< http://www.feer.com > CHINESE CREDIT RATINGS By Joel Baglole/HONG KONG Issue cover-dated January 08, 2004
AS INCREASING NUMBERS of Chinese companies turn to the capital market, international credit-rating agencies are charging into China hoping to capitalize on a huge new business opportunity. But they're operating in such a murky atmosphere that many investors question the value of their assessments. Demand for credit ratings--an assessment of how willing and able a company, bank or government is to repay its debts--is growing as more Chinese companies list shares and issue bonds, both at home and in international markets. The value of initial public offerings from China has risen 45.6%, and the value of bonds issued has increased 253% in the last five years, according to financial-data provider Thomson Corp. The success of agencies such as Fitch Ratings, Moody's Investors Service and Standard & Poor's in China could prove a key test of the country's ability to develop world-class companies and capital markets. The ratings assigned by the agencies help investors decide if a company is a risky or safe investment. For companies, ratings can determine how costly it will be to raise funds. But while China is opening, it's a slow process. Faulty accounting, evolving regulations, poor corporate governance, government interference and a lack of transparency hamper agencies' efforts. Chinese companies must get government permission before they can approach an agency for a rating. And market research, a key factor to assessing sectors that companies operate in, remains tightly controlled by Beijing. Analysts at rating agencies say they're frustrated as China doesn't adhere to international accounting standards, companies often don't know how to collect certain data, publicly listed companies can be controlled by private parent companies that aren't required to disclose financial information and the government issues misleading economic statistics to meet state planning targets. "China is one large grey area," says John Bailey, director of corporate ratings at Standard & Poor's in Hong Kong. "You have to go in with your eyes wide open," he adds. Yet, despite the enormous hurdles, agencies are issuing ratings in China. So far Fitch, Moody's and Standard & Poor's have been focusing on China's sovereign bonds and companies listed on overseas stock exchanges, where disclosure is better than at private enterprises. Public companies such as China Mobile (Hong Kong) and Huaneng Power International as well as several state-owned banks have been given investment-grade ratings. China is a potentially lucrative market for rating agencies, with more than 8 million corporations and 130 banks. To date, the international agencies combined have rated less than 100 Chinese enterprises. "If they can get their ratings well established in China, then eventually they'll have millions of companies lining up to buy ratings from them," says Pieter van der Schaft, director of economic research at Barclays Capital Asia in Hong Kong. Many analysts criticize the agencies' work in China, saying it's of little use, based as it is on limited, often inaccurate information. "If you have any credibility as a rating agency, you would probably be rating everything junk in China," says Scott Kennedy, an assistant professor at Indiana University in Bloomington, Indiana, who specializes in China's political economy. Kennedy adds that international rating agencies tend to give Chinese institutions overly high ratings because they weigh favourably the country's huge economic growth, low foreign debt and government support of banks and state-owned enterprises. "They look at these factors and conclude that the chances of a crisis emerging are low and so give them a decent rating," he says. Fitch, Moody's and Standard & Poor's tie their ratings of China's banks to the sovereign-debt ratings of the government's bonds. But executives say they have to do this, as the country's banks are technically insolvent with nonperforming loans accounting for as much as half their total loan portfolios. Institutional investors say that, given the limitations, they too are reluctant to give much weight to credit-rating agencies' work. "Credit-rating agencies can keep the markets and investors abreast of ongoing structural problems in China, but in terms of data that affects markets on a daily basis, rating agencies aren't that useful," says Brad Aham, an Asian-equities portfolio manager at State Street Corp., who has $2 billion invested in emerging Asian markets. "Most investors are hoping to gain from [China's] economic growth." Indeed, investors have shown themselves perfectly willing to charge into China blind, even when rating agencies refuse to rate a company or bond. In September, for example, Cosco Pacific, a Chinese container-leasing firm that's listed on the Hong Kong Stock Exchange, issued a $300 million 10-year bond without any rating on either the company or the bond. Credit-rating agencies say they were unable to issue ratings because Cosco's privately held parent company, China Ocean Shipping (Group), refused to release an adequate amount of financial information. While the lack of a rating kept institutional investors out of the issue, retail investors looking for exposure to China piled in. The deal's book-runners recorded $1.6 billion worth of orders for the bond. Rating agencies say the problems they encounter are inevitable as China moves from being a state-planned economy to a free market economy. "Ratings are not an exact science. They're opinions. And opinions are always based on inconsistencies," says Wei Yen, a China bank analyst at Moody's in Hong Kong. "You'll never have all the facts. You get what information you can and make a decision based on your logic." Credit-rating agencies do have their supporters. "I think you've got to take