Debt Capital Markets in China E-Book

Jian Gao

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 1125

Veröffentlichungsjahr: 2011

Beschreibung

An in-depth look at China's burgeoning capital markets Author Jian Gao is the number one authority on fixed income markets in China, and with this book, he brings his considerable experience and knowledge about these markets to investors worldwide. For those interested in becoming active in China's growing fixed income markets, Debt Capital Markets in China is the book you need to get started. It includes coverage of the primary and secondary markets, government debt instruments, corporate bonds, the collateralized bond market, and asset-backed securitizations. Debt Capital Markets in China also examines the developing market trends, which affect investors and institutions looking to make the most of this incredible financial opportunity. Dr. Jian Gao, PhD (Beijing, China) is the Vice Governor of China Development Bank (CDB).

Leseprobe

Contents

Foreword

Preface

Acknowledgments

Introduction: Bond Market Reform and Financial Innovations, a Historical Perspective

Part One: Bond Market: Theory and Practice

Chapter 1: Theory of Institutional Economic Engineering in China

Institutional Economic Engineering

Primary Exchange and Secondary Exchange

Primary Economic Exchange and Anatomy of Economies in Transition

Applicability of Truth and The BVP Trilogy

Repression of Financial Institutions and Economic Development

China’s Financial Market Today

New Methodology For The Analysis of Financial Issues

Summary of Ieen

Chapter 2: The Practice

Structural Issues in China’s Financial Market

Institutional Economic Engineering Theory and Bond Market Development in China

Part Two: The Emergence of a Primary Market

Chapter 3: Primary Market for Treasury Bond Transactions

Bond Market Reform Timeline

History of China’s Treasury Bond Market

Lessons Learned From China’s Treasury Bond Experience

Conclusion

Chapter 4: Issuing Methods and Practices Around the World

Issuing Methods in Developed Market Economies

Features of Treasury Bond Issuance Worldwide

Chapter 5: Path to a Cost-Efficient Treasury Bond Market

Changes In China’s Treasury Bond Issuing Techniques

Technical Issues

How Tender Issues Work in China

Considerations For The Future

Chapter 6: Evaluation of Treasury Bond Issuance in China

Issuing Cost: Composition and Comparison

Analysis Of Treasury Bond Issuing Costs in China

Evaluating Treasury Bond Market Development: Establishing Criteria

Part Three: Emergence of a Secondary Market

Chapter 7: History of China’s Secondary Bond Market

Treasury Bond Secondary Market, 1988 to 1990

Treasury Bond Secondary Market, 1990 to 1992

Treasury Bond Secondary Market, 1992 to 1993

Treasury Bond Secondary Market, 1993 to 1994

Treasury Bond Secondary Market, 1995

Treasury Bond Secondary Market, 1996

Treasury Bond Secondary Market, 1997 To 1999

Treasury Bond Secondary Market After 1999

Future Bond Market Development: Lessons Learned

Fundamental Relationship Between Primary and Secondary Bond Markets

Crucial Role of Financial Intermediaries

Chapter 8: Secondary Market: Operational Issues and Role of Participants and Financial Intermediaries

Operating Procedure For Spot Transactions on The Stock Exchange

Operating Procedure in The Interbank Bond Market

Development And Functions of Securities Intermediaries

Financing Channels of Securities Intermediaries

Rationale for Developing The Secondary Market

Chapter 9: Treasury Bond Investment Fund

Treasury Bond and Securities Investment Funds

Stock Investment Fund

Fixed Income Funds

Chapter 10: Treasury Bond Repurchase Market

History of Treasury Bonds Repurchase

Repo Market Overview

Treasury Bond Repurchase Today

Newly Emerged Swap Market

Part Four: Policy Issues

Chapter 11: Treasury Bond Market and Open Market Operations

Institutional Framework of Open Market Operations

Early Stage of Open Market Operations in China

Reform and Development of The Treasury Bond Market Paves The Way For The Central Bank’s Open Market Operations

Policy-Related Financial Bonds and Open Market Operations

Future of Open Market Operations

Chapter 12: Government Debt Policy and Macroeconomics

“Crowding-Out” Effect of Government Debt

Impact of Government Debt on Expenditures

Why Commercial Banks, Not The Central Bank, Should Hold Treasury Bonds

Rationale For Countries To Issue Foreign Debt

Reasons For Financing and Developing A Sound Bond Market

Defining and Setting Goals For The Treasury Bond Market

Chapter 13: Government Policy on Debt Instruments and Term Structure

Objectives And Types of Debt Instruments in An Advanced Bond Market

Brief History of China’s Government Debt Instruments

Chapter 14: Impact of Government Policy on Term Structure of Interest Rates

Forms of Payment For Medium- and Long-Term Treasury Bonds

Interest Rate Structure for Medium- and Long-Term Treasury Bonds

Chapter 15: Types of Bonds

Nontradable Bonds: Government Savings Bonds

Price Index Bonds

Chapter 16: Government Policy on the Holding Structure of Treasury Bonds

Holders of T-Bonds in China

China’s Bond Market Structure and International Practices Compared

Future of China’s Bond Market

Part Five: Organization and Legal Structure

Chapter 17: Organizational Structure and Institutional Arrangement of the Treasury Bond Market

Role of Government: Budget, Treasury, and Debt Management Agencies

How The Launch of T-Bonds is Managed

How Debt Management Departments Should be Organized

Chapter 18: Legal Framework of the Capital Debt Market

Laws and Regulations Governing Treasury Bonds

Laws and Regulations Governing The Primary Market

Laws and Regulations Governing Public Finance

Laws and Regulations Governing The Secondary Market

Laws and Regulations Governing Taxation Policy

Laws and Regulations Governing Bond Issuance

Laws and Regulations Governing The Primary Dealer System

Laws and Regulations Governing The Redemption of Treasury Bonds

Chapter 19: Legal Framework of the Capital Debt Market

Laws and Regulations Governing Treasury Bond Subsidies: A Historical Perspective

Laws and Regulations Governing The Treasury Bond Custody System

Laws and Regulations Governing Transaction Fees

Laws and Regulations Governing Operating Mechanisms and Clearing and Trust System

Laws and Regulations Governing Clearance and Settlement

Laws and Regulations Governing Clearance and Settlement

Chapter 20: Regulation and Deregulation Related to Bond Market Risk Management

Objectives of Liabilities Management

Assets and Liabilities Management

Part Six: The International Market

Chapter 21: Foreign Debt Issuance

Objectives

Sovereign Debt Issuance in The International Market

Preparation of Government Bond Issuance in The International Market

Selecting Lead Underwriters and Legal Counsel

Legal Issues and Procedures For Market Entry

Road Show: Disseminating Information About The Issuance

Offering Strategies

Executing Market Strategies

Debt Management

High-Yield Corporate Bonds

Issues Related To International Offerings

Part Seven: The Non-Government Securities Market

Chapter 22: Structure of the Non-Government Bond Market

Market Structure of Non-Government Bonds in The Inter-Bank Bond Market

Structure of The Exchange Market

Inter-Bank Bond Market Versus The Stock Exchange Bond Market

Role of Underwriters in Issuance of Corporate Bonds

Future of The Non-Government Bond Market Development

Chapter 23: Financial Debentures and the China Development Bank’s Financial Innovation

Financial Debentures

Financial Innovations of The China Development Bank

China Development Bank’s Floating-Rate Bonds

China Development Bank’s Option Bonds

Reopening Bond and its Pricing

Chapter 24: Development of China’s Corporate Bond Market

Corporate Bond Market Development

Corporate Issuing Status

Development of Regulatory Framework

Market Innovations

Underwriting Corporate Bonds

China Development Bank’s Market Promotion Efforts

Recent PBOC Initiatives

Corporate Bond Development: Problems and Solutions

Chapter 25: Asset Securitization of the China Development Bank

Need for Securitization of Credit Assets and The Role of The China Development Bank

Deal Structure Design of Credit Assets Securitization

Splitting The Maturity of Asset-Backed Securities

Standards for Selecting Securitized Assets Pool

Pricing Asset-Backed Securities

Asset-Backed Securitization Structure and Offer

Information Disclosure

Issues Affecting Future Development

Part Eight: The Debt Capital Market

Chapter 26: Debt Capital Market and the Macroeconomy

National Savings As A Financing Instrument

Changes in The Pattern of National Savings

Changing Characteristics of Private Savings Objectives and Investment Direction

Analysis of Saving and Investment

Financial Sources For Investment in Bonds

Institutional Changes and Their Impact on The Bond Market

Changing Investor Base

Financing Before 1994

Fiscal Deficit in China

National Debt as A Financing Item in The Budget

Fiscal Deficit, Government Bond Issuance, and Foreign Exchange Reserves

Instruments to Finance Fiscal Deficit and Their Economic Consequences

Chapter 27: Size of Government Debt

Current Conditions: Revenues and Expenditures

Government Bond Issuance and Debt Service

Indicators of Government Debt Scale

Chapter 28: Debt Capital Market as a Stage of Financial Revolution

Origin of Credit

Function and Forms of Credit and Debt

Economic Principles of Credit

Characteristics of Credit

Government Policy and Debt Capital Market

Chapter 29: Development of the Chinese Government Bond Market

International Experiences and Their Implications For The Development of China’s Treasury Bond Market

Institutional Development and The Formation of An Institution-Based Market

Market Infrastructure

Postscript

Appendix A: Laws and Regulations Governing Financial Debentures

Appendix B: Primary Government Securities Dealers Updated by the Federal Reserve of New York on August 3, 2004

Index

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Copyright © 2007 by Jian Gao. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Gao, Jian.

