The offshore reminbi market suffered an unexpected setback in late 2011 as expectations for the currency wavered. Hopes are high, however, that the once-hot market can regain some of its strength.
The offshore renminbi, or Dim Sum, bond market has had a tricky start to 2012. Renminbi deposits in Hong Kong posted their biggest monthly decline in December. According to the Hong Kong Monetary Authority, so-called CNH deposits dropped 6.2% that month to Rmb588.5bn (US$93bn), even as cross-border trade settled in the Chinese currency rose 29.2% Rmb239bn during the same period. (See Chart, SP24.)
The decline underlines the drop in appetite for the currency that has wreaked havoc on the Dim Sum bond market. After a breakneck start to 2011, CNH bonds reversed much of their earlier gains in the second half of the year, raising questions over the market’s long-term appeal.
“The era of explosive growth is over,” said Frances Cheung, senior strategist, Asia ex-Japan, at Credit Agricole. “The CNH market is maturing, as tighter liquidity is leading to convergence of the currency rate and interest rate with the onshore market, while volumes are rising due to increasing acceptance of the CNH in the investment community and among corporate clients.”
Hopes for renminbi appreciation ended dramatically in September, when foreign institutions started to sell the Chinese currency in order to raise funds to support their home businesses as the eurozone debt crisis worsened. The caused the CNH exchange rate to trade, at some points, below the onshore rate for the first time in history.
Yields on Dim Sum bonds have kept on rising, as much as doubling in some cases since mid-2011.
Bankers, however, seem to be cautiously optimistic with some downplaying the drop, saying the renminbi deposit base is just one of the factors fuelling the growth of the CNH market. In fact, major Chinese banks in Hong Kong have issued certificates of deposits of more than Rmb65bn to retail and institutional investors and these do not count in the deposit base.
More competition
Dim Sum bonds are facing greater competition from other renminbi-denominated products, such as RQFIIs, renminbi gold products and proposed renminbi ETFs.
China has gradually opened up the onshore capital market, where bond yields are still generally higher than offshore yields. As such, there is promise that higher accessibility will push up offshore yields.
“RQFII funds are more attractive [before taking fees into account] than Dim Sum bonds because, for the same credits, such as the Ministry of Finance, the onshore yields are much higher,” said Wendy Lam, chief executive officer of GF Holdings (Hong Kong), which launched a RQFII fund on January 31.
The MoF’s five-year Dim Sum paper was quoted at around 2% in the secondary market on February 1, while onshore government bonds were quoted at 3.113%.
However, not many people are worried about RQFIIs substituting Dim Sums.
“The total quotas awarded to RQFII funds is capped at a tiny Rmb20bn. This is far from enough to satisfy the investment demand of Hong Kong’s huge renminbi deposits, which increased tenfold in two years from Rmb60bn in 2009. Although such quotas may increase depending upon the success of the pilot scheme, it still has a long way to catch up to the Dim Sum’s surging trajectory,” said Nathan Chow, an economist at DBS Bank (Hong Kong).
With the lure of lower yields in the offshore market and the easier repatriation of renminbi funds back to the PRC, Chinese entities will likely remain major suppliers to the Dim Sum market this year.
China has granted approvals for 10 domestic banks to issue Dim Sum bonds totalling Rmb25bn in Hong Kong. Of the 10, Agricultural Development Bank of China and China Development Bank have together already printed Rmb5.5bn. Another Rmb25bn will come from corporate issuers. Adding multinationals and other issuers to the game, and with over Rmb68bn of CNH paper due in 2012, Dim Sum bond sales are expected to hit Rmb200bn this year.
Such heavy supply will push up offshore bond yields and narrow the differential with onshore rates. Still, any increase in Dim Sum bond yield is likely to be gradual, as onshore yields are facing downward pressure because China is expected to ease its monetary policies to prevent a hard landing of its economy amid deteriorating global markets.
Global issuers are still embracing the renminbi as a funding currency even after a spike in yields in the Dim Sum bond market. Recent issues, especially some from Korea, show that the fall in the cost of cross-currency swaps is boosting the renminbi’s appeal to international borrowers.
Foreign exchange investors adjusted their expectations for an appreciation of the renminbi during a global sell-off in September, and the non-deliverable forwards market has been pricing in a slight depreciation over the next 12 months. That has moved the basis swaps, presenting some good arbitrage opportunities if an issuer taps the renminbi bond market and then swaps the proceeds back to US dollars.
Opportunistic issuers, willing to pay higher yields in CNH terms as long as the after-swap dollar costs stay favourable, could take advantage of the situation and lock-in favourable funding costs in Libor terms, a banker said. To date, more than 10 foreign issuers have completed roadshows and are lining up deals.
Looser rules
Hong Kong is determined to maintain its dominant position as China’s offshore currency hub, and a series of recent measures are set to give the Dim Sum bond market a welcome boost.
On January 17, the HKMA expanded the limit for renminbi net open positions to 20% from 10% and broadened the list of eligible assets under its liquidity requirements.
The HKMA also broadened its qualification of liquid assets that can count towards an institution’s CNH reserves. Each institution is required to maintain eligible assets equal to at least 25% of its renminbi deposits. The eligible assets now include renminbi cash; settlement account balance with the renminbi clearing bank; balance maintained in the fiduciary account; renminbi sovereign bonds the Chinese MoF issued in Hong Kong; and renminbi bond investments through the PRC interbank bond market.
Previously, only the first three assets were included in the calculation of the renminbi risk management limit.
“The refinements allow banks to set aside fewer assets as idle cash, take on more renminbi risk, enjoy greater flexibility and lay foundations for offshore renminbi loans to take off,” said Becky Liu, strategist, Asian credit research at HSBC.
Hopes are high for a resumption of primary issuance. “The (HKMA) moves are generally positive for the overall Dim Sum bond market. The adjustment could improve liquidity,” said Liu. “This, in turn, suggests less aggressive competition in the primary market and, therefore, less upward pressure on yields in the near future. The impact of the adjustment is likely to be greater for entities that have smaller deposit bases and higher dependence on wholesale funding.”