the view that some information and a rating is better than none," says Tony Latter, a visiting professor of economics at the University of Hong Kong. To be sure, credit-rating agencies are moving cautiously within China. Analysts at rating agencies say they're aware that their credibility would be badly damaged if they give overly high ratings to companies and banks that default on their debts. "The companies we rate are the premier companies," says Bailey at Standard & Poor's. He notes that Standard & Poor's is taking a top-down approach in China, moving from the best to worst companies. The credibility of credit-rating agencies was badly damaged during the 1997-98 Asian financial crisis, when ratings on some companies, banks and foreign exchange remained investment grade until after the crisis had emerged. Many agencies didn't adjust their ratings until the crisis was well under way, leading some analysts to describe the ratings as "review mirrors," rather than forward-looking, as the agencies themselves claim. Credit-rating agencies have given investment-grade ratings to companies that defaulted on their debt. In 2002, 46 companies worldwide rated by Fitch Ratings defaulted on their debt payments. Of those 46, six were investment-grade-rated companies, representing 13.1% of total defaults that year. However, that figure was down from 2001, when investment-grade defaults accounted for 26.3% of total defaults by companies rated by Fitch. Standard & Poor's saw 17 of its investment-grade-rated companies default in 2002, representing 7.3% of total defaults worldwide that year. Standard & Poor's officials say a record 234 of its rated companies defaulted on a record $178 billion in 2002. The rating agencies blame the high number of defaults, both investment grade and speculative, on the global economic slump, which has contributed to deteriorating credit conditions worldwide. Moody's declined to provide default data for this article. The international agencies stress that they're more critical than China's 20 domestic credit-rating agencies. Indeed, of the 29 bond ratings issued by China's domestic agencies since 2001, 26 have been the highest triple-A rating and three have been the second-highest double-A rating. Analysts give little credence to the domestic agencies. Two years ago, China's Xinhua Financial Network launched Xinhua Far East Credit Ratings, the first domestic Chinese undertaking that aims to apply international rating standards to Chinese companies. Xinhua has to date issued 175 ratings, half of them investment grade. But, in another sign of the lack of demand, Xinhua has managed to attract only 20 subscribers, who each pay $1,000 a month to access the agency's ratings and research reports. When possible, the international ratings process is interactive: Companies approach agencies and cooperate by disclosing financial information. However, responding to rising investor demand, Fitch and Standard & Poor's are also conducting public-information ratings, which use publicly available information and media reports to evaluate a company and then sell the rating to investors. Such ratings don't involve the cooperation of a company under review, and, in China, can rely on censored media reports. Of the 14 Chinese banks rated by Standard & Poor's, half have been done using public information. All 175 ratings issued by Xinhua Far East have been based on public information. (Moody's has stopped public-information ratings, saying they're too inaccurate.) Dilip Shahani, head of fixed-income research, Asia, at HSBC Bank in Hong Kong, says public-information ratings are "not as thorough as interactive ratings," and adds, "Engaging management is important when doing a rating." Agency executives say public-information ratings are necessary in China, where company cooperation is often hard to get. "We may have to do some adjustments and take educated guesses from time to time, but if we do a rating on a company it should tell people that we had sufficient information to do that rating," says Lincoln Chan, managing director of credit- market services at Standard & Poor's. Executives also stress that they'll decline to rate companies if they feel the lack of information is too great. Fitch doesn't place long-term debt ratings on banks in China because of "a lack of adequate data," says David Marshall, managing director of Asian financial institutions at Fitch in Hong Kong. SELECTIVE APPROACH Bailey at Standard & Poor's notes that about 20% of the time Chinese companies will pull out of the ratings process early on if they feel they're going to get a negative rating, or they'll shelve a bad rating. Companies can keep ratings confidential, unless there's a pressing capital-markets issue involved such as a bond. Another major problem is that China doesn't adhere to international accounting standards and has a shortage of accountants. Government officials in Beijing have stated the country needs 300,000 qualified accountants, though some private accounting firms estimate the figure at closer to 4 million. China is making efforts to improve corporate governance. The government has made it mandatory for public companies to report financial data on a quarterly basis rather than every six months. Beijing has opened two national accounting institutes to train people in international accounting, and steps have been taken to revise the legal system to deal with shareholder disputes and disclosure irregularities. Moreover, Beijing recently announced that it would revise its GDP figures for the first three-quarters of 2003, marking the first time GDP data has been revised. Agencies say these measures will lead to more accurate ratings in the future. In the meantime, Kennedy at Indiana University says rating agencies will "have to weigh transparency and disclosure issues against the ability to make a lot of money."