Debt capital markets in China /Jian Gao.

p. cm. — (Wiley finance series)

Includes bibliographical references and index.

ISBN-13: 978-0-471-75120-5 (cloth)

ISBN-10: 0-471-75120-0 (cloth)

1. Government securities–China. 2. Bond market–China. 3. Debts, Public–China. I. Title.

HG5785.G35 2007

332’.04150951–dc22

2006026721

Foreword

The stunning transformation of the Chinese economy over the past 28 years is, by far, the most remarkable chapter the world has ever seen in the modern-day saga of economic development. The breakthroughs have been especially dramatic since the early 1990s. As recently as 1991, China and India stood at parity in terms of gross domestic product per capita—around US$350 per person. In 2006, China’s living standard as measured by this gauge was about $2,000 per capita—more than double the $800 level in India. It is not that India fared poorly on the road to economic development—to the contrary, its improved state of economic prosperity has been most impressive. But India’s accomplishments pale in comparison. In the past 15 years, China has rewritten all that we once thought we knew about economic development.

China’s extraordinary journey has revealed its strengths but also unmasked some if its weaknesses. China’s strength can be boiled down to one simple concept—reform—and by the willingness of its leadership and people to push ahead on reforms at all costs. In doing so, China is engineering a truly remarkable transformation from a state-owned system controlled by central planners to a privately owned system ruled by the marketplace. Today, China is close to midway in this transformation—essentially a blended economy that straddles both state and private ownership regimes. Market forces are evident in many areas of economic activity but glaringly absent in others. But China is now past the point of no return—its commitments to a market-based system have now taken on a life of their own, and there is no turning back.

That places China at a critical juncture in its transformation to a modern economy. It has pushed its current growth model to the limit—a model dominated by exports and by investments in infrastructure and manufacturing capacity that support export production. In fact, China may well have taken this model too far. It has become overly reliant on becoming a supplier to the rest of the rest of the world and has neglected the development of its internal demand. Collectively, exports and fixed asset investment now make up about 80 percent of Chinese GDP. By contrast, private consumption fell to a record low of 38 percent of Chinese GDP in 2005. The result is an unprecedented—and unsustainable—state of internal imbalance in China’s booming economy. As indicated in the newly enacted eleventh Five-Year Plan adopted by the National People’s Congress in March 2006, the Chinese government is committed to an important rebalancing of its economy, with focus aimed at correcting the imbalance between excess supply and inadequate internal demand by reining in a runaway investment boom while at the same time taking actions to boost the emergence of a strong and vibrant consumer culture.

Chinese is missing one key piece in its development model that is essential in order to engineer a successful rebalancing: capital markets reform. In particular, the allocation of capital remains very much in the hands of an inefficient, fragmented, and antiquated banking system. In 2005, for example, China’s domestic capital markets—equity and bonds, combined—accounted for only about 15 percent of the total funds raised by the business sector. Banks, however, accounted for fully 85 percent of total credit intermediation. Yet China’s banking system is ill-equipped to handle the bulk of the capital allocation process. There is a veritable absence of risk-adjusted commercial lending practices—an important mainstay of modern market-based financial systems. With a fragmented banking system long focused on funding China’s vast network of inefficient and largely unprofitable state-owned enterprises, the Chinese banking system has become encumbered by a massive buildup of nonperforming loans. In the meantime, the projects those loans have funded have left the real side of the Chinese economy with an equally serious problem of excess capacity in many key industries and sectors. especially aluminum, cement, steel, coal, autos, and, of course, residential property.

A fragmented banking system, with lending practices dominated at the local level by the employment and social stability objectives of local Communist Party officials—is a recipe for a chronic misallocation of capital and a further buildup of excess capacity. Putting bank lending on a sound, risk-adjusted commercial basis through accelerated banking reform is an increasingly urgent challenge facing China in its next phase of economic development. The good news is that Beijing is very focused on this task. The bad news is that it has only just begun. Two of the four major policy banks have been publicly listed in world equity markets, and the remaining two should follow suit shortly. But the initial public offering is only the first step in a long reform process that must, in the end, lead to the establishment of a centralized, commercially sound lending culture—a far cry from the legacy of policy-based lending that has long plagued Chinese banks. Nor can banks be expected to do the job alone. The market-driven allocation of well-developed equity and bond markets are two additional and very important legs of the stool that must be added to the Chinese capital allocation process. The sooner China pushes ahead on such capital markets reforms, the better.

