Recent guidance for regional and local governments (RLGs) and local government financing vehicles (LGFVs), issued by China’s Ministry of Finance and five other government ministries, is a credit positive says Moody’s.

The regulations, Document 50, Further Regulating Local Government’s Debt Financing, published on May 3, concern the financial management of RLGs and LGFVs. According to Moody’s, the guidance improves the governance of regional and local governments (RLGs) and aims to protect their creditworthiness.

“Document 50 clarifies the division of responsibilities between RLG and LGFV debts, and greatly reduces RLGs’ ability to guarantee LGFV debts. It also restricts the misuse of public-private partnership (PPP) funding mechanisms, which can increase RLG debt obligations,” says Moody’s in a recent Credit Outlook report dated May 11.

According to Moody’s, the regulatory guidelines are consistent with the principles set out in previous policies on reforming the RLG fiscal framework since October 2014. These policies reflect the central government’s determination to limit the potential for an RLG’s creditworthiness to deteriorate because of excess leverage at the LGFV that it owns.

The new regulations prohibit RLGs from injecting any more public welfare assets, public land, or pledging future land sale proceeds into LGFVs to enhance the LGFVs’ creditworthiness. Land sales are an important source of revenues for RLGs and the prohibition of pledging them to LGFVs will preserve land sales as a revenue source for RLGs and help maintain their creditworthiness.

“The regulatory guidelines include new LGFV borrowings disclosing to creditors that they are not borrowings on behalf of RLGs. Additionally, their RLG owners will not provide any kind of guarantee to any LGFV debts or accept liability for them,” says Moody’s.

“Earlier this year, the MOF referred cases of non-compliant financing-guarantee activities at the city and county levels to five provincial authorities. Document 50 urges speeding up credit checks and correcting any misconduct within three months. We expect the more disciplined implementation of the no-guarantee regulation to limit the spillover of highly leveraged LGFVs or other corporate debts onto RLGs’ creditworthiness.”

Document 50 also prohibits RLGs from promising non-government partners in PPPs any guarantee on repurchases, bailouts or minimum returns on capital. PPPs have grown rapidly in the past two years, although the misuse of PPP funding mechanisms can sometimes increase RLG debt obligations.

The new regulations re-emphasize the importance of explicit risk allocation and adequate public disclosure to attract private capital to fund public projects.

Document 50 also aims to improve information transparency of RLG debt management by requiring counties and cities to disclose their outstanding debt, their debt structure in terms of borrowing instruments, interest rates and maturities, use of debt proceeds and debt ceilings.

“We expect the improved transparency to further develop the RLG bond market, which totalled 11 trillion yuan (US$1.6 trillion) at the end of March 2017,” says Moody’s.

In addition to the MOF, China’s National Development and Reform Commission, the Ministry of Justice, the People’s Bank of China, China Banking Regulatory Commission and China Securities Regulatory Commission all participated in drafting Document 50.