China will experiment with letting small and private companies issue junk bonds this month or next, a change that could make it easier for such companies to obtain credit, media reported on Tuesday.
"The stock exchanges have handed this proposal over to the China Securities Regulatory Commission, and we expect it to be approved this month or next month at the latest," an anonymous source from Nanjing Securities told the Nanjing-based newspaper Modern Express.
The "junk-bonds" tested in the experiment will be deemed "private placement bonds for small and medium-sized enterprises", or SMEs, in China, the source said.
The CSRC said on Tuesday that it is considering allowing SMEs to issue the bonds.
Modern Express said the proposal will be first tested in Shanghai, Beijing, Tianjin and Shenzhen and the provinces of Jiangsu and Zhejiang.
The source also said the proposal is likely to require that bonds put on the market stay there for more than a year and that their interest rates be lower than three times the national benchmark interest rate. Real estate developers and financial firms are not included in the pilot program.
Still unclear, though, is what rules will govern the investors and trading markets for the bonds.
"I think the priority right now is in helping investors figure out the risks," said Zhao Xijun, deputy head of Renmin University of China's School of Finance.
The bonds, which will carry high risks but also offer high yields, will give companies that have trouble getting bank loans an alternative means of raising capital. Investors, to ascertain if such bonds are good investments, will have to conduct more risk analysis before buying them.
"Generally speaking, investors in China are less astute than their counterparts in developed countries in their ability to deal with risks," Zhao said.
For that reason, authorities must go to extra lengths to ensure that information released about the bonds is clear and reliable and to encourage investors to make rational investments, he added.
Zhao said it is hard to know how big the market will be for the bonds. He said the instruments' interest rates should be set by the market.
The possibility of allowing companies to issue junk bonds has long been a topic of discussion in China.
Eighty percent of the bonds issued in China are backed by State credit and most of the rest come from large companies that have AAA or AA ratings, meaning they are effectively risk-free, said Sun Lijian, a professor of private economic studies at Fudan University in Shanghai.
In February, the CSRC met with executives at large Chinese brokerage houses and told them it wants the country to have a market for high-yield bonds. Rebuilding confidence in high-yield instruments will be difficult and will require reforms among issuers, Shanghai media have reported.
By the end of 2011, 22.1 trillion yuan (US$3.5 trillion) in outstanding bond debt had originated in China, compared with $36 trillion in the United States.