Building debt capital markets in China

The main directions of our project are organized under three headings.

Sovereign bonds: This concerns the trading of securities issued by the central government to domestic and foreign savers including short-term instruments (Treasury bills) and longer term instruments (Treasury notes and bonds). The modernisation and liberalization this market has typically proceeded by organizing security issues to permit trading over the full range of the term structure from less than one-month to twenty years or more. By issuing standardized contracts (e.g., non-callable, non-amortizing bonds) at regular intervals it can allow users and the fiscal authority the means of managing risks flexibly over a very long time horizon. Through a process of arbitrage it can facilitate the development of liquid trading of a wide range of other instruments used in money markets and debt capital markets. Liberalizing this market involves increasing the range of institutions participating in the market and eliminating or greatly relaxing quantitative controls. Institutional development to support this process involves simplification and effective regulation of pre-trade and post-trade services including market-making (both primary and secondary), clearing and settlement, managing central securities depositories and custodians. The development of this market is often accompanied by a change of the methods of monetary control with the progressive elimination of quantitative tools (credit quantities, reserve ratios...) and increased reliance on controls through broad monetary aggregates and price-based (interest rate) policy tools. Implementing monetary policy using a liquid sovereign debt market requires policy makers to rethink how they hope to achieve objectives for price stability, exchange rates and credit (and investment) growth.

Corporate bonds: The development of a broad and liquid corporate bond market can provide an effective means of providing funds to private sector enterprises as an alternative to bank finance which may result in lower costs of debt capital and thus promote growth. For savers investing in a broadly diversified portfolio of corporate bonds can provide better risk adjusted returns than investing in stock markets or bank savings accounts alone. They can play a large and important role in retirement finance as one of the main investment vehicles for life insurers and pension funds. Developing an efficient corporate bond market involves overcoming a range of important institutional challenges. It requires provision of investor protections against abusive trading practices. These rely on sound accounting and reporting standards for issuers, insurance, pensions and fund managers. It requires collection and dissemination of information about credit histories and ratings. It requires well-designed bankruptcy regimes with sound legal foundations and efficient administration. Corporate bond markets can become fragmented across maturities and legal status of issuers. Providing liquid trading of corporate bonds is challenging, and developing repurchase agreements, securities lending and other forms of securities funding transactions can be key to reducing transactions costs.

Sub-sovereign/muni bonds: This segment of the bond market is directed at the funding of public sector investments that are not supported by the budget of the central government. It involves bond issues by regional and local governments and special purpose public and quasi-public entities (highway authorities, water authorities, etc.) The development of this market segment is intimately related to the organization of local public finance. Thus our research will necessarily take into the account the particular Chinese structure of organizing both government entities and also state owned enterprises. In the current context reforms in the area will need to deal with the issue of an overhang of non-performing loans.

The project aims at two primary goals: (a) building awareness of how the future development of the market for fixed income securities in China will have significant impact on many facets of Chinese economic development generally and (b) to carry out world class research to study of Chinese debt markets.

The project design began with the visit of Ron Anderson with academics and business leaders in Guangdong Province in November 2015. Two addresses he gave on "The Internationalisation of the Renminbi" at Sun Yat-sen University and Guangdong University of Foreign Affairs each attracted audiences of more than 500 and were widely covered by the press. There was a high level of interest by regional business leaders as well as faculty and students who all are struggling to understand the unprecedented fluctuations of the foreign exchange market, how this relates to volatility in the stock market, how to understand the public pronouncements of Chinese authorities, and what all this has to do with bond defaults by major enterprises and the appearance in most banks of unfamiliar savings products promising much higher interest rates than traditional savings accounts.

To respond to this questioning convincingly, there is a need to combine a solid awareness of Chinese institutions with analysis based on good data and up-to-date methods. Our project will bring together scholars at LSE and Fudan U. Jointly their expertise spans the subfields of financial economics that can help address some of being asked. Shengxing Zhang is in communication with Chen Xuebin and Lijian Sun, specialists on Chinese macroeconomy, on how the recently developed macro financial methods can be applied to Chinese monetary policy. Ron Anderson who has worked on theoretical and empirical credit risk and also transition of financial institutions in Eastern Europe will work with Zhang Zongxin (empirical financial economics), and JIANG Xianglin (contingent claim pricing), to examine the changes underway in regimes to resolve failing companies. And Chenggang Xu, a leader in applying organizational theory in the Chinese legal system will join with Yang Qing, who has worked on SOE reforms, and with Ron Anderson to explore how the changing relation between local and regional governments and SOE's are being reflected in the pricing of SOE bonds.

We will reach the academic beneficiaries (described elsewhere in this application) through our workshops which will be open to researchers in our home universities, at other universities and at think tanks. By making all of the working papers from our project available in English on the work paper series at LSE and at Fudan we will reach a wider scientific audience in a timely way. And by placing our research in top quality journals we will assure its impact in the years to come.

Additional beneficiaries are practitioners and policy makers. Our universities have strong and high level contacts with official sector researchers and policy makers. We have considerable experience in organizing public events that bring together a high level mixed audience to engage in a two-way exchange of knowledge and views on important issues of public policy with good press coverage. A recent example is the two-day mixed policy and scientific conference on "Macroprudential regulation and stress testing: A transatlantic assessment organized" at the Systemic Risk Centre http://www.systemicrisk.ac.uk/events/stress-testing-and-macro-prudential-regulation-trans-atlantic-assessment which gave rise to proceedings volume published by the Centre of Economics and Policy Research http://voxeu.org/article/stress-testing-and-macroprudential-regulation-transatlantic-assessment . We have experience in reaching out to senior private sector practitioners through public speeches, participations of our academics in practitioner symposia, and smaller scale meetings.