Investors are expressing concerns over the use of standby letters of credit (L/Cs) to guarantee Chinese bond offerings.

They say the structure's reliability has yet to be tested and the rapid growth of L/C enhanced bond issuances may prompt regulators to curb the practice.

Concerns

Reports from Hong Kong suggest that the concerns of institutional investors over so-called L/C-enhanced bonds are raising doubts over the future of this increasingly popular funding tool for Chinese bonds.

Elsewhere, doubts over this new financing instrument have already emerged in respect of an issue by troubled Indian wind-turbine maker, Suzlon, (DC World News, 4 April 2013).

L/C backing

Chinese offerings have so far met a favourable response, but the L/C-enhanced US$900m offering from brokerage Haitong Securities has received a much cooler reception.

Backed by a standby L/C from Bank of China, Haitong received orders of US$4.5 billion for the bond at a coupon rate 275bp over US Treasuries.

The coupon rate is much lower than unrated Haitong could have expected without an L/C enhancement, but much higher than Bank of China risk would have fetched.

Possible default

Investors do not seem concerned that Bank of China would not honour the L/C if Haitong were to default, but they are reportedly concerned that the L/C-enhanced bond remains untested in the case of default.

Investors are also concerned that foreigners have no recourse to the bank's onshore assets under Chinese law.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.