FITCH: BOND DEFAULTS A LONG-TERM POSITIVE FOR CHINA MARKET

The default by Chinese computing firm Cloud  Live Technology on a CNY400m bond reflects an increasing tolerance for defaults in China's onshore corporate debt market. Fitch Ratings believes that allowing  for defaults is a long-term positive for the Chinese bond market, as it will enable investors to price risk more effectively and appropriately. 

The Cloud Live default is unlikely to have a major market impact in the short  term, being a relatively small company that was already under investigation by the China Securities Regulatory Commission. However, the event is significant as it is only the second default of an onshore publicly traded bond in China, and the first to default on its principal. 

Chaori Solar was the first company to default on an onshore bond when it failed to make a CNY89m interest payment in March 2014. Chaori's default ultimately resulted in a restructuring plan which saw state-owned asset-management companies provide guarantees on bond repayments. 

More defaults of this kind are likely. Government has expressed a greater willingness to allow for individual cases of corporate bond defaults, particularly for companies in non-strategic sectors where the default will not lead to systemic risks. 

Allowing for more defaults, and establishing a clear legal process for managing corporate bankruptcies, is essential to instilling greater market discipline - and ultimately for a more effective and appropriate pricing of risk. 

The lack of defaults in China's onshore bond market results in an inefficient allocation of capital and artificially inflated risk-free rate. Larger, state-owned companies in particular benefit from this environment because of a broader investor assumption of state support.

Thus far, though, there have been few examples to gauge how the government's position will be put into practice. Notably, China continues to lack clarity on the legal process for domestic bankruptcies and restructuring. The law governing bankruptcies remains embryonic and lacking in practical details, while more defaults could prompt greater progress on regulatory clarity. 

As such, the process to instill greater market discipline and more efficient allocation of capital will only take place over the long term.