By Andrew Galbraith
SHANGHAI (Reuters) - By day, Yao Yu heads up risk control for an investment firm in the southern metropolis of Shenzhen. By night, he goes on the prowl for his own business, Ratingdog, sniffing out data that could bring clarity to China's notoriously opaque bond market.
Yao and a team of about a dozen part-time analysts scour information from China's exchanges and clearing houses to produce ratings, analyses and pricing models for new bonds. Their findings are then posted to a public WeChat account that bears Ratingdog's logo - a smiling, sunglasses-wearing border collie.
Since Yao founded the service in 2017, Ratingdog's free YY Rating, YY Valuation and YY Pricing products have become widely used points of reference for investors and analysts wary of unreliable credit ratings provided by official agencies in the world's third-largest bond market.
"In China, for fixed income, we need these kinds of services," said Shen Yi, chief executive officer of Shanghai ShenYi Investment Co, referring to companies such as Ratingdog. "There's a lot of space in the market for good information."
Two defaults this year highlight the gap between official ratings and the Shenzhen upstart, which investors say is the country's leading provider of free, independent credit research.
(For a graphic on 'China corporate bond defaults' click https://tmsnrt.rs/2ChVjf7)
On Jan. 29, China's state-backed Minsheng Investment Group, a private investment conglomerate, missed a deadline for a maturing 3 billion yuan onshore bond, belying its rock-solid AAA rating from Shanghai Brilliance Credit Rating, one of China's four big agencies.
Ratingdog, however, had flagged Minsheng's heavy debt burden and limited profit potential as early as 2017.
Then on Feb. 22, Qinghai Provincial Investment Group (QPIG), rated AA by three agencies including Dagong Global Credit Rating Co Ltd, became the first state-owned enterprise in decades to miss a deadline for an offshore bond coupon payment.
Ratingdog, however, had warned in 2017 of QPIG's "very large susceptibility" to a downturn, giving it a speculative-grade rating of 7 out of 10.
Both Minsheng and QPIG subsequently made delayed payments.
(For a graphic on 'Investors demand more from riskier debt' click https://tmsnrt.rs/2ChWLOB)
IMPLICIT SUPPORT
While quantifying Ratingdog's reach is difficult, Josh Sheng, chief investment officer at Shanghai Tongshengtonghui Asset Management, said a "large proportion" of domestic mutual funds and securities companies refer to its ratings and pricing. In contrast, many investors all but ignore official ratings, which rank most issuers as AA or higher, implying little default risk and giving little guidance on pricing.
That is despite efforts by Beijing to improve the quality of ratings and strengthen oversight, including freezing Dagong's core ratings business last August for violating industry rules.
One reason for the preponderance of highly rated firms in China is an implicit assumption of state backing.
Jean-Charles Sambor, deputy head of emerging market debt at BNP Paribas (PA:BNPP) Asset Management, said analysis of issuing companies has tended to focus on the likelihood of government support, rather than balance sheets.
"We basically don't use official ratings for our investment decisions, and they're not even very meaningful as a reference," said Liu Xiaofang, head of investment research at Shanghai Fengshi Asset Management Ltd.
More than a month after Minsheng Investment's technical default, and with the yield on a Shanghai-traded 4.88 percent Minsheng bond hovering above 13 percent, the company continues to boast an untarnished AAA issuer rating.
Ratingdog has rated Minsheng bonds at 7/10 since December, a level indicating "many credit issues" and a recommendation to avoid.
Shanghai Brilliance and Dagong did not respond to Reuters' requests for comment.
ISSUER-PAY
Drawn in part by the imminent inclusion of Chinese bonds in global indexes, foreign rating agencies have been racing to set up shop in China.
S&P Global (NYSE:SPGI) Ratings recently became the first global agency to receive a license to rate Chinese onshore bonds. Fitch Ratings, which has established a domestic entity, and Moody's Investors Service have also applied for licenses.
Some investors hope that the international agencies will encourage greater ratings transparency.
However, S&P Global will follow an "issuer-pay" model in China, similar to the one that domestic agencies currently use. Many investors in China have been wary of the practice, whereby ratings are given to issuers enlisting the agency's services.
S&P provides issuer-pay ratings in other markets and says it has measures in place to guard against potential conflicts of interest. Its ratings of some Chinese issuers of both onshore and offshore debt, including QPIG, are notably different from those of domestic agencies.
But, says Ratingdog's Yao: "There's a problem here, and it's a problem with overseas agencies, too, and that is: In the end, who are you serving? Is it investors or issuers?"
'DIFFERENT ROAD'
While interest is high for Ratingdog's products, monetizing that demand may prove difficult.
Only companies officially licensed to rate securities are permitted to charge for rating services in China.
But Yao plans to press ahead anyway, by introducing investor-paid customised research alongside its free analysis.
"Charging for services is meant to help speed up our development and expansion, but it's also to understand real market demand," he said. "After all, the only real demand is demand that's willing to pay."
Ratingdog's growth could pose problems for it in what Hayden Briscoe, head of Asia Pacific fixed income at UBS Asset Management, calls "a very licensed regime".
"I would suspect that he wouldn't last for very long unless he had a proper license," Briscoe said of Yao.
A senior rating industry source, who follows Ratingdog on WeChat, said that regulatory requirements are "very strict", including annual audits with on-site checks conducted by regulators.
"If you give a rating, you also need to bear responsibility for it," he said.
Yao said he is following a "different road" and not seeking a rating license, but how to operate legally is "a long-term consideration."
BOTTOM-UP SHIFT
Ratingdog is not alone in looking to feed the market's hunger for information. Domestic brokerages and investment banks offer sell-side credit research, often bundled for free alongside equity research.
One bank even uses a Ratingdog-like canine theme for bond analysis in its proprietary app.
BNP's Sambor said the rise of these alternatives indicates a broader shift.
"What policymakers are trying to achieve is to make sure that investors are looking at credit research from a bottom-up perspective rather than a top-down perspective," he said.
A "massive repricing" of onshore corporate bonds in the past 18 months has followed attempts to introduce more credit risk into the market, encouraging differentiation and better price discovery, Sambor said.
The spread of riskier 5-year AA corporate debt over AAA debt of the same tenor was 101 basis points on March 12, 56 basis points wider than at the end of 2017.
Still, even after 2018 saw a record level of corporate defaults, Chinese issuers remain relatively unlikely to default.
The marginal default rate - the proportion of the value of defaulting bonds to that of total outstanding credit bonds - was just 0.07 percent in December, according to China Central Depository and Clearing Co.
With defaults comparatively rare, developing reliable ratings will take time, said Yao, noting that global agencies and markets have had more than a century of competition and experience.