director and Head of Emerging Markets Debt at PGIM Fixed Income, calling in from PGIMís Global Headquarters in Newark, New Jersey.
We're happy to welcome two other experts on China's bond market - joining us from Shanghai, Michael Chen, Managing Director and Head of the Overseas Clients Department at China's Central Depositary in Clearing Corporation, and joining us from New York City, Peter Eastham, Managing Director and Head of Analytics for S&Ps Global Business in China.
Before we begin, a few housekeeping items, the format for the panel will be very brief presentations from each Cathy, Michael and Peter, followed by question and answer discussion.
On your screen, you'll see multiple boxes, but the most important one is the Q&A box.
We encourage you to submit questions at any time during the event and we'll to answer all the questions that are raised.
If we run out of time, we'll make every effort to answer your questions via email in the coming day.
Also, it's important to note that an on-demand version of the webinar will be available after today's event for your colleagues who may be interested.
Now, I'll turn it over to Cathy to kick off with her presentation, followed by Michael's and then Peter Eastham.
Over to you, Cathy.]
>>[DESCRIPTION: Cathy Hepworth is now speaking
The title of the slide is:
"Risk, Reward, and Transparency in China's Bond Market- Cathy L. Helpworth, CFA, Head of Emerging Markets Debt".
Below this is the date "July 2020" followed by the PGIM logo and "Fixed Income" and the following small print:
"the Global fixed income business of Prudential Financial, Inc. Prudential Financial Inc. of the United States is not affiliated with Prudential plc, Headquartered in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, Incorporated in the United Kingdom, Confidential, not for further distribution.
For professional investors only. All investments involve risk, including the potential loss of capital.".
The window to the right of the screen now shows Cathy Hepworth.]
>>[AUDIO: Great.
Welcome, everyone.
And my goal here is to really set the discussion for Peter and for Michael, and from my perspective to introduce what's important from an investor because obviously, that's all important to you, and how we at PGIM Fixed Income emerging markets with our team of economists, portfolio managers, as well as corporate analysts located in Singapore with Mandarin speakers really delve down and analyze the China offshore and onshore bond market.
So let's get started with slide three.]
>>[DESCRIPTION: Slide changes with the new title of "Size of China Market vs. Other Developed Markets".
This is followed by the subheading "China Bond Market is catching up to other developed Markets".
Below are two bar charts, one detailing the "Size of China's bond market relative to the U.S and Japan- as of December 2019".
It shows that the size of Chinaís band market was $9.4 trillion USD in 2016, compared with $11.2 trillion USD in Japan and $38.5 trillion USD.
In 2019, Chinaís bond market was measured at $14.7 trillion USD, while Japanís was $12.8 trillion USD and the United Statesí was $41.2 trillion
The other graph shows " Domestic Bond debt outstanding/nominal GDP - as of December 2019".
Chinaís is 85 percent, compared with Japanís being 217 percent and the United Statesí 285 percent.
Below the graphs is the source of the graphs: ìSource: Haver Analytics, AsiaBondsOnlineî
At the bottom of each slide has the PGIM Fixed income logo at the bottom right and "Confidential- Not for further distribution" on the bottom left.]
>>[AUDIO: So, first, we're going to hear more about this throughout the morning and evening for the -- for some of you, this -- what's the size of the market.
Quick, quick look at it.
If you look at the bar chart on the left-hand side, we've got the absolute size, comparing China to Japan and the US, China markets growing clearly not as big as the US market in absolute terms.
What's relevant is to look at the chart at the right compare it to as a percentage of GDP, 85%.
And this is the domestic bond market.
It's not clearly as big as the USA or Japan, other DMs and about the same as some other emerging market countries.
What's the takeaway here? Room to grow. And it has not gone unnoticed by Chinese policymakers.
Let's go to the next slide.]
>>[DESCRIPTION: Slide changes with the new title "Growth of China Bond Market" and the subtitle "The growing importance of China's Bond Market"
There is a line graph underneath, with the heading "China Index Weight Growth Over Time (In Percentage Terms) as of June 30, 2020."
The line graph shows that five variables - EMBI Global Diversified (China Capped at 10%), EMBI Global, CEMBI Broad Diversified (China Capped at 10%), CEMBI Broad, GBI-EM GD ñ all five remained reasonably consistent from March 94 to December 2009 under 3 percent.
By June 2020, CEMBI Broad soared to 25 percent. The EMBI Global and CEMBI Global Diversified is just under 10 percent, the EMBI Global Diversified (China Capped at 10 percent) is approx. 5 percent and GBI-EM GD is 0 percent.
At the bottom of the slide it reads: "Source: JPMorgan and Bloomberg. Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan's prior written approval. Copyright 2020,
J.P. Morgan Chase & Co. All rights reserved. An investor cannot invest in an index."
>>[AUDIO: So what about the relevance and the scope of the Chinese bond market, both offshore and onshore?
And you hear a lot of these different lines represent the offshore, ie, dollar denominated Chinese bond market and a couple things standout.
If you look at that gray line it just takes off and after 2009, that's the dollar denominated CEMBI corporate China bond market.
And you can see just how much that's grown.
That's by intent.
A lot of the Chinese corporates who want it to borrow in dollars did so clearly growth in some of the other markets, the EMBI Global is the sovereign.
And SOE market, you can see the growth there.
A couple things to point out, the China sub-index of the CEMBI, the corporate emerging market bond index China represents 25% of that.
And for the EMBI which is the sovereign bonds, China is the third largest issuer in those markets.
The GPI, which is the local bond index, these are all JP Morgan family.
China is currently, will be 5% in the beginning of August, and it's growing to 10%.
So, pretty substantial.
So let's go to the next slide.]
>>[DESCRIPTION: The title of the slide is "Performance of China Subindices vs. Other Market Indices" with the subhead reading "Less Volatility in China Returns Relative to the Rest of the Index"
There are three line graphs below.
The first line graph, top left, has a heading saying "Emerging Markets Debt Hard Currency Bonds - China Subindex vs EMBI Global As of June 30, 2020"
The three lines are China, EMB IG, and EMBI IG Portion.
The graph illustrates a similar incline for both China and EMG IG from 100 percent in March 1994 up to 400 percent in June 2020. The EMBI IG Portion climbs higher, although with more fluctuation, from 100 percent in March 1994 up to 1000 percent in June 2020.
The second line graph, top right, has a heading saying "Emerging Markets Debt Corporate Bonds - China Subindex vs CEMBI Broad As of June 30, 2020"
The three lines are China, EMB IG, and EMBI IG Portion.
The graph illustrates an almost identical incline for all three starting at 100 percent in April 2002 and rising to 300 percent in June 2020.
The third line graph, bottom, has a heading saying "Emerging Markets Debt Local Bonds - China Subindex vs GBI-EM GD"
The two lines are China and GBI-EM GB.
China shows a modest incline from 100 percent in December 2018 to 105 percent in June 2020. GBI-EM GB shows a slightly sharper rise from 100 percent in December 2018 to 115 percent in December 2020.
At the bottom of the slide it reads "Source: JPMorgan and Bloomberg. Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy.
The Index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan's prior written approval. Copyright 2020, J.P. Morgan Chase & Co.
All rights reserved. An investor cannot invest in an index."
>>[AUDIO: So what are other things that are really relevant for all of us as investors?
Well, what's the volatility? And what are the returns look like?
So let's start on the upper left-hand graph.
And just looking at this optically, you can see over time, the hard currency index, the sovereign hard currency index so offshore, has the returns have been great.
So here, a shameless plug for emerging markets broadly.
Look at these returns here over time.
And the China's sub-index, which is the blue line, has lower returns but has absolutely lower volatilities and a really high information ratio.
OK?
On the corporate side here, on the upper right-hand side, you see lower returns and more volatility.
The China corporate bond index, where there are many more high yield issuers has more volatility compared to the non-China issuers.
So, that's interesting, but still attractive returns and information ratios.
The chart on the lower, the China local bond index you can see here clearly, lower risk lower return.
So that has investment implications.]
>>[DESCRIPTION: The heading on the slide reads "Onshore China Bond Market Overview" with the subheading "China Bond Market Comprises only 30% of Total Outstanding Credit"
There are two bullet points.
ï Chinaís credit markets comprise 308.2 trillion (CNY) of debt as of 2019 year-end, largely driven by bank financing and dominated by corporate borrowers.
ï Looking deeper into the composition of the onshore bond market, central and local governments dominate issuance while a large part of the 30% attributed to corporate borrowers are driven by quasi and government-related entities There are four pie charts underneath.
The first pie chart is headed "By Suppliers of Credit"
Small/medium-sized banks account for 36 percent and Large banks 35 percent.
The second pie chart is headed "By Instruments"
Banks loans account for 52 percent and bonds 30 percent
The third pie chart is headed "By Borrowers"
Corporates account for 40 percent and both households and local government account for 20 percent.
The fourth piece chart is headed "Bond Market Composition"
Central and local governments account for 44 percent, Corporates account for 30 percent and Financials 26 percent.
At the bottom of the slide it reads "As of December 31, 2019. Source: Goldman Sachs"]
>>[AUDIO: So now moving to slide six, what's -- the importance of type -- slide six is I've been only talking about a small liver of the China credit market.
China bonds on slide six, back to slide six, are really only 30% of the overall China credit markets.
And you can see that that's made up primarily of China's government and corporates, many of which are state-owned enterprises.]
>>[DESCRIPTION: The heading on the slide reads "Comparison of Onshore vs. Offshore Market" with the subheading "China Bond Market Is Still Relatively SmallóMostly Dominated by Banks and Government"
There is a bullet point.
ï Credit quality break downñaccording to Moodyís, 89% of onshore bonds are rated AA and above, which maps roughly to BB and above in the offshore bond market
There is a bar chart underneath, with the heading "China Bond marketsóOnshore Vs. Offshore - As of December 2019"
The Onshore Bond Market is made up of Government (7,883) and Corporates (4,577)
The Offshore Bond Market is made up of both Government and Corporates, with a combined total of 780.
There is a pie chart, with the heading "Onshore Bond Ratings Distribution - As of September 2019".
AA makes up 47 percent.]
>>[AUDIO: If you move to slide seven the takeaway on slide seven is now we're going to compare a little bit more closely onshore and offshore.
And offshore again when I say offshore, these are the dollar denominated bonds.
Onshore, local currency denominated bonds.
Onshore market much bigger will continue to grow dominated by government and corporates.
What about the rating attributes?
So the rating attributes of the locally rated by local rating agencies tends to be pretty high rated and you can look at the pie chart on the right, you can see about 90% is rating doubling above.
But if you look at what that map's into from a Moody's rating perspective, particularly with the corporates, it's about a double B rating.
>>[DESCRIPTION: The heading on the slide is "Comparison of Onshore vs. Offshore Market" and the subheading is "Onshore Yields Hedged Relative to Offshore Yields Are More Attractive from Chinese Borrowersí Perspective"
The heading above four line charts reads "Funding Cost Differential Between Onshore and Offshore"
The first line chart, top left, has a heading "China IG (Unhedged)"
The three lines are US$ IG, Onshore AAA 5-Yr Yield, and Offshore Yield Over Onshore Yield (%)
The US$ IG starts at 5 percent in January 2012 and finishes at 4 percent in January 2020, with the high-point being 6 percent in January 2014.
The Onshore AAA 5-Yr Yield starts at 5 percent in January 2012 and ends at 3 percent in January 2020, with the high-point being 5 percent in January 2019.
The Offshore Yield Over Onshore Yield (%) fluctuates mildly between 0 percent in January 2012 and -1 per cent in January 2020, falling to -2 percent in January 2014 and January 2018.
The second line chart, top right, has a heading "China HY (Unhedged)"
The three lines are US$ HY, Onshore AAA 3-Yr Yield, and Offshore Yield Over Onshore Yield (%)
The US$ HY starts at 14 percent in January 2012 and ends at 8 percent, having fallen from 14 percent as recently as January 2020.
The Onshore AA 3-Yr Yield starts and 6 percent in January 2012 and ends at 5 percent in January 2020, remaining reasonably consistent throughout.
The Offshore Yield Over Onshore Yield (%) starts at 8 percent in January 2012, falling to 0 percent in mid-2017 before its high-point at 10 percent in January 2020 and falling to 6 percent thereafter.
The third line chart, bottom left, has a heading "China IG (Hedged)"
The three lines are US$ IG, Onshore AAA 5-Yr Yield (Hedged),and Offshore Yield Over Onshore Yield (% Hedged).
The US$ IG starts at 5 percent in January 2012 remaining reasonably consistent between 3 and 5 percent before finishing at 3 percent in January 2020.
The Onshore AAA 5-Yr Yield (Hedged) starts at 4 percent in January 2012, reaches a high-point of 6 percent in January 2014 before falling to 0 percent in January 2016 and concluding at 2 percent in January 2020.
The Offshore Yield Over Onshore Yield (% Hedged) starts at 0 percent in January 2012 -1 percent in January 2014 and rising to 3 percent in January 2016. It concludes at 1 percent in January 2020.
The fourth line chart, bottom right, has a heading "China HY (Hedged)"
The three lines are US$ HY, Onshore AA 3-Yr Yield (Hedged), and Offshore Yield Over Onshore Yield (% Hedged)
The US$ HY starts at 14 percent in January 2012 and ends at 8 percent, having fallen from 14 percent as recently as Janaury 2020.
The Onshore AA 3-Yr Yield (Hedged) starts at 6 percent in January 2012 and finishes at 2 percent in January 2020. It's high-point is 7 percent in January 2014 with the low-point 0 percent in January 2016.
The Offshore Yield Over Onshore Yield (% Hedged) starts at 7 percent in January 2012 before its low-point of 2 percent in January 2014 and its high-point of 14 percent in January 2020. It has since fallen to 8 percent.
In the bottom corner it reads "Source: Bank of America, Wnd, Bloomberg"]
>>[AUDIO: We move to slide eight.
So the point of slide eight is to understand the returns from the perspective of the Chinese issuers, the yield, as -- and also from the investor, the offshore investor, who has the option of investing in the onshore or the offshore market.
And what we did was if you focus on the left-hand side first, where we're looking at China investment grade, offshore and onshore, so the upper left-hand side on an on hedge basis, you can see that the onshore yields are higher but once you factoring hedging costs, it's become much cheaper for Chinese borrowers to borrow onshore.
And it's more attractive for us, for investors to, and it's a little bit more attractive for investment grade.
But when you move to China high yield, which is primarily corporates, if you look at the upper right-hand side, on an unhedged basis, China offshore, the dark blue line has higher yields.
And that's even more apparent on a hedge basis if you look at the chart on the bottom right-hand side.
So, more attractive for the Chinese borrower to issue onshore but more attractive from the perspective of the investor, in particular for high yield to be investing in the offshore.
>>[DESCRIPTION: The heading on the slide is "Trend in Foreign Investorsí Holdings of China Onshore Bonds" with the subheading "Strong Technical Trend in Foreign Holdings of China Local Government Bond Market"
There is a chart titled "China Bond Yields vs. Foreign Investor Flows As of June 30, 2020" containing both a line and bars.
The bars represents "Monthly Change in Foreign Investors' Holdings of Onshore Bonds on 6/30/20 (LHS)"
The line represent "Yield on China's 10-Year Government Bond (RHS)"
The "Monthly Change in Foreign Investors' Holdings of Onshore Bonds on 6/30/20 (LHS)" bar starts off at 0 percent in 2015 and ends at 80 Change in billions of Yen/ 3.7 percent in 2020.
There are big fluctuations, falling to a low-points of -20 Change in billions of Yen/ 2.7 percent in early 2017 as well as a high of 80 Change in billions of Yen in 2019 and 2020.
The "Yield on China's 10-Year Government Bond (RHS)" lines starts at 80 Change in Billions of Yen in 2015 before a low-point of -20 in 2016 and a high-point of 120 in late 2017. It concludes in 2020 at 0.
At the bottom of the slide it says "Source: Bloomberg. This is based off of the CHCAEI Index which captures bond depository balance cleared via the China Central Depository and Clearing by investor type".]
>>[AUDIO: So now, let's move to slide nine.
Here -- I'm sure at some of the other speakers will talk about this.
It's just the evolution of what the yields on China government bonds have been.
That's on the right axis. You can see that they come down over time, in particular the period from 2018 to 2020, as China has decided to open up the China local bond market for investors, and we'll get into the reasons in a second.
Some of this has been coincident, obviously, with the increased flows into that market.]
>>[DESCRIPTION: The heading on the slide is "China Real Yields" with the subheading reading "China Real Yields Attractive to Other Developed Market Real Yields"
There are three line charts
The first line chart, top left, is titled "Nominal Bond Yield As of June 30, 2020"
There are two lines - "5yr China Govt Bond" and "5yr US Treasury"
The 5yr US Treasury line starts at 2.75 in 2007, reaching a high-point of 5 in 2014 and ending at 2.75 in 2020.