Dr. Gao Jian offers an important prescription on how that task can be accomplished. There is no practitioner better qualified than Dr. Gao, who is known to insiders as the father of the Chinese bond market, to lay the groundwork for what could well end up being the most rapidly growing corporate bond market in the world. Debt Capital Markets in China is a living testament of the genesis of the Chinese bond market. It is actually Dr. Gao’s third book on the Chinese bond market but the first such effort ever published in English. But it is far more than a history book—it is a bible of a market at the dawn of creation. It offers the reader a detailed assessment of what it will take for the Chinese bond market to grow and prosper.

Gao Jian does not underestimate the daunting task that lies ahead for China in the establishment of a fully functioning corporate bond market. But he is equally insistent that China has no choice other than to move quickly down that path. He argues forcefully that it is not only an essential piece of the efficient capital allocation process but that it is equally important to ensure the efficacy of monetary and financing policies of the central government. As the experience in the West has long demonstrated, bond markets are linchpins of well-developed financial systems. They also provide important benchmarks for international investors to value one economy relative to others—in this case, offering China an international scorecard on its accomplishments. Given the heavy lifting that lies ahead in the next stage of Chinese reforms and development, Dr. Gao argues that it is hard to envision success without a well-developed bond market. I couldn’t agree more.

This book is, by far, the most complete reference document I have ever seen on the subject. From the history and legal framework of the Chinese bond market to its interface with China’s treasury market and public policy, Debt Capital Markets in China leaves few stones unturned. I took away three lessons from this masterful text: First, the development of the Chinese bond market cannot occur in a vacuum. As Dr. Gao stresses, the establishment of the rule of law and private ownership rights go hand in hand with a fully functioning bond market. The development of market-driven currency and monetary policies are equally important byproducts of the capital-market reform equation. Second, China cannot hope to establish a thriving business sector without the assistance of a robust domestic bond market. China has the most “open” development model I have ever seen, stressing cross-border connectivity to a vast network of suppliers and end markets. Yet an increasingly market-based Chinese economy will not succeed in pushing ahead on the next leg of its development journey unless the financial underpinnings of such a corporate structure are, as Dr. Gao notes, deep and balanced. Third, China’s bond market will not spring to life overnight. Dr. Gao underscores the painstaking efforts that have been required to get this far on the journey. Given the complexity of Chinese regulatory and bureaucratic oversight, capital markets reform, in general—and the development of the bond market, in particular—is a process that could easily take another five to ten years.

In recent years, the world has been stunned by the emergence of China as a major economic power. So far, however, this emergence has been quite lopsided: concentrated more on the production side of the real economy than on the financial side of its capital markets. That imbalance needs to be rectified in the years ahead. China is now the fourth largest economy in the world. Yet, adjusted for its size, it has the smallest bond market in the world. That bond market must grow to a size that is commensurate with the scale of its business sector and real economy. Such growth is now under way, but it is only a glimmer of what to expect in the years to come. In fact, I can’t imagine a more exciting growth story for any financial market. For English-speaking market participants who are on the outside looking in, Dr. Gao Jian’s Debt Capital Markets in China is both a handbook and a guide of what to expect along the way. It is a reference manual that I am confident will stand the test of history for years to come.

Stephen S. Roach

Chief Economist, Morgan Stanley

New York

September 2006

Preface

Debt Capital Markets in China is a book about the history and development of China’s contemporary debt capital market. It is the culmination of my 15 years’ experience in, as well as my research into, China’s treasury and banking systems. In it, I hope to introduce readers to China’s debt capital market, which is essential for an understanding of its financial market and the economic reform occurring throughout China today.

The bond market is part of my life—it is the focus of my devotion and dedication. I belong to a generation whose destiny was randomly governed by various political movements. Prior to the reform, I was sent to the countryside for reeducation, a movement that reshaped the lives of at least two generations. Next, I served in the armed forces. Later, I stepped into a public securities bureau. Such experiences were typical at that time. Like a small boat adrift on the tide of political movements, I had little freedom to select a job in which I might really be interested. However, I was fortunate and always landed in the forefront of the times. Although my early life contributed very little to my academic career, it had a positive impact on building my character, and, as the rest of my life demonstrates, I have benefited a great deal from those experiences.

After the reform, I had an opportunity to study in university, and I graduated from Beijing College of Political Science and Law in 1982. I immediately went to work in the Ministry of Finance. I began in the comprehensive planning department, first in the Division of General Financial Planning and then in the Statistical Division. I spent one year with the Legal Department before stepping into the State Debt Department in 1990, which was the beginning of my career in the bond market.

China’s financial market is becoming increasingly integrated with the world’s financial markets. As a result, there has been a growing interest in understanding China’s economic development. On the eve of World Trade Organization participation, China is pressing ahead with its commitment to open its capital markets to foreign competition by 2007. It is therefore essential that those outside China understand its bond market. This book is intended for a wide audience, including investors, academics, and others generally interested in Chinese contemporary economic development.

WHY I WROTE THIS BOOK

As Norman Chan, the deputy chief executive of the Hong Kong Monetary Authority pointed out during the discussion at the UNESCO roundtable conference in April 2000:

There are numerous studies and literature about the bond market in Asia explaining why it is relatively underdeveloped. There has been little disagreement amongst the policymakers and regulators in Asia on the desirability of developing their domestic bond markets. The advantages have become even more self-evident after the latest Asian financial crisis. Yet, despite this consensus, the question still remains: why is it that domestic bond markets are still developing at a rather disappointingly slow pace notwithstanding the benefits an economy can gain from them?

This is a very good question indeed. It is my hope that China’s experiences can provide some insight into the question. In my view, bond market development in China rests on four pillars:

1. Innovative ideas

2. Institutional evolution

3. The role of agencies

4. Technological progress

This view later evolved into the IEEN (institutional economic engineering) framework, reinforced and transfixed throughout this book. However, most of the comments thus far on this issue emphasized only on the importance of market structure and regulatory framework without a consistent theoretical framework to reveal the essence of the debt capital market, which I would set as my task.

LEARNING FROM HISTORY: SHARING EXPERIENCES, DRAWING LESSONS

Although Asia’s bond capital markets are generally underdeveloped, and China’s is no exception, the reasons behind this underdevelopment are manifold. The case in China is unique. China is a large country, and its debt capital market in particular is built on an inefficient financial market at a nascent stage in the development of its market economy; that is, China is in the process of transforming itself from a planned economy into a market economy.

Using historical development as our road map, we must gain insights and draw lessons from this important period, so that we can further improve China’s market mechanisms. As Victor Hugo stated, “If a writer wrote merely for his time, I would have to break my pen and throw it away.” In this book, therefore, I summarize the experience of China’s bond market in order to achieve a better understanding that will help us improve it.

First, it is apparent that an appropriate strategy is essential to the development of China’s bond market. The reasons for establishing a sound bond market need to be very well defined. The lesson we can draw from the past is clear: If a bond market is built only for the purpose of financing, the bond market will inevitably fail. China’s stock market around the turn of this century was an example of this failure.

It is also apparent that the strategy used has to be consistent with Chinese characteristics. Government agencies need to understand that if the objective is financing, first a financial market must be established. To build a financial market, there must be a clearly delineated institutional framework.

Second, the establishment of an institutional framework for the bond market is crucial to the market. Institutional investors, financial intermediaries, a bond dealers’ association, and a settlement and clearance company are all interconnected and critical to the overall success of the bond market.

China’s experience shows that without a sound institutional investor base, it is impossible to establish a liquid and cost-effective bond market. Institutional investors are market experts who tend to participate in the primary market and trade bond instruments frequently.

A financial intermediary whose function is to reduce trading costs is essential to the smooth functioning of the market. For a long time, China’s financial intermediary industry did not exist; financial intermediaries were thought of as a “merchants,” people who earned money without incurring cost, which in China has a negative connotation. This prevailing view hindered the thinking of government debt managers and eventually dragged down the development of China’s financial intermediary industry. Today the role of the financial intermediary is recognized, and this led to the first step of market-oriented reform (i.e., the 1991 underwriting syndication program).

For many years prior to bond market reform, bond distribution (placement) was very costly. For example, the expenses incurred in printing, transporting, and safeguarding paper securities were extremely high, creating a large financial burden for the government. Thus, it is in the government’s interest to reduce these costs. Therefore, a paperless bond trading system (book-entry form) is a prerequisite for a cost-effective bond market. The government realized that it was necessary to eliminate the costs associated with paper securities; however, this is possible only if institutional investors and financial intermediaries are part of the system.

Third, the rational sequencing of any reform program is very important. A well-prepared reform program has to include every step of the reform program. China’s bond market reform followed a rational sequence.

Institutional investors and financial intermediaries were introduced first, so that paperless securities could be instituted. Before 1991, bonds were sold mainly to individuals through an administrative network, so there was no need for institutional investors. Individuals, each of whom held a small number of bonds, preferred paper securities because they were easy to store at home and could be seen and touched, which made individual investors feel safer.

In 1991, when the underwriting syndication was introduced, syndicate members included both financial intermediaries and institutional investors, who preferred the convenience of book-entry form securities, which were introduced in 1993. (As newly issued securities become paperless, the stock exchange can use its electronic transmission system to trade securities.)

Following the introduction of the book-entry form for newly issued securities in the primary market, the Shanghai Stock Exchange in collaboration with the Ministry of Finance set up a special section for trading government securities; however, the coupon or rate of interest of newly issued government bonds was still determined by the State Council. As a consequence, the primary issues were not market based, and there was no de facto primary market at all.

The need for market-based pricing of the primary issue soon became evident. In 1995, the Ministry established the settlement date auction, creating a market-based primary market that continues to this day. However, existing bearer bonds remained untradable at the time.

The Ministry next set in motion a series of programs to establish a settlement and clearance system that was designed to eliminate paper securities—specifically, to create paperless book-entry form securities that are traded electronically. In 1996, the Ministry, in collaboration with the People’s Bank of China, officially established the China Government Securities Depository Trust Company. Financial innovation, including the China Development Bank’s (CDB) endeavors in the post-reform era, started to flourish. In 1996, 10-year bonds, which were the longest-maturing bond in China at that time, were introduced. Their creation was possible because pension and insurance funds had developed and become the mainstay of institutional investors.

In only five years, China had established a framework for its contemporary bond market, an achievement that has as much to do with its strategy, implementation sequence, and institution-based efforts as it does to its vision and courage.

Fourth, without a sound money market and sound financial market, a bond market cannot be developed. As China’s debt capital market developed faster than other components of its financial market, the weaknesses of the money market have become problematic. In Hong Kong, it is noted, the Hong Kong Monetary Authority (HKMA) is always able to stimulate bond market development, but the government bond market there is small because the government has been running a fiscal surplus for many years. Hence, there is little need to issue government bonds. Therefore, the HKMA has to issue short- term commercial paper to absorb liquidity. As Hong Kong’s money market has been put in place, should conditions permit (as is present the case), the HKMA is ready to develop a sound bond market.

Unlike Hong Kong, China has a growing government deficit since reform, which it must finance by issuing government bonds. This requires that government bonds be issued on a regular basis. Thereby it is possible to provide a benchmark for China’s bond market. However, although the bond market is developing, the slow pace of money market development has held the bond market back. The recent development of money market instruments is reassuring and should activate and energize the interbank bond market. Although the central bank’s move is driven by its desire to streamline its monetary policy instruments, it is also conducive to the bond market.

SPECIAL CHARACTERISTICS OF CHINA’S BOND MARKET

Admittedly, the reform of the bond market has benefited from the experiences of Western countries, especially the United States. Working in the Ministry, I have had many chances to learn from my experiences abroad. I benefited tremendously from the study and training I received in the United States and Europe. I studied debt management at the World Bank program at the Economic Development Institute in 1989 and 1990 and the banking business in Italy in 1983. Three years later, I spent a few months attending a program in the Japan Economic Planning Agency on macroeconomic planning, followed by the International Monetary Fund program on financial programming. Later, working in the Government Bond Management Department, I attended seminars sponsored by JP Morgan, Credit Suisse First Boston, Lehman Brothers, Chase, and Salomon Brothers on fixed-income and derivative instruments. These experiences and on-the-job training acquainted me with advanced financial theory and fresh ideas, which I have used as I formulate and apply the latest ideas to the reform of China’s bond market.

It is important to understand, however, that the reform of China’s bond market is by no means a copy of the Western system. The Western tree cannot be transplanted on China’s soil without grafting. This is true for every reform program. For example, the United States uses an auction system to sell government bonds; syndicates are available only for selling corporate bonds. In China, the Ministry of Finance holds syndicate members liable for subscribing government bonds because without this requirement, syndicate members have no incentive to bid in the auction process. Furthermore, Chinese bond auctions use both the multiple-price (American) auction and uniform-price (Dutch) auction systems while the United States and the United Kingdom use only multiple-price auctions.

In China, the financial intermediary industry remains underdeveloped. Moreover, since there are not enough instruments traded in the secondary market and there is no when-issued short selling before the offering, bidders cannot be certain what the “right” price bid should be. Therefore, changing price differentials were designed to narrow the bidding range. This practice is also unique to China.

Combining the latest innovations in the West with China’s specific situation is a difficult task. Symmetrical bonds, for example, were a Chinese invention. China issues the same amount, same maturity, fixed-rate bonds as floating-rate notes, and, after one year, investors can swap one with the other. China Development Bank recently launched a securitization program. It is not, however, a simple replica of the U.S. practice in which an asset-backed security or mortgage-backed security is issued via a special-purpose vehicle (SPV). Although use of SPVs is against China Securities Act and Corporate Act, the CDB instead pursues its securitization program via a trust institution.

All these synthesized instruments are China-specific. I resist the temptation to assert that this universally applicable, but it fits well on an ad hoc basis in China presently. Using innovative ideas and considering successful experiences around the globe, China has been able to create its own version of financial market development; indeed, China’s fertile soil will undoubtedly engender fresh models as a legacy for the rest of the world.

