This month, Chinese regulators allowed US credit rating agencies to open wholly-owned operations onshore. Moody’s subsequently downgraded China’s sovereign rating, catching the markets by surprise.
As a result, a PBoC working paper, co-written by Jiang Xianfeng from the central bank’s financial research institute and Frank Packer from Bank for International Settlements (in Chinese) was released in attempt to explain domestic and international credit rating differences.
In China, 81% of ratings sit between AA and AAA, the paper noted. They are known as “national scale ratings” as the agencies only consider domestic companies, as opposed to the international scale which compares a bond issuer to its global peers.
(Currently international credit rating agencies such as Moody’s can only grade a Chinese issuer for its offshore issuance).
In the paper, the authors tried to explain the differences between domestic and international ratings, which is due to the way the agencies give weight to certain factors.
Domestic agencies put more emphasis on asset size as a positive factor and global agencies assign more value to leverage as a negative factor. Factors such as profitability and state-ownership also carry more weight for a positive rating from international agencies.
“We find that larger asset size and higher leverage tend to result in firms receiving higher domestic ratings than adjusted global ratings, but higher profitability or state-ownership are more likely to result in firms receiving higher adjusted global ratings than domestic ratings,” the paper noted.
The paper concludes by showing the resulting rating differences for investment grade bonds: A domestic investment grade for onshore bonds is AA- or above compared to BBB- or above for international ratings.
It is slightly different from the conventional rule of thumb, which holds that BBB- on a global scale rating will be the equivalent of AAA onshore, according to Dagong Credit Rating.
The authors also noted that in China, some rules set the investment grade standard much lower than AA- or above, meaning the bond buyers would face higher-than-expected risks.
“It might trigger risks on finanncial stability when facing a more volatile market. Relevant regulators can consider resetting the minimum threshold accordingly.”
Allowing global rating agencies to set up onshore should raise the standards for domestic ratings agencies and attract more foreign investor interest. Some Chinese agencies, such as Dagong Credit Rating, already intend to apply global standards to rate offshore bonds, FSA reported earlier.
Domestic vs international credit ratings
| Domestic | International | |
| Investment grade rating | AA- or above | BBB- or above |
| Criteria for higher rating | Larger asset size, Higher leverage |
Higher profitability, Lower leverage, State ownership |