The 5yr China Govt Bond line starts, at its high-point, of 5 in 2007 before ending at 0.5 in 2020, with a sharp decline from 3 in late 2018.
The second line chart, top right, is title "Real Rates - As of June 30, 2020"
There are two lines - "10yr China Real Rate" and "10yr US Real Rate"
The 10yr China Real Rate line starts at 2.25 in 2007 before reaching a high-point of 5 in 2010 and ending at 2 in 2020.
The 10yr US Real Rate line start at 2 in 2007 before reaching its high-point of 2.75 in 2011 and ending at its low point of -1 in 2020.
The third line chart, bottom, is titled "Term Premium - As of June 30, 2020"
There are two lines - "China Govt Bond 1s5s" and "US Treasury 1s5s"
The US Treasury 1s5s line starts at 1 in 2008 before concluding at 0.25 in 2020. Its high-point is 2 in 2010 and low is -0.25 in 2019.
The China Govt Bond 1s5s starts at 0.5 in 2008 and ends at 0.3 in 2020, with its high-point 1.5 in 2009 and low point 0 in 2013.
At the bottom of the slide it reads "Source: Bloomberg".]
>>[AUDIO: So now, we can go to slide 10.
What's another investment consideration for investors?
What they're going to be investing in the onshore market, and here, I'm showing you what the yields are for the onshore government bond market?
What do we compare them to?
Well, let's compare them to US treasuries here.
You can see in the upper left-hand side when you compare the yield on just a representative five-year bond in China higher than then treasuries, hey, maybe you would expect that.
China's somewhere in between a developed market and emerging market, clearly, attractive from a real yield perspective, as well.
And from the term premium perspective, there's value out the curve in the five-year part of the China local bond market.
So these are relevant investment theses for the offshore investor. Now, we can turn to the next slide.]
>>[DESCRIPTION: The heading on the slide reads "China Bond Market" with the subheading "Macroeconomic Themes"
There are five bullet points:
Post global financial crisis, Chinaís leverage increased within the system as fiscal
deficits increased. As a result, it follows that China rates need to come down. How to
help that?
ï Initially, segments of the credit market increased issuance of hard currency bonds ñ a stepping stone.
ï Onshore market was not relevant for foreign investorsñit was not investible.
ï Fast forward: Policymakers realized need to grow local for the future ó an additional
funding source, and technical flows to help bring local yields lower.
ï China wants to rival U.S. in size of local market.
At the bottom of the slide it reads "As of July 2020. Source: PGIM Fixed Income. Provided for discussion purposes only. Does not constitute a recommendation regarding the merits of any investments. Does not constitute investment advice and should not be used as the basis for any investment decision. Does not constitute a representation
that PGIM Fixed Income has purchased or would purchase any of the investments referenced or that any such investments would be profitable. Past performance is not a guarantee or a reliable indicator of future results."]
>>[AUDIO: And I thought it would be helpful, on slide 11, just to talk about what are the underlying macro themes that really are informing a lot of the topics that I'm mentioning here.
So the post global financial crisis, clearly, the China bond market, the China debt leverage increased substantially.
We know that leverage in the system in China's close to 300% of GDP.
That means that along with that fiscal deficit increased a lot in China.
So an underlying thesis here is it's really important in China from perspective of the policymakers to get interest rates lower.
So that the financing role of that debt in the system that they've -- debt service costs, if you will, can be lower.
And the Chinese policymakers want to make it an attractive investment proposition to do so. Initially, the first foray into the bond market for borrowers was the hard currency market.
These were a lot of corporates who needed access to dollars.
The emphasis now is going to be on a lot of the -- for the bond market to be borrowing more in the onshore market for some of the reasons that that I already mentioned.
And while initially, the onshore market wasn't necessarily all that relevant for us, the offshore investors, it's becoming increasingly more relevant, and we can see that just by the growth of the size of it.
China has as a goal it wants to rival the US in terms of the size of the bond market.
So, so what are some other considerations if you can turn to slide 12 now?
>>[DESCRIPTION: The heading on the slide is "China Bond Market" with the subheading "Macroeconomic Themes".
There are five bullet points:
ï Local funding: Asia is different; deposit base is massive in China; real yields likely to remain low.
ï Foreign participation to increase structurally: Accessibility and index inclusion to drive foreign participation
ï Relative Value: Hard currency high yield corporates offer pick-up to hedged onshore bonds and also to similarly rated developed market corporates
ï High yield offshore market dominated by property sector: China industrial sector seeing increasing defaults (PK Founder, Luckin Coffee/ Carinc) with low recovery rates; regs investors dominate
ï Scale of universe enormous and growing: Double-digit nominal growth rate of economy, leverage at 300% of GDP remains elevated, bonds to increase as percent of TSF
ï Volatility profile: China hedging costs have increased, China high yield offshore bonds tend to be high beta to market
At the bottom of the slide it reads "As of July 2020. Source: PGIM Fixed Income. Provided for discussion purposes only. Does not constitute a recommendation regarding the merits of any investments. Does not constitute investment advice and should not be used as the basis for any investment decision.
Does not constitute a representation that PGIM Fixed Income has purchased or would purchase any of the investments referenced or that any such investments would be profitable. Past performance is not a guarantee or a reliable indicator of future results."]
>>[AUDIO: What are some other investment themes that you need to keep in mind? Well, first of all, when you think about the local funding sources, Asia is a different. It's a different animal than what, you know, most of us are used to in the West.
Deposit base is huge in China, in real yields are likely to remain low, which is an attractive investment thesis if we think they're going to continue to come down.
We think that foreign participation will increase structurally as the access to the market improves for relative value.
A takeaway that that we have is that hard currency high yield corporates are more attractive offshore compared to onshore, we'll delve more into that later, onshore.
In part, that's a function of liquidity and transparency.
The high yield off of -- the high yield offshore market likewise is dominated by the property sector in other lower rated components.
So we have to think about default rest, et cetera.
The scale is going to continue to grow of all of the issuers in the China debt markets simply because of the growth of the economy.
And the volatility profile is hedging costs have increased in China.
So that makes the China high yield offshore bonds tend to be a little bit more high beta.
So our expectation in investing is those, is to get the adequate return.
And if you recall from one of the slides that I had, they are clearly much more higher yielding.
So from a relative value perspective, we're accomplishing that goal.
>>[DESCRIPTION: The heading on the slide reads "China Bond Market" with the subheading Current Market Risks"
There are five bullet points:
ï Risks for onshore bond market: FX volatility, convertibility, disclosure, transparency
ï Growth: The recovery from the Covid crisis has been uneven; the consumer and services sectors remain challenged; SMEs have been disproportionately impacted
ï Defaults: The default rate both offshore and onshore, while low, has been increasing; the high level of leverage in the system intensifies economic volatility
ï Geopolitics: Sanctions/Geopolitics spill-over from US/China disputes (Huawei or Rusal type scenarios)
ï Financial Risks: Banking sector is adequately capitalized but we are mindful of increasing NPLs
At the bottom of the slide it reads "As of July 2020. Source: PGIM Fixed Income. Insert: The comments, opinions, and estimates contained herein are based on and/or derived from publicly available information from sources that PGIM Fixed Income believes to be reliable. We do not guarantee the accuracy of such sources or information. This outlook, which is for
informational purposes only, sets forth our views as of this date. The underlying assumptions and our views are subject to change. Past performance is not a guarantee or a reliable indicator of future results. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment."
>>[AUDIO: Well, let me finish up on slide 13. What are some of the risks?
And again, we'll elaborate more on these with some of the other panelists.
Clearly, there's restaurant investing in any local market and the onshore markets, the local market.
There's the FX volatility to it, certain extent convertibility risk.
We think the Chinese authorities are not -- are going to make this a little bit less relevant simply because they want the offshore investors to come in.
There are disclosure transparency issues.
The growth rate has slowed down in China as a result of recent developments.
That factor needs to be taken into consideration. Defaults, I mentioned clearly geopolitics.
And I think that we can elaborate more on that in the Q&A.
So now, I am going to turn it over to the other panelists and look forward to your questions.]
>>[DESCRIPTION: The slide says "Reference"
>>[DESCRIPTION: The slide contains a Biography of Cathy L Hopworth CFA.
It reads: îCathy L. Hepworth, CFA, is a Managing Director and Head of PGIM Fixed Income's Emerging Markets Debt Team. Ms. Hepworth co-founded the Firm's emerging markets debt management effort in 1995.
Previously, Ms. Hepworth was an analyst in the credit unit group of the Firmís Capital Management Group, focusing on various sovereign, financial and corporate sectors. Prior to joining the Firm in 1989, she held analyst positions at
Bankers Trust, Merrill Lynch, and Golembe Associates. Ms. Hepworth received a BSFS from Georgetown University, School of Foreign Service. She holds the Chartered Financial Analyst (CFA) designation.î
>>[DESCRIPTION: The slide's heading is "Notice: Important Disclaimers"
It reads "PGIM Fixed Income operates primarily through PGIM, Inc., a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and a Prudential Financial, Inc. (ìPFIî) company. Registration as a registered investment adviser does not imply a certain level or skill or training. PGIM Fixed Income is headquartered in Newark, New Jersey and also includes the following businesses globally: (i) the public fixed income unit within PGIM Limited, located in London; (ii) PGIM Netherlands B.V. located in Amsterdam; (iii) PGIM Japan Co., Ltd. (ìPGIM Japanî), located in Tokyo; (iv) the public fixed income unit within PGIM (Hong Kong) Ltd. located in Hong Kong; and (v) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore (ìPGIM Singaporeî). PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. Prudential, PGIM, their respective logos, and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.
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>>[AUDIO: Cathy, thanks so much for an excellent overview of the market.
Now, turning it over to Michael Chen, will talk to us based on CCDC's front row stead in market and perspective.
Michael over to you. Thanks.]
>>[DESCRIPTION: The slide is a title slide of Michael Chen's presentation. The title reads "Overview of Chinaís Bond Market Opening"
Below it says "Michael CHEN Managing Director, Head of Overseas Client Department CCDC Shanghai Headquarters. July, 2020]
>>[AUDIO: OK.
Thanks, Kesha and thanks PGIM for inviting us.
I come from CCDC which stand for China Central Depository Company.
We are kind of financing infrastructure here in China.
We depository all kinds of the bonds, especially 100% of central government bonds, financial institutions bonds and the policy of the bank bonds 100% deposit reserves.
Just -- Cathy just shared with us a very comprehensive introduction about China's bond market overall.
So in my part, I want to just to spend few minutes to just give you more detailed information about China's interbank bond market.
How you can access this and how you can get your information for your investment.
So let's go to next page, the first page.
>>[DESCRIPTION: There is a timeline titled "Chinaís Bond Market Development and Opening"
It contains the following information:
1996 ï CCDC was established.
1997 ï CIBM was formed.
2005 ï ABF2 was approved to enter.
2010 ï Three types of eligible foreign institutions were allowed into CIBM.
Since 2011 ï QFII and RQFII were allowed to invest in CIBM.
2016 ï PBOC announced to open
CIBM to an expanded scope of overseas investors
2017 ï Bond Connect
Northbound Program was launched.
2018 ï Chinaís bond market became the second largest globally.
2019 ï Chinese bonds were included into Bloomberg Barclays Global Aggregate Index.
2020 ï Inclusion into JP Morganís Government Bond
Index Emerging Market series
ï Electronic account opening, recycling settlement, non-standard settlement cycle
ï Ö]
>>[AUDIO: Here is a timeline for the overall development of China's interbank bond market.
It's a very young market only 23 years.
But now, as Cathy mentioned, is the second largest market in work.
And each of the market, I can say it's the coal, which contributes 80% of deposit to volume over total, China's bond market.
And our company is as the same age of China's interbank market and we provide all kinds of full life circle services account issuance, depository and evaluation as well as collateral, information disclosure services.
I think in the first 10 years, the market grew slowly, and also it's a local market - very few international investors.
Please note that from 2016, there were [inaudible] regulator, PBOC, would like to fully open the door for overseas investor to accept this market.
What's the reason? I think two or three reasons.
The first is, let me be and as you all know, stopped the appreciation in 2015.
So we need to have more inflow from capital account to balance the inflow and offload of all currencies. This is the first thing. So we need to open our capital market.
The second thing is that internally, we need a more globalized, a more modern or more well-developed capital markets, especially bond market to increase their financial efficiency.
So that's the reason in 2016, we all fully open to global investor and we can say the bond market open is very, very full open. So you don't have any quota.
You just defining and you can just access. And in the recent two or three years, you can see a lot of initiative happened here. Bond connect to ensure you can just open offshore and I can access.
And also a lot of global index inclusion. I thought a lot of investor, passive investor need to follow and the need to include China exposure. So I think that's the context we are setting here to see what will happen next.
So let's move on next page.
>>[DESCRIPTION: The heading on the slide reads "Market Structure - CIBM as the Dominant Segment"
There is a table headed "Infrastructures by market segment"
It highlights the fact that 'All three types of IG bonds are almost 100% under CCDCís depository' - SHCH, CCDC and CSDC.
On the other side of the slide, the right, there's a bar chart headed "Onshore bonds outstanding by major bond market segment"
The bars are made up of CIBM (CCDC), CIBM (SHCH), and Exchange Bond Market (CSDC).
The CIBM (SHCH), and Exchange Bond Market (CSDC) remain consistent throughout at 20 and 10 from March 2019 to May 2020.
The CIBM (CCDC) shows a gradual rise over the same timeframe from 60 to 70 Trillion Chinese Yen, this increasing the overall from 90 to 100 Trillion Chinese Yen.
Beneath the graph it says "CCDC = China Central Depository & Clearing Co., Ltd; CNY = Chinese renminbi; CSDC = China Securities
Depository and Clearing Co., Ltd; PRC = Peopleís Republic of China; SHCH = Shanghai Clearing House.
Notes: Statistics for the SHCH include negotiable certificates of deposit. Sources: CCDC, CSDC, SHCH"]
>>[AUDIO: So here is the kind of marketing infrastructure here in China a bond market.
As you know, China bond market has two major markets.
The one is China interbank market, which contributes 80% of market share and another is exchange market. CCDC, we are the depository.
We contribute about 80% of China interbank bond market and the regulator here in China in the bond market is PBOC.
In the exchange market, the investor a bit more retail-oriented and it's more kind of the regulator is China Security and Regulation Committee.
So it's kind of totally two different markets.
But we see recently more and more efforts have been linked to these two markets.
So I think we can share more in the follow up Q&A session.
So let's move on to next.
>>[DESCRIPTION: The heading on the slide reads "Market Access - CIBM Direct"
Everything under the headings 'Core Advantage' and 'Value-added Advantages' point to a centre-point, which reads 'Direct Flight - CIBM Direct' and 'Bond Connect - Connecting Flight'
Under Core Advantages, it lists:
ï Transaction Cost - Average around 1bps lower *1
ï Fungible with QFII/RQFII - Allow two-way bond & fund transfers for the same investor
ï Eligible Products - Support NOT only cash bonds
ï Counterparties - Around 20,000 vs. 47
ï Direct Holding - Clear recognition of beneficial ownership
Under Value-added Advantages, it lists:
ï Cut-off Time - 17:00 vs. 12:00 (T+0)
ï Flexible in FX Hedging - 3 counterparties vs 1
ï Bond as - CGB as margin for futures trading
ï Collateral One Funds, Multi-AMs - BSA supports multi-AM for one fund*2
ï BSA Local Services - Direct communication with regulators
At the bottom of the slide it reads: "Note: 1) average price is estimated by market participants 2) multi-AM support is depending on BSA internal capabilities"]
>>[AUDIO: About -- the review about CIBN access, there are two approaches. One is the IBM direct. The second is bank net. We can see the CIBN direct is the majority channel which about 90% of investor access by CIBN direct.
Why? The first is much less intermediary. So lower costs. The second you can have a more product, you can do repo and not only cash bond. And then the more important, you know, that, you know, in CIBN direct you can also have three trading FX counterpart case while in bank net, so far, you only had one.
So I don't want to extend more but I'm happy to share more in the Q&A section.
>>[DESCRIPTION: The heading on the slide reads "CIBM Information and Pricing Disclosure"
Below there are several screenshots of market performance pages under the headings CCDC, CFETS and PBOB etc on Chinese websites.
>>[AUDIO: So my last page is that information disclosure. I think the language barrier is here but I think everyone here is from regulator to our infrastructure level.
We want to make it more transparent. So currently, you can visit our website, PBOC website and CFETS website for all kinds of information. Some of them are already in English.
But I think we are kind of working on one project to make our portal to make the information integrated and can present in a portal in a very convenient website.
So we just so would like to share with you when the photo is online. So here, I think [inaudible] is already off. So I just want to just give a very brief introduction and look forward to share more in the Q&A session.
Thank you.]
>>[DESCRIPTION: The heading on the slide reads "Thank you. July 2020."
>>[DESCRIPTION: The headling on the slide reads "Disclaimer"
It reads "This presentation is a non-public and confidential document issued by China Central Depository & Clearing Co., Ltd. (hereinafter referred to as ìCCDCî), which is only for the internal use of institutions permitted by CCDC. In addition to the published information, the institutions that receive the slides shall be obliged to keep confidentiality of the slides and the information contained therein; they shall neither transmit or disclose all or part of the information in the slides in any form to any third-party institution or individual including media agencies or peers, nor quote any information in any form.
CCDC endeavors to ensure the accuracy and completeness of the slides, but it will neither guarantee its accuracy or completeness, nor assume any responsibility for any loss caused by the inaccuracy or missing content in the slides. The information on which all or part of the slides is based is sourced from third parties, which is true and reliable but has not been verified; and the slides does not guarantee the accuracy of the above information. The opinions expressed in the slides represent only personal views of researchers and do not represent the views of CCDC. They are for usersí reference only and do not constitute any research and investment advice for users.
CCDC maintains the intellectual property rights of the slides.
Note: The data related to bonds in the slides are sourced from CCDC, which reflect relevant business of overseas institutions that have opened an account with CCDC."]
>>[AUDIO: Keshav Rajagopalan is speaking. Michael, thanks so much. Great background in the market infrastructure as well as the evolution of the market. Now, I'll turn it over to Pete Eastham at S&P.
S&P has been on the ground in China for over 18 months and Pete has been at the forefront of S&Ps efforts build out for business there and really focused on [inaudible].
Pete, over to you.]
>>[DESCRIPTION: Intro slide with the title 'S&P Global (China) Ratings']
>>[AUDIO: Peter Eastham is speaking
Thanks, Keshav.
Thanks to PGIM for inviting us to participate in the session today.
If you can just start to the next slide for me, please?
>>[DESCRIPTION: Heading on slide is "Ratings Distribution"
On a bar chart titled "Existing ratings distribution of domestic corporate issuers" it shows that AA has the highest rating.
There are two related bar charts.
The first of those is titled "S&P Global (China) Indicative credit quality of 700 corporates" where it is highlighed that [BBB+] has a reasonably high number of entities.
The second bar chart is titled "S&P Global (China) Indicative credit quality of close to 1700 LGFVs" and shows that [BB+] has the highest number of entities.
At the bottom of the slide it says "*Data source: S&P Global China Ratings"
Under the heading "Transparency" there are the following points:
ï Stand-alone Credit Profile
ï Issuer Credit Rating
ï Group or Government Support
ï Key drivers
ï Forecasting
ï Outlook]
>>[AUDIO: You know, when S&P has been actually operating in the China market for around 20 years, we've been doing that predominantly through the offshore markets and that teams in Hong Kong where we have a large portfolio right across the credit spectrum.
The regulators in China changed rules in terms of allowing foreign rating agencies to enter into China about 18 months or so ago.
And that was -- that allowed us to be able to go into the market with a wholly owned entity now that we were able to control the direction of, and really focus on the domestic market.
And I think the government changed some of the rules for some real really important reasons.
It was about trying to bring that international discipline and experience of the global rating agencies not just S&P, but Moody's, Fitch, et cetera, as well.
To be able to sort of overall increase the standards in the market in China and start to make it more and more truly investable, particularly for international investors.
Clearly, one of the goals of the Chinese regulators is about trying to attract international capital.
Make the market more investable and ultimately, that flows into things like internationalization of the R&B, reserve currency status, and those sort of factors.
And what we found when we looked at the local market, certainly from a ratings perspective is, and you can see it on this chart here and Cathy alluded to it earlier.
The current ratings distributions are basically all done way above, essentially. The ratings are all gathered around there.
They are there for a few reasons, right? There's a number of local rating agencies and there are also some regulatory considerations around the role of ratings in the marketplace.
An example of that is the insurance regulator for insurance companies in China currently, has requirements that say that insurance companies can only buy securities that are rated double A or above.
And so what that does is it actually squashes a rating distribution into only two or three notches, right, which makes the ratings not that useful for people in terms of having a reasonable benchmark and paying out a credit I credit distribution.
It's not just the insurance regulator, though there's multiple different regulators looking at different parts of the market that have similar sorts of requirements.
And, you know, I think Michael alluded to the fact that, you know, there are things that change in China all the time and this is one of the areas that is likely to be changing over time because it currently creates perverse outcomes in terms of providing good quality information to the investment community.
So what we did when we looked at an entity into the domestic market was establish our own entity fully staffed with local analysts that we have brought into the S&P fold.
But we've developed a set of methodologies and approaches for China really tailored towards how to differentiate credit risk in the domestic market in particular.
So if you look at what we've been doing globally, we've been analyzing massive banks and massive corporates et cetera in China or out of Hong Kong for many years.
But that body of issuers in China is not just 4 or 500 or maybe a thousand but there's potentially 3, 4, 5000 issuers that go up and down that credit spectrum.
And to make sure we can get relative differentiation of that credit risk, we actually decided to build a scale specifically designed for the China market to try and create that credit distribution and credit differentiation.
So on the top of this chart is the current distribution from the existing local rating agencies all heavily biased to very high ratings.
In the bottom part is actually some of the distributions that we have been looking at in terms of all the testing and building out of our capabilities in the marketplace.
So what you're showing is too very, very different distributions.
These ratings that we have on the bottom here, you see they go all the way to triple A.
And I think Cathy mentioned before reference of Moody's about, you know, what their global scale versus local scale ratings might look like.
You know, all the international rating agencies from a global scale perspective tend to have sovereign constraints because, you know, we're not dealing with a triple A sovereign here.
So when we look at it from a domestic scale perspective, you are able to look at the full spectrum of a rating distribution on a domestic lens from triple A through to -- through a single B.
Here, we've got our distributions.
The big difference between the left and right of this chart is the left is really looking at some of the largest culprits only in China.
And that's both privately-owned and state identities.
On the right-hand side that includes the universe of local government financing vehicles, and I think in this universe, we had somewhere around 8 or 900 or maybe a thousand or so LGFEís in there at that time.
We've actually now tested out over 2000 entities in China to really try and fill out our body of experience and understanding of the world in sectors. And you can see that when you add the local government financing vehicles into the space, your credit quality distribution moves pretty dramatically to the right.
Yeah, as a general rule, that pretty highly levered vehicles, their own pure standalone credit quality tends to generally be weaker.
And so it really becomes a story about government support, and who is the government that might support them and how much support is next going to receive.
If you can just go to the next slide, we've put on here a little bit distribution of defaults in the sort of sectors they've been coming from in China.
>>[DESCRIPTION: There is a large pie chart titled "Defaults in Chinaís Domestic Bond Market(cont.)" with the subheading "Bond Defaults by Sector (since 2014)"
The largest segments on the chart are "trading" followed by "conglomerate"
At the bottom of the slide it reads "Source: S&P Global (China) Ratings. Copyright©2020 by S&P Ratings (China) Co., Ltd. All rights reserved."]
>>[AUDIO: Yeah, defaults historically, didn't tend to happen or that they were marked in the past in the China market, and defaults were sort of worked out before they became overly public.
You know, the government is now allowing defaults to actually occur.
You know, they're careful in terms of how they managed defaults in terms of the ramifications and you see different things happen with different entities.
So over the course of say the last year or so, you saw a major bank vouching bank defaulted.
And, you know, the resolution of that, you know, and some, some losses that were taken by different segments of a capital structure, you know, did occur, right?
So they would they allow things to sort of happen a little bit without, you know, complete collapse.
But then you also have recently, I think was Hong Kong bank got into big trouble had huge NPLs.
And the government came in and essentially fixed the problem, right.
And there were no real losses, and that bank will get restructured and sort of continue on and have improved governance.
Now, I guess the big difference there is we obviously had COVID-19 occurring in between that exercise.
So having any sort of destabilization in the banking sector would not be a very helpful thing for the Chinese economy right now and I imagine that was one of the reasons why they chose a different approach in how to protect one particular bank versus look at another bank default.
But there are defaults happening and we think defaults will continue to happen, progressively.
You know, that's part of the marketplace - dealing with issues.
And we think that's going to continue to happen over time.
The next couple of slides, and I won't go through the detail of these but in terms of -- if you can just go to the next slide.
>>[DESCRIPTION: The heading on the slide reads "Red Flags and Warning Signs ñ Internal Control"
There are eight bullet points listed. They are:
ï Aggressive operating objectives, putting management under high pressure to reach profit targets;
ï Overly ambitious agreements made with investors;
ï Listed companies face being delisted after two years of losses, putting pressure on turning a profit in the third year to maintain listed status;
ï Defective corporate governance systems;
ï Conflicts between shareholders;
ï Ineffective Internal control system;
ï A large amount of trades or assets yet to go through legal procedures;
ï Frequently switching accounting firms;
ï Frequent turnover of senior management within a short period;]
>>[DESCRIPTION: The slide has a main header saying "Red Flags and Warning Signs ñ Production and Operations" and "Financial"
Under "Red Flags and Warning Signs ñ Production and Operations" there are five bullet points. They are:
Overly complex business model and production or capital flow;
ï Sales rely heavily on related party transactions;
ï Sales exceed the industry avg, despite no apparent competitive advantage;
ï High growth rates when compared with industry competitors, despite having no clear technical edge or higher market position;
ï Company enters the market based on attractive production subsidies, but cannot achieve sufficient capability after removal of subsidies.
Under "Financial" there are five bullet points. They are:
"Qualified audit opinion;
ï Artificially inflated increase in revenue;
ï Significant use of capital by major shareholders;
ï Stocks of listed companies are pledged in large quantities, major shareholders heavily rely on external financing;
ï Risks in specific areas of accounting."
>>[AUDIO: About two slides here. And I imagine that PGIM were making the slides available so that's the audience, is some of the things that we've looked at when we've done our deep dive into the marketplace to try and understand what are the sorts of things that we can see as a precursor to default,
either in terms of financial numbers, in terms of behaviors, in terms of corporate structures. What are the sorts of red flags that are out there that we can try and capture?
So part of my job and my team's job is about being able to try and build analytical approaches to be able to capture these things so that everything is timely and forward looking, as opposed to just looking backwards after a default has happened.
So we've done a lot of testing around actual default cases to see how would have added methodologies and analytical approaches captured those, so that would have we had a rating transition that we thought was reasonable before default actually occurred.
And we're pleased that we think we have built that. And we've managed to capture that. Obviously, S&P is a global company has been doing this for 150 years.
So we're able to leverage so much of that global experience and deploy it for a local deployment inside China. There are lots of things in here.
Some of these may come up in the Q&A.
But I encourage you just to keep an eye on these red flags because they are common across many issues where you start to see problems emerging.
With that, Keshav, I'm conscious of the time in the Q&A, so I might hand it back to you.]
>>[DESCRIPTION: The slide says "Thank You"
>>[DESCRIPTION: The slide reads "This document is prepared in both English and Chinese. The English translation is for reference only, and the Chinese version will prevail in the event of any inconsistency between the English version and the Chinese version.
Copyright © 2019 by S&P Ratings China Co., Ltd. All rights reserved.
S&P Ratings China Co., Ltd. (ìS&P Ratingsî) owns the copyright and/or other related intellectual property rights of the abovementioned content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content). No Content may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of S&P Ratings. The Content shall not be used for any unlawful or unauthorized purposes. S&P Ratings and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively "S&P Parties") do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an ìas isî basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENTíS FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P Ratings' opinions, analyses, forecasts and rating acknowledgment decisions (described below) are not and should not be viewed as recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P Ratings assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and / or clients when making investment and other business decisions. S&P Ratings does not act as a fiduciary or an investment advisor except where registered as such. While S&P Ratings has obtained information from sources it believes to be reliable, S&P Ratings does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
A RATING ISSUED BY S&P RATINGS IS ASSIGNED ON A RATING SCALE SPECIFICALLY FOR USE IN CHINA, AND IS S&P RATINGS' OPINION OF AN OBLIGORíS OVERALL CREDITWORTHINESS OR CAPACITY TO MEET SPECIFIC FINANCIAL OBLIGATIONS, RELATIVE TO THAT OF OTHER ISSUERS AND ISSUSES WITHIN CHINA ONLY AND PROVIDES A RANK ORDERING OF CREDIT RISK WITHIN CHINA. AN S&P RATINGS' RATING IS NOT A GLOBAL SCALE RATING, AND IS NOT AND SHOULD NOT BE VIEWED, RELIED UPON, OR REPRESENTED AS SUCH. S&P PARTIES ARE NOT RESPONSIBLE FOR ANY LOSSES CAUSED BY USES OF S&P RATINGS' RATINGS IN MANNERS CONTRARY TO THIS PARAGRAPH.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P Ratings reserves the right to assign, withdraw or suspend such acknowledgement at any time and in its sole discretion. S&P Ratings disclaims any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P Ratings keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P Ratings may have information that is not available to other S&P Ratings business units. S&P Ratings has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P Ratings may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P Ratings reserves the right to disseminate its opinions and analyses."]
>>[DESCRIPTION: The slide has a PGIM logo with the Prudential Rock in the top left and says "Q&A. Keshav Rajagopalan is on the right of the screen and speaking"
>>[AUDIO: Thanks so much, Peter.
Hopefully, for everyone to get us kicked off three different perspectives on the bond market but now, to the Q&A discussion, just a reminder to our audience, please submit Q&A and we're going to try to get as many questions as we can- over the next 30 minutes. So to kick off Cathy, a question to you just start the dialogue.
We just heard presentations that were very much the bull case for the China Bond Mark, what do the bears have right? What are they talking about? And what are the concern of the -- as an active income investment think as well on [inaudible]?]
>>[DESCRIPTION: Cathy Hepburn appears on the right of the screen and is speaking]
>>[AUDIO: Sure, I think the biggest risks for the bears are really related to geopolitics and China-US relations and that could be represented by the currency volatility - It's been OK of late.
But if geopolitical risk were to increase incrementally from here, either because of an escalation of the trade war, or concerns about the trade surplus in China, that would perhaps diminish some of the attractiveness of investing in the local bond market or just from a risk sentiment pecks perspective, more broadly.
The prospect of potential sanctions against Chinese issuers, you know, we don't think it's going to go down the road that it perhaps went down for some Russia issuers or even more extreme instances where US investors aren't allowed to invest in some names.
But that's a risk that's out there, particularly when you have an administration where, you know, sort of there's a lot of policy on uncertainty.
Some of the decoupling that's happened in the technology sector in China, and restrictions from the US related to that, could that spill over into the financial sector?
And I think, you know, Peter did an excellent job about talking about some of the risks of investing in, in the local corporates with related -- as it relates to, you know, accounting fraud and fraud more broadly.
So those are things that I think bears would tend to point to.
And from our perspective, those are risks you just have to take into consideration and, you know, assess your probability of those]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks, Cathy. I'll -- Peter, I'll pose that same question to you, specifically thinking about the onshore market of S&P [inaudible].
Obviously, one of the major non-Chinese rating agencies on the ground now there, what are you seeing and hearing? And what are you trying to do Professor?]
>>[DESCRIPTION: Peter Eastham appears on the right of the screen and is speaking]
>>[AUDIO: Yeah, I mean, yeah. As writing I can see what neither a bull nor a bear right?
Where in the market to try and call it -- a call credit risk as we see it and that's what we think is that rolled in.
You know, the China market is complex and changing, right?
So a lot of markets around the world have nuanced changes, whereas China probably will have larger changes by the time where I think new rules or new things are introduced.
You probably have a little bit less certainty about what happens in China when things start to go wrong and so your decisions about whether it's the private sector, the public sector, the local government, financing vehicle sector, the ability to think about recoveries in the event that things go wrong, they're all sort of tough issues in China.
I think Cathy's right that geopolitics, you can't ignore it.
It's real. You know, you turn on the television this morning and you see a fresh round of geopolitics coming up, right, on a daily basis.
And, you know, these can all have implications.
You know, we think longer term, though, and that's certainly S&Ps perspective on what we've been doing and why we've gone in with boots on the ground into China, is that longer term we think -- you know, the China market is not just one that you can ignore, but it's actually one that is very important and going to become more and more integrated in the global platform.
And, you know, China wants to have a robust, stable, reliable investable capital market, not just for domestic investors, but for global investors.
And, you know, that requires participating in global standards and global behaviors and I think they're pretty focused on that.
And, you know, when we meet with senior officials from different regulatory bodies, you know, they're pretty clear on where they want to get to and the standards that they want to have operating in the market.
