Caged potential

With yields onshore renminbi bonds lower than those on their offshore equivalents for the first time, foreign issuers should be keen to take advantage of onshore liquidity to reduce funding costs, but red tape remains a powerful obstacle.

For all the desire of market participants to get China’s Panda bond market going, there has been little to talk about over the years. To date, these renminbi-denominated bonds from non-Chinese issuers in the PRC have been slow off the mark.

Panda bonds date back to 2005, when International Finance Corporation and the Asian Development Bank became the first issuers. Each bond was for 10 years, with IFC’s Rmb1.13bn (US$182m) at 3.4% and the ADB’s Rmb1bn at 3.34%. The offerings were greeted with some fanfare, but the market never took off. The most recent offering was in March 2014, when Daimler became the first and only foreign firm to issue a Panda bond. It printed a Rmb500m one-year bond at 5.2%.

Corporate issuers say an onerous regulatory framework and the inability to convert bond proceeds are keeping them away from the market. China’s strict capital controls mean foreign issuers face great difficulties in repatriating money offshore.

Accounting regulations complicate the matter further as the Chinese Government requires three years of financial statements in its own version of the GAAP standards. Bond issuers must produce audited accounts, adding to the cost of documentation for foreign aspirants. They also need extensive regulatory approvals and a local credit rating.

These rules reflect the concerns of regulators that opening the capital account too fast could expose China’s economy and markets to substantial volatility.

Tough domestic rules have helped fuel the rapid growth of Dim Sum bonds, which are denominated in renminbi, but issued offshore. The overseas route gives borrowers more flexibility to manage proceeds and a familiar legal framework, typically through international MTN programmes.

However, bankers say the Panda bond market is likely to pick up in the longer term and they expect it to attract more attention in coming years. Some have gone as far as arguing that Panda bonds, if comprehensively liberalised, may eventually make the Dim Sum market irrelevant.

“Recently, more issuers have been considering Panda bonds. However, there are still some obstacles for issuers to move the bond proceeds out of China. Therefore, the types of issuers are likely to be those who have capital needs in China. In theory, capital controls have been relaxed in the Shanghai and Qianhai free-trade zones, but that hasn’t really been tested yet.”

Although Panda bonds have slightly lost ground in recent months, onshore yields are now cheaper than their offshore equivalents. Talks to resolve disagreements over capital controls and accounting are said to be making progress, with a possible compromise that would see issuers take advantage of more flexible rules in the free-trade zones of Shanghai and Qianhai.

“It would be a huge boost to the Panda bond market, because, at the moment, it’s just too difficult for it to be meaningful,” said a knowledgeable Hong Kong-based DCM banker. “If they made accounting and capital movement easier, it could be a huge step forward.”

Many remain sceptical. Connie Cheng, a partