The Daily Update - China's SOE reform plans evolve

Citing an increasing debt burden, S&P downgraded China’s long-term rating by one notch to A+ (stable), bringing it in-line with the other two main rating agencies (A1 and A+); this is the rating agency’s first downgrade to the country since 1999. Although Chinese authorities have taken huge steps in reigning in financial risks, particularly within the ‘shadow banking’ sector, debt has continued to grow, albeit at a slower pace more recently. The S&P move was no surprise, as such, market reaction was muted post the announcement, which suggests that asset classes had already priced in the downgrade. Strangely enough, the renminbi did, in fact, appreciate against the dollar after markets reopened, seemingly shrugging off the announcement, and Chinese government yields were marginally unchanged. Market reaction was starkly different from the sell-off witnessed after Moody’s downgraded China in May. S&P also downgraded a number of Chinese banks, which we do not have exposure to.

As China endeavours to reform state-owned enterprises (SOEs), we heard yesterday that the State Council has approved measures to centralise SOE financing funds. We suspect this move is aimed at boosting efficiency within the sector and in turn manage a huge chunk of the country’s corporate debt burden. It is said that a ‘centralised financing company’ will oversee all SOE borrowings and investments reportedly worth RMB2tn (~USD305bn). ‘Opaque’ non-financial SOE deposit and loan packages would be facilitated through this new entity, instead of across the number of institutions; leading to increased transparency. Currently there are no official details on the entity or potential regulatory controls, however, reports suggest that China Chengtong and China Reform Holdings will be in charge of establishing a centralised company which would: ‘coordinate business cooperation between companies, cut costs, reduce debt and promote other financial ties between state firms in and outside of China,’ according to Bloomberg.

China’s SOEs dominate the country’s most strategically important industries: including energy, banking, and telecoms. These entities, therefore, have an advantage over their private counterparts, as they not only receive cheaper financing but easier access to local and overseas business. There are therefore calls for more private investment and involvement in SOEs, thus more diversified governance, as opposed to increased government control. There are currently over 100 SoEs, which in manage a large chunk of the country's assets. It will be interesting to see what will be discussed at the Party Congress next month. A decision could be made to sell-off smaller companies in favour of consolidating and streamlining assets, and improving overall efficiency within the industrial, investment and operating group companies.

In terms of SOEs, we have holdings in China’s largest producer of crude oil and natural gas, state-owned CNOOC (rated A1), and China's largest refiner and chemicals producer, Sinopec Corp (also rated A1). Despite the recent downgrades, Sinopec 3.125% 2023s for example, continue to offer sufficient credit notch cushion of 2.5 notches; which suggests the issue is being priced as a BBB bond. We currently see no reason to be concerned about the high-grade SOEs that we hold, however, we continue to monitor our holdings and aim to rotate into better value opportunities if necessary.