And all that stuff actually gives us a level of confidence in terms of a longer term direction.
You know, day in, day out, things can change.
But longer term, you know, we certainly have formed the view that, you know, we think this is a story that we want to be part of and help shape and contribute to, not just for the next two or three years, but for the next 20, 30 years.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks Peter.
Just stay with you just for a second, there was a question from the audience regarding recovery rate that you mentioned recoveries and something you all analyze. What are you all gleaning from the data or have recovered from that?]
>>[DESCRIPTION: Peter Eastham appears on the right of the screen]
>>[AUDIO: Yeah, it's tough.
You know, on recoveries with China because, you know, they're -- because a lot of things get worked through and sometimes it might not be entirely transparent how those recovery rights work or there may be debt to equity swaps and things like that.
It's a hard one in terms of being able to get a handle on it. We look at that not just in the context of corporates, but banks. You know, clearly, we look at recoveries and securitization in terms of recoveries on mortgages or auto lines and things like that.
You know, we have a fairly conservative view on it in terms of how those recoveries will come through. It's something we spend a lot of time thinking about.
I'm not sure if we found the right answer entirely yet in terms of where recoveries sit.
You know, it's because of that potential variability and uncertainty in terms of how some of these workouts may actually go, and what the stepping arrangements may be and where those losses get born. it just adds a level of additional risk and uncertainty to an investor.
The classic one there is you have a local government financing vehicle get in trouble, and the government wants to try and package three or four vehicles together to bail it out.
Maybe you have a land grant that goes in from a local government or a major equity injection from a related SOE or something like that.
You have that all works and so in the wash, where the bondholders get made [inaudible].
Those examples are still working their way through.
And you're likely to see very, very different sorts of outcomes and those outcomes might change over time as well.
You might have a period where you've got great recoveries and then another period where your recoveries pretty [inaudible.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks, Peter.
Michael, coming to you, we're getting a lot of questions just about institutional controls in the onshore market.
And specifically, obviously, a lot of what CCDC is doing.
There's recent news this weekend about the integration, the further integration of bond markets in China to attract foreign capital.
How should foreign investors -- why should they feel comfortable?
What are -- what is the Chinese regulators and overall market infrastructure doing to make that onshore market more like the offshore market?]
>>[DESCRIPTION: Michael Chen appears on the right of the screen and is speaking]
>>[AUDIO: I think the answer is the onshore regulator is very, very committed in the opening of China's bond markets. And we can see in the recent two or three years, I think every one or two months we have new regulations, we have new policies to make the market more international, more connect to the rest markets investors.
For example, some market participant overseas investors, they say they need longer tenure for the settlement. So the last year PBOC guide us to launch the T+3 and even we recently launched T+N and can be larger than three of.
We can do a very longer tenure settlement cycles. I think this is well very welcomed by Japanese investors and some investors say we don't want to sign off me. So the PBOC now recently allows a selective solving plan to sign this agreement.
So, some examples say onshore regulators is very, very keen to listen to investors, and they make the change all the way.
And I will also share with some evidence here that demonstrates such kind of commitment. For example, people we know, we need international people to sell this market global.
So, for me, I work in foreign banks over 10 years, HSBC, Standard Chartered, JP Morgan, and I never imagined one day I work in an organization sponsored by Minister of Finance, PTDC.
So you can see with the governor on the regulator welcomes people talents from everywhere to make this market more international. And secondly, and I already mentioned is the standards. We also introduced lighter S&P in Moody's to do ratings here.
So I think this is a well connected with the rest of work. And the third, I think, is the pioneers. We work very closely with the S&P. We recently worked with them and we also work very closely with Bloomberg Tradeweb.
So we connect to Western to develop market players and to make these markets more connected, more friendly, more transparent to overseas investor, so you should be very comfortable.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks, Michael.
On that theme of transparency, Cathy, question to you.
What do you -- when you look at and make your assessments in terms of alpha generating potential and that risk reward trade off, how are you feeling and your team's feeling about the information transparency specifically in our being able to analyze balance sheets and things like that?]
>>[DESCRIPTION: Cathy Hepburn appears on the right of the screen and is speaking]
>>[AUDIO: Yeah.
For the onshore corporate market, it's clearly challenging.
You know, even having a team that's regionally located and as I mentioned that speak Mandarin and travel under normal circumstances there, that's a little bit more challenging. So when it comes to investing in the China corporates, we prefer offshore, where we think liquidity is a bit better and transparency is better, you know, still, perhaps some deficiencies in that regard but it's a bit better.
When it comes to investing in the government bond market, we're comfortable with transparency of, you know, Michael did a great job of explaining the approach to opening that market.
But government statistics that were necessary for assessing whether or not we want to be investing in that market are readily available and analyzable.
And it's fairly liquid and the offshore government bond market is smaller because China didn't need to be borrowing in dollars itself, given that it had, over time had had huge surpluses and a huge store of foreign exchange reserves.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks, Cathy. Appreciate it.
On liquidity, are you able to shed some light on kind of do you think about the layers?
You mentioned, you know, government onshore, corporates offshore is how a piece in fixed income approaches it. But even just looking under the hood, what liquidity and various layers look like. There was a question or comment from one of the audience members talking about the volatility that slide you put earlier, is some of that volatility dampen volatility because there's actually a lack of maybe around basic currency thought it could just be attributed to liquidity's factor?]
>>[DESCRIPTION: Cathy Hepburn appears on the right of the screen and is speaking]
>>[AUDIO: I think you have to separate the different markets.
If I'm looking at the government offshore market, it's just lower volatility because that's just the nature of the beast, as well as if you look at the segmented investor base, you have regional Asian investors who, you know, want to own that, and I don't necessarily -- I wouldn't characterize that as -- because it doesn't trade that means it's less volatile. It's just kind of the nature of the beast.
When it comes to the government bond market onshore, it's just to the whole -- the technicals in terms of the inclusion of the different bond indices is helping to drive that. And a lot of what we've been talking about today, it was efforts to make it more liquid help that.
The offshore corporate market and the onshore corporate market are, I think, are clearly more vulnerable, we saw that and the liquidity is in part related to the volatility is in part related to the liquidity.
It's a little those markets both offshore and onshore are less liquid, and that perhaps a contributes to the volatility doesn't make it less volatile.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: In terms of dealers, their primary dealers not specific numbers, but are you seeing more kind of come in especially into the government market?
And then, you know, looking at corporates, is that evolving to our parties that are not playing?]
>>[DESCRIPTION: Cathy Hepburn appears on the right of the screen]
>>[AUDIO: More so on the government side, less so on the corporate side from my perspective.
I don't know if I'm, you know, Michael has a different view on that.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Yeah. Michael, it would be great to get your thoughts especially as CCDC in other parts of the regulatory infrastructure trying to get more participants.
What are you all seeing in terms of dealer volume and overall dealer participation?]
>>[DESCRIPTION: Michael Chen appears on the right of the screen and is speaking]
>>[AUDIO: I think currently, onshore the liquidity provider mainly from common local commercial bonds.
And, you know, so far, they have found challenging access to onshore bank future market.
I think this may have some constraint in the market making, which provide liquidity to the market participant.
But the good thing is recently, the onshore regulator, PBOC, CBRC are not allowed other commercial local commercial banks and also insurance companies to participate on future market which I think they may have a very good too to manage their risk exposure and also I think a lot of things happen.
For example, Minister of Finance that we found recently insurance, new insurance are mostly reopen to Asian. So they aware of the importance of -- to make the one or two several bonds of being very good liquidity to make them to better position to lower their financing costs.
So I think everyoneís aware the importance of liquidity and they're making improve on that.]
>>[DESCRIPTION: Keshav Rajagopalan appears on the right of the screen and is speaking]
>>[AUDIO: Thanks, Michael. Peter and then Cathy as well for this question, leverage in the system, you always read about it, obviously, the growth in the market.
And Cathy, as you pointed out during your presentation, it will continue to grow, it needs to grow more.
But that means a lot of leverage in the system.
So, Peter would love to get your take from a ratings perspective on concerns.
I know you've talked a little bit about how S&P thinks about it, but just an overall macro view on leverage and then Cathy, as well, to you.]
>>[DESCRIPTION: Peter Eastham appears on the right of the screen and is speaking]
>>[AUDIO: Yeah, I mean, the government was on a pretty focused pathway precoated around trying to bring leverage in the system down, you know. Generally speaking, the China system is pretty highly leveraged, the corporate sector is highly leveraged.
LGFE these look pretty highly deleveraged. It's not that the government have changed tack necessarily on that leveraging.
It's the -- similar to every other government around the world.
You know, COVID-19 throws up some interesting challenges in terms of governments needing to actually stimulate to protect economies.
So I think it's probably fair that they have, you know, put the deleveraging thing on the slow burner.
You know, I don't think the macro desire to actually continue on with that deleveraging I think that is still there. It's just the timing is not right, right now.
So I would imagine if, if you look at the some of the statistics that you see in terms of how China is potentially coming out of COVID-19, you know, in terms of that economic rebound, it's looking pretty strong so far.
Now, who knows what happens with that?
You know, that's the biggest challenge for our economists -- and every economist around the world at the moment is to try and go how do these roads of recoveries postcode that actually occur?
Is there a postcode? You know, none of us know the answer to any of these things right now, unfortunately.
You know, I think China, just the rebound the amount of air travel that's going on, the economic reason from a very, very serious GDP downturn.
So moving to some level of recovery is impressive.
Well, I hit some bumps in the road, probably. You know, you're seeing surgeons around the world. China may we'll get one.
I guess so far, they've had a pretty strong ability to be able to deal with ramifications of flare ups and stuff with coronavirus pretty quickly and sort of not derail some of their recovery pathways.
So I think longer term they are going to return to get in that system deleverage down because overleveraged can create instability, right?
And they want to try and getting that more under control.
And they've got time to do it, and they have plans around how they were doing it.
And I don't think those plans are shelved.
I think they -- it just put on the back bottom for a little bit.
Cathy?]
>>[DESCRIPTION: Keshav Rajagopalan]
>>[AUDIO: Cathy, your thoughts?]
>>[DESCRIPTION: Cathy Hepburn on the right of the screen and is speaking]
>>[AUDIO: Sure. Sure. Just two points to add to what Peter said.
The way in which they're seeking to use stimulus this time around is really more with infrastructure.
So it's less with the financial sector or with the shadow banking sector. And I think that that's relevant because those were some of the concerns surrounding the leverage in the system.
So it seems to be more of the traditional infrastructure lead investment, which perhaps has a few -- fewer risks than some of the other financial systemic risk that people were concerned about.
And the other point is, you know, we have to remember that just -- it's a more of a closed system where obviously, where few were talking about it being more open, but from the perspective of how it's domestically financed with just a huge deposit base within EMBI, the banking system, financial repression, et cetera, that the way in which leverage impacts a system like China is different than how we think about it in the West.
And if you look back to what happened in the period of 2015 when they tried to lift capital controls that didn't necessarily work so well in, for the domestic market.
So those will likely remain in place. And the challenge going forward as the market is opened up to offshore investors, more of us are investing in the onshore market is how that lever, if you will, the capital controls are managed.
And again, I don't think that thereís going to be any mistakes we need in this regard.]
>>[DESCRIPTION: Peter Eastham on the right of the screen and is speaking]
>>[AUDIO: Can I just adds that, Keshav?
So -- I mean, you just look at some of the announcements that were made in terms of, you know, the government have basically just came out and said what they're expecting the banking system to be putting back into the economy.
I mean, they've mandated that, you know, overall earnings for 2020 will come down by 1.1 or one and a half trillion or whatever it was RNB, because they want that stimulated back into the economy.
So that sort of that control does give an amazing power, right, in terms of being able to deploy resources into a market target of had at different programs, as Cathy said, right?
So, you know, it's a unique system and, you know, that's one of the things we absolutely found.
We put 35 analysts on the ground there as part of our, when we first went in, that was the first thing we did was to put a whole heap of local analysts on the ground there to try and understand and keep track of all of these different nuances of how they play out with the market, because it's very complex, it's very integrated and it takes a lot of resources to understand.]
>>[DESCRIPTION: Keshav Rajagopalan on the right of the screen and is speaking]
>>[AUDIO: Thanks, Pete.
Thanks, Cathy.
Cathy, to stay with you, and probably our final question just in give time, but look, Peter, your view and Michael as well.
Obviously, the geopolitical situation when you think US-China relations, I don't want to get too much down the political rabbit hole but Cathy, you presented that as, you know, the bear case kind of something to be concerned about, where are you seeing investment opportunity today?
[inaudible] and whether it's governments or friends or local currency, where are you seeing value in that relative value different?
>>[AUDIO: Yeah. Absolutely value in the local China government bond market, because we think by design, it's imperative for the Chinese policymakers to want to get rates and down and so we think that there is opportunity for yields to come down when we think there's value relative, not only to other EM markets, but to DM markets but importantly, from a volatility perspective, risk on risk off.
The China local bond market doesn't trade like some of the other local bond markets that EM investors operate in, even the low risk ones.
So that, from our perspective, is attractive and I think that will likely be the case notwithstanding some of the geopolitical risks of and in the hard currency market.
And this is more of a risk-on, risk-off sort of a trade, if you will, or investment if you will.
We do think there are attractive opportunities in offshore China corporates.
You have to be incredibly selective and be mindful of that you're getting paid appropriately for all of the risks that we talked about.
And if geopolitical risks do increase, you know, who knows that if they would include sanctions, prohibitions, et cetera.
Those sectors could be vulnerable.
There's a low probability of that, but you just have to be mindful of that - but they are attractive.]
>>[DESCRIPTION: Keshav Rajagopalan on the right of the screen and is speaking]
>>[AUDIO: Michael, I know, you're obviously [inaudible] from the market.
[Inaudible] the geopolitical environment and some of the things you all are doing outreach perspective is given for intention.]
>>[DESCRIPTION: Michael Chen on the right of the screen and is speaking]
>>[AUDIO: I think the first thing -- I think opportunity comes from the central government bonds and also some positive bonds because I think this is driven by the amount of these bonds is very, very consistent and very, very solid.
I can share with you currently all the China's central government bond, 8% is held by overseas investors.
We estimate in the next two or three years, the percentage of overseas investor will go up to maybe 15 to 20%, which means every year we may have maybe half a trillion that might be coming to our onshore from overseas investors. They are active or passive investors for such kind of government bonds.
So I think the demand is very strong, backed by the strong economy growth going forward because I think China currently is the only country we foresee can record a positive GDP growth this year. So we are very proud of that.
And the second opportunities I think, comes from the cut amounts.
I think that story comes from, I think, the infrastructure here like the S&P global rating methodology is rooted and developed very quickly here.
And I think the real opportunity actually come from the China credit bonds, which I think is still our emerging island to invest in overseas investors.
Currently, no one can understand this market, but this market can bring a huge alpha true to your portfolio to your investors.
So I think we need to have a global standard like S&P and also like other tools to tax good quality, good credit and also we need to have some local as we mentioned. We need to have local people. We need to have the local partners know how to select the real good quality credit.
And the third I think, we also need to have the mechanism like how to rating, how to disclosure, how to process the in default case, how to treat the tax in treatment, and also how to improve the liquidity of credit bonds.
So I think all these well, on their way to further improvements.
So I think the second opportunity from credit bonds, maybe immediate term.
And also the long-term is also the ETF.
It's related to credit and also related to offshore immediate development. We see globally in US, in Europe or the ETF, they are in kind of redemption allowed. Here, currently no.
So I think we are also working with some panel offshore exchange partners to see how to offer such kind of features and also with a more good index providers, include the rating service provider, like Peter mentioned. So I think we are underway to give more opportunity to global investors.]
>>[DESCRIPTION: Keshav Rajagopalan on the right of the screen and is speaking]
>>[AUDIO: Well, thank you. I think we've come up on the hour.
I want to thank all of our presenters and all of the audience and Michael, a special thanks to you as it is nearing 9 P.M. in Shanghai right now so appreciate your staying in the office a little late for this discussion.
But a very, very insightful discussion, I think, a lot more to come in this market. We're certainly going to stay tuned, do it. I know Cathy and her team have worked well within PGIM fixed income.
And for all of our audience, this is just the first part of our series for the PGIM China Investment Symposium.
But please stay tuned for the next part of the series on the public equity markets, where we'll host another discussion like this in the fall.
But until then, stay safe.
Keep well and look forward to seeing everybody soon.
Thank you.]
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Examining China's rising role in the world economy.
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PGIM brings together a panel of thought leaders to discuss China’s rising role in the global economy and surrounding geopolitical tensions.
Part 3 featuring Stephen Joske in a fireside chat, focused on some of the less-bullish considerations that institutional investors should give weight to.
This five part series brings together institutional investors and industry leaders to examine China's rising role in the world economy.