Discussion of “Bonded to the State: A Network
Perspective on China’s Corporate Debt Market”
Li Jin
Guanghua School of Management
Peking University
June 2016
GCGC 2016 Conference in Stockholm
Summary
 This paper used a network perspective to examine
the major features of China’s corporate bond market.
 It finds that a key attribute of the market – state
centricity – has indelibly shaped its developmental
trajectory and operation, and channels its future
evolutionary path.
 A network perspective on China’s corporate bond
market helps frame an inquiry into the challenges of
China’s transition toward a more market-oriented
financial system.
 It is nicely done, comprehensive and rigorous.
Key observations

A well functioning financial market in China calls for the
development of corporate bond market.

While such market does exist in China, and seemed to have
developed rapidly in size, a closer examination revealed
troubling facts.

Large quantity of activities on the market are actually LGFV
related, and thus local government debt in disguise.

Of the remaining “true” corporate bond market, the
observation that it is the same “privileged” firms: largely
SOEs and listed companies, that are receiving financing.

Private sector SMEs still finds it very inaccessible.
Comments

Paper compares China with Japan and Korea, two other East
Asian economies.

The same pattern emerges: bond issues were effectively
limited to the largest firms that are already enjoying close
relations with major banks and, by extension, the financial
regulators.

These firms don’t lack other channels to finance. So what use!

The very actors lacking access to other funding channels
(particularly SMEs in the private sector) do not seem to
benefit from the development of corporate bond market in
its early development phase.
Comments

How is the “pecking order” in China different from that of a
mature market such as the US?

Typical sequence in a mature market:





Internally generated
Founders’ own capital (could be from family, relatives, etc)
bank (private debt)
public equity
public debt (corporate bond)

At various stages, private equity could be engaged (more on
this later).

Interestingly, public debt (corporate bond) comes pretty late
in the game, even in mature markets such as the US. DISPITE
the perceived info. disadvantage of equity.

A number of listed firms don’t even have a bond rating.
Comments

Problems

SMEs have huge growth potential.

But also large CF volatility.

Also, typically limited collateral.

Other common issues:

Disclosure, compliance, governance, etc.

Investors of (good quality) corporate bonds don’t like these.

In fact, many are not well equipped with monitoring and
disciplining, unlike the private creditors such as a bank.
Comments

Tend to see corporate bonds in mature and stable firms.

These are firms that probably already have access to other
financing channels, perhaps including an exchange traded
stock.

But still, introduction of corporate bond financing can
meaningfully lower the cost of capital, if it creates
competition from suppliers of capital.

Also, the listed firm share price provides a meaningful info
transmission mechanism for the bond investor.

So, corporate bond often comes after publicly traded shares,
at least for “high quality” bonds.
Comments

What about “low quality bonds”?

In the US, it came pretty late in the game.

“speculative” nature limits its demand from “regular” bond
investors.
Mom and pop, widows and orphans.


Limited scope, but potentially much higher expected risk and
return.

The tip of the debt “pyramid”.

SMEs can potentially use it. But also other investors, notably
PE use it for large financing request.
Comments

What about “low quality bonds”?

In the US, it came pretty late in the game.

“speculative” nature limits its demand from “regular” bond
investors.
Mom and pop, widows and orphans.


Limited scope, but potentially much higher expected risk and
return.

The tip of the debt “pyramid”.

SMEs can potentially use it. But also other investors, notably
PE use it for large financing request.
Comments

Framework of paper very valuable in evaluating other
potential funding channels.

PE

Converting debt to equity

Asset securitization, particularly distressed related.

Myriad of recipes, all need to satisfy the same rigorous scan
as proposed by the paper.
PE in the complete life cycle of a firm
Own funds
Seed - For initial concept for R&D of a
product
Angel Investors
Early - For product development and
initial marketing; the company may be in
the process of being organized or may
have been in business for a short time,
but has not yet sold its product
commercially
Venture Capital
Sales
Growth
Mezzanine
Private Equity
Late Stage
IPO/MBO/MBI/LBO
Turnaround
Distressed situation
Expansion Stage
Early Stage/Start up
Time
Seed Stage
VC
PE
Expansion - For growth and expansion of
a company that has built up a short track
record; used for increasing production
capacity, market/product development
and/or additional working capital
Growth/Mezzanine - Financing to help a
company go public/trade sale
Late Stage - Financing in form of
loan/equity to enable MBOs or MBIs of
an existing product/business
Turnaround - Financing to re-establish a
business which has encountered some
performance difficulties
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Conclusion

Extremely insightful and comprehensive.

Not entirely agreeing with the conclusion regarding the
(regular) corporate debt market as ample solution to the
problem of SME financing.

The framework proposed in the paper offers a valuable
evaluating toolkit for any proposal for solving the funding
difficulties of private sector SMEs in China and any other
developing economies.

A must-read for anyone interested in understanding financial
market in China!