FOREIGN INTEREST IN CHINA’S BOND MARKET

Foreign interest in China’s domestic market can be traced back to 1993, when executives from Morgan Stanley started to talk to me about how to open China’s market to the outside world. Subsequently, many efforts were made to position China’s market on the world stage. Clearly, it is in our interests to integrate our market with those of the rest of the world.

I am frequently asked about the timetable for opening China’s bond market. Actually, the gradual process is already underway. There are a number of joint ventures between foreign banks and their Chinese counterparts (domestic securities firms). Recently qualified foreign institutional investors were introduced to participate in the secondary bond market, though at the early stage, some restrictions have been imposed. The CDB wishes to see foreign participation in its syndicate and, better still, foreign bank participation in China’s primary bond market. Foreign banks still need to obtain the licenses from the China Banking Regulatory Commission.

As China’s financial market is increasingly integrated with those of the rest of the world, it is essential that investors and financial institutions alike gain a greater understanding of this market in order to pave the way for future participation in it.

The growing importance of the bond market to developing a sound financial market and facilitating economic development stimulated government officials and researchers to consider the main weakness of China’s current economy. Many books have been devoted to the stock market, but so far relatively little attention has been paid to the problems in the bond market. Yet we have seen a growing need for a thorough inspection and review of the bond market in order to convince the decision makers of the need for a fundamental change. I have written several books on the subject in Chinese since the mid-1990s, which I have modified over time to reflect the changes that have occurred in the bond market as well as the evolving economic environment.

From my experience with bond market reform and the concomitant financial innovations, I realized I had to address two kinds of problems:

1. The growing need to improve awareness of market participants—for example, securities firms—of the positive implementation of reforms.

2. The need to educate market participants, especially individual investors, about how to calculate bond yield.

The need to educate investors and even bank depositors stimulated my thinking about initiating an investor education program, and the books I wrote were part of these efforts. I hope that they are useful for those who are engaged in bond investment and trading, researchers, and others who are interested in China’s bond market. My first book, written in 1993, is a research paper named The Issues on China’s Government Debt. The second book is a descriptive introduction to China’s bond market and covers its historical development, the functional and operational aspects of the primary and secondary markets, settlement of bonds, and market participants and financial intermediaries. Its original title was China’s Government Bonds, and it was published in 1996. After I wrote that book, I moved to the China Development Bank, where my focus has been on the bond market. The CDB is one of the major bond issuers in China, with an issuing volume second only to the Ministry of Finance. Thus my knowledge of the bond market was no longer confined to government bonds, and therefore, in 2000, I updated the book and renamed it China’s Bond Market.

At the CDB, my devotion to the bond market remains unchanged. Moreover, CDB governor Chen Yuan, a reform-minded former central bank governor, is fully supportive of my innovative endeavors and academic pursuits. After several years, the CDB became the pioneer in bond market innovations. Furthermore, since 2002, the CDB has been one of the largest underwriters of corporate bonds. During this time, I have had several opportunities to participate in seminars and conferences on bond market development in China.

My third book, Government Bond Market, is a technical introduction to the bond market in China. Its focus is on the time value of money and the calculation of the yield of different bond instruments. I also introduced derivative markets to give the reader some idea of how derivative instruments, such as swaps, options, and futures, are priced in China.

Debt Capital Markets in China is based on China’s Bond Market, but with four major changes. First, a theoretical framework is established to give a full explanation of debt capital market development in China. Second, it is a translation of a more up-to-date, not-yet-published Chinese version. Third, it provides more background information to make it easier for non-Chinese readers to understand the evolving processes of the market. Fourth, it provides greater focus on the operational aspects to reflect the fact that technical progress played an important role in the development of China’s bond market.

HOW TO USE THIS BOOK

This book, which provides a comprehensive introduction to China’s debt capital market based on a theoretical framework, is divided into eight principal parts:

Part One provides a sketch of the overall financial market in China from a theoretical and practical perspective. To highlight the main features of the bond market in China, comparisons are made between the bond market there with that in the rest of world.

Part Two provides a historical perspective and offers a description of the development of the primary market in China.

Part Three focuses on the bond market’s status and the historical development of the secondary bond market in China as well as the relationship between the primary market and secondary market. Special attention is paid to the operational aspects of the bond market, including how to open an account in a securities firm, delivery versus payment trading, and the development of financial intermediaries in China.

Part Four focuses on policy issues.

Part Five is devoted to the organization and legal structure of China’s bond market.

Part Six looks at the international market and considerations affecting market entry, covering the history of international bond offerings. The legal process is described in detail to give practitioners a road map to how to conduct an international bond offering for Chinese issuers. This part also highlights the market strategy of the issuers; Chinese borrowers always misunderstand this strategy when they enter the international capital market.

Part Seven delves into non-governmental bond instruments. The corporate bond market and the financial debenture bond market, among others, are described in detail, as are innovations of the CDB.

Part Eight emphasizes the relationship between the economy and the bond market. Special attention is paid to the size of government debt calculated as a debt to gross domestic product ratio.

In order to be faithful to the original framework, which I believe is sound, I have primarily used the writings and source materials developed for the Chinese version of this book. However, the English version is designed to meet the needs and preferences of English-language readers who are interested in China’s bond market. Therefore, sections that are of interest only to Chinese readers have been eliminated. Every effort has been made to facilitate the understanding of the bond market for those who do not live in China. International practices and experiences have been introduced only for comparison, and to the extent necessary; therefore, they are discussed as briefly as possible.

1. Norman Chan, UNESCO roundtable conference, April 2000.

Acknowledgments

Although the original book is basically a result of my own effort, my intellectual debt is to the schools, the international organizations and financial institutions where I learned about finance banking and the securities market. This book would not have been possible without inspiration from many people. My deepest gratitude goes to each and every one of them. My largest debt goes to those who support my work and encourage me to go ahead with the reform efforts. First I want to acknowledge former minister of finance Liu Zhong Li and Vice Minister Liu Ji Bin, whose understanding and support were invaluable. Their appreciation of the idea that I proposed for the reform program served as the main impetus to support my academic endeavors. Second I must acknowledge the numerous men and women who worked with me in designing the bond market reform program and innovative financial instruments, and those who encouraged me and gave me the confidence to press ahead with the bond market reform in China. I am deeply indebted to each and every one of you.

This book could not have borne fruit without the kind and generous support of my colleagues at the Ministry of Finance and the China Development Bank, and many other financial institutions, to whom I would express my profoundest gratitude. Jing Zhao Jeme, Jin Jing and Mark Fang, who have remained longtime, loyal friends, and have firmly supported me in my endeavors. Their frequent discussions with me on many subjects concerning the economy and bond market have been critical. Special thanks to my colleagues working in the Debt Department of the Ministry and the National Association of Government Securities Dealers and Treasury Department of the CDB, who participated in the landmark events in China’s bond market development. A special thank you goes to Mr. Zhu Fu Lin and Mr. Zhang Jia Lun, who supported the 1991 underwriting syndication.

I would also like to thank all my students who have helped me to gather data and information to update the statistics. Among them are Nin and Yang, Guangjin Teng, and Zhiping Zhou. My students have also shared their insights and views with me. Their assistance and support were valuable and crucial to the book. I am also indebted to my secretary, Jianming Liu, Tenshan Men who arranged the translation and many logistical issues, without whom this book could not have been prepared in time for publication. Windy Liu, who contributed to the first-round editing work, deserves many thanks. Without her, the manuscript would not have been ready for submission to the publisher.

At Wiley, special thanks to developmental editors Ellen Coleman and Emilie Herman, senior editor Bill Falloon, and senior production editor Stacey A. Fischkelta. I am grateful to these people and many others at Wiley who contributed to the production of the book.

The book would not have been possible without the help and inspiration from my family. My sister and brothers generously shouldered my part of family responsibilities while I studied and worked in Beijing. Finally, I want to thank my wife, Like Wang, and my daughter, Weishan Gao, from the bottom of my heart. Their love and care light up my world and provide a constant source of joy.

Introduction: Bond Market Reform and Financial Innovations, A Historical Perspective

I keep some paper securities as a reminder of a bygone era. They call to mind many episodes related to that special period when bond market reform was in progress. It is not the reform itself but the way in which the reform was carried out that is most important to an understanding of China’s financial market and economic development as it exists today.

The reform of the bond market was an agency-initiated program, something unprecedented at the time.

The debt capital market in China had experienced profound changes, yet the path in the 1990s was rocky and labyrinthine. Reform triggered a debate over whether the placement of treasury bonds (T-bonds) should be targeted to individual or institutional investors. Of course, this is no longer the subject of debate since bond market reform, which focused on institutional investors, turned out to be hugely successful, especially when it is compared with the stock market and corporate markets, both of which suffer from either cyclical or placement problems.

In some sense, I, as one of the major designers, was at the heart of the bond market reform. However, it is the collective efforts that made it possible, and I am proud of being part of this process.

In the second half of 1990, when I transferred to the Government Bonds Management Department (now the Treasury Department) from the Comprehensive Planning Department in the Ministry of Finance as a deputy director general, treasury bonds were still distributed through administrative placement. The Finance Department set the quota and arranged with local financial departments to distribute the bonds to government agencies, institutions, and state-owned enterprises (SOEs). At that time, the public demonstrated little enthusiasm for this practice.