Research On Developing Municipal Infrastructure Project Bonds In China

Local governments nowadays are cumulating debt risk with financing models which still lack of regulation. There is an urgent need of change in order to limit their risk exposure while still duly support regional infrastructure development. The possibility to tap the fast growing domestic capital market with emerging bond instrument for infrastructure development is attracting more and more attention from both central and local governments.Surveys have been carried out for domestic Municipal Infrastructure Project Bonds (MIPB) market, mainly focusing on bonds of Local Financing Platform and ABS. The price of domestic related bonds are mainly influenced by local public finance, the quality of mortgages, the credibility of guarantors, etc, which brings potential risk to local public finance.Investigation has been made across the global market. Bond samples has been taken out from the US and typical financing structure of US Municipal Infrastructure Project Revenue Bonds (MIPRB) has been identified, by examining its repayment source, account setting, cash flow control, external guarantee, DSCR calculation, etc. based on bond prospectus. Project future revenue as the primary prepayment source lies in the center of the whole financing structure. Further investigation is made through two case studies. Comparison with domestic market has been carried out, which shows an obvious difference from MIPRB structure and pricing model, and the necessity to improve.Main principles on capital risk management from BaselⅡ(prevailing in global banking industry) and RAROC (Risk Adjusted Return on Capital) pricing model have been introduced in order to set up a two-layer pricing analyze framework for MIPRB in which pricing determinants have been classified based on credit risks, market risks, operation risks and liquidity risks. Based on this framework, credit spread determinants for MIPRB primary market issuance have been analyzed by econometrics modeling. The final model comprising bond maturity, rating, tax treatment, market condition and other related factors have well been verified. The credit spread variation of MIPRB on the secondary market trading has also been examined in a case study. The output of the econometrics model shows the volatilities are mainly driven by the fluctuation of risk exposures which have not been fully covered in contract structures.Based on research findings and expert interview, suggestions for the further development of China MIPB have been made: change the source of debt repayment and credit enhancement scheme and prioritize the development of Project Revenue Bonds; for the development of MIPRB, rating system needs to be upgraded, and contracts of the project need to be well structured in order to address the inherent risk.