The Chinese corporate sector could find itself under funding pressures due to the prevalence of put options in Chinese bonds. Systemic stress is not expected, but companies may face challenges if market liquidity tightens.
According to a new report by Fitch Ratings, about a fifth of onshore nonfinancial corporate bonds in China contain a put option, which grants investors the opportunity to demand early repayment of the principal. (In comparison, only about 4% of corporate bonds are puttable globally.) Puttable bonds, or put bonds, allow the holder to force the issuer to repurchase the security at specified dates before maturity, according to Investopedia. In China, corporate bonds with put options are valued at $420 billion, compared to $233 billion outstanding in the rest of the world.
Issuers can plan for refinancing, since the number of exercisable puts will peak in 2018 and 2019, Fitch said. This is the reason that systemic stress is unlikely. The put bonds will increase the cost of debt servicing sooner than some companies may have planned, however, and shift forward funding needs. Those companies that rely heavily on puttable bonds are likely to face pressure if liquidity conditions tighten significantly.
According to Fitch, liquidity and refinancing risks from puttable bonds are dampened by coupon-adjustment options. The ratings agency expects issuers to raise coupon payments when possible to dissuade investors from exercising puts, which would then allow issuers to avoid re-issuance costs. This would, however, increase the debt-servicing cost.
– Adam Fusco, associate editor