Why do Chinese borrowers like risky structures?
Special points to highlight in this issue:
• Roughly two-thirds of all the outstanding putable bonds in the world, according to Fitch Ratings, were issued by Chinese corporations. Historical precedents suggest that the popularity of this type of structure in China almost certainly reflects difficult and deteriorating conditions for Chinese corporate borrowers.
• While the systemic impact of putable bonds is likely to be low in sophisticated financial markets like those of the US or Europe, where the puts are triggered mainly by increases in underlying interest rates that can be modelled and easily hedged, this isn’t necessarily the case in less sophisticated financial systems. A large outstanding amount of putable bonds can increase systemic risk if the put is triggered not by an increase in underlying interest rates but rather by a nation-wide or sector-wide jump in credit spreads.
• Putable bonds can sharply increase already-high sensitivity to rising interest rates, for example when issued by borrowers in the real estate sector. In China, unfortunately, the real estate sector is the most avid issuer, with roughly half of outstanding bonds in putable form.
• If the borrowers are under severe financial strain, or if their leading shareholders are near insolvency, issuing putable bonds can nonetheless be rational even for the real estate sector. The popularity of putable bonds may tell us that Chinese corporations and their principle shareholders may be facing greater stresses than we think.
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