By Wang Yang

Research Report Vol.19 No.1, 2017

In early August 2016, I visited a number of local financing platforms in Jiangsu for investigation. Based on what I learned and supported by other investigations in similar platforms in other provinces and relevant information disclosed, this article analyzes the current status of local financing platforms following the issuance of the Opinions of the State Council on Strengthening Local Government Debt Management (GF [2014] No. 43, hereinafter referred to as Document No. 43) and gives some policy suggestions.

I. Current Status of Local Financing Platforms

1. Rules are unclear in Regard to the Recognition and Swapping of Local Debts

The recognition and swapping of local government debts enjoy relatively large room in terms of timing while relevant rules remain largely unclear. In the audit and recognition of government debts of 2013, local governments were unsure about the policies of the central government and followed different standards when reporting their debts. As a result, local government debts were in most cases underreported. After government policies were clarified for debt swapping, in 2014, much more local government debts were reported to make up for the underreporting of the previous year. Debt reports continued in 2015 and 2016, but local governments received no confirmation. Opinions from companies that run financing platforms indicate that the criteria for the recognition of government debts are not clearly defined, the distinction between government and non-government debts is blurry, and the result of government debt recognition is not transparent enough; and similarly, transparency and clear rules are also required for the allocation of swapping quotas from the central to the provincial, municipal levels and then to platform companies.

In debt swapping, since the quota is sufficient and financing costs differ a lot, local governments tend to try swapping some of their unmatured debts. But creditors, including banks and other financial institutions, general are unwilling to do the swap due to low risk and low interest rate. In comparison, swapping is easier for loans from local commercial banks and harder for loans from policy banks that have no branch in the local area.

2. Risks are Lower in the Short Term

After Document No. 43 was issued, companies running local financing platforms suffered from a fund shortage for some time, but things are much better now. By adjusting the overall debt structure, prolonging the terms, and swapping high-cost debts for low-cost financing projects, financing platforms have managed to bring down their overall risks substantially. This can mainly be attributed to the following reasons: First, these companies are doing fewer government investment projects. In some more developed regions, this is because they have already it made it through the peak time of local municipal infrastructure building and investment reduces naturally. In some other regions, this is because the companies are reluctant to make investment. Second, debt swapping reduced the pressure of financing platforms. Third, the platforms obtained more financing channels after Document No. 43 was issued.

3. Financing Platforms now have more Financing Channels and Lower Costs

Local financing platforms are making better use of all kinds of financing tools. For financial institutions, local financing platforms, with better financing environment, are more reliable debtors as private companies and state-owned industrial enterprises are seeing higher credit risks. For the financing platforms, as regulatory policies differ and change frequently, it is risky to rely solely on one financing channel and it is therefore wise to find more channels, which will also bring down financing costs.

Since 2015, local financing platforms have been going down and the reasons are as follows: First, there is debt swapping. Second, as economic growth slows down, monetary policies are easier and the general interest rate is lower. Third, as industrial companies suffer from higher credit risk and higher non-performing loan ratio, bond defaults occur more frequently, and investors swarmed towards city investment bonds, further lowering the financing costs of the financing platforms. As a result, the ROI of city investment bonds have long been lower than that of industrial bonds of the same rating and term. With smooth financing channels and only a limited number of investment projects, many financing platforms now hold ample funds and high credit lines remain unused. Therefore, they are more sensitive towards capital price. For example, Company A requires an interest rate of no higher than 4.8% for a five-year bond, while the interest rate of bank loans are not allowed to exceed the benchmark interest rate.

For financing platforms, three types of financing tools should be mentioned here. The first is corporate bond. After the CSRC launched new policies for corporate bonds in 2015, fundraising in this sector has surged and a large number of such financing projects involved local financing platforms. The second is industrial fund and PPP financing projects. Financing arrangements of this kind grew rapidly after Document No. 43 was introduced and most of the products were structured with financing platforms holding the posterior grade, thus maximizing the financing leverage. But behind such arrangements, the government usually serves as the potential safety net. The third is overseas bond. Overseas bonds issued by local platforms have been growing significantly since this year. Main issuers include Chongqing, Yunnan, Tianjin, Jiangsu, etc. and more of the bonds are now denominated by US dollar instead of Renminbi. Though these issuers have not fully enjoyed the benefits of low-cost financing on the overseas market due to their low ratings and hedging requirements, and such bonds constitutes only a very small share in the overall portfolio, we can still see the advantages of an additional financing channel and lower financing costs. See the table below. ...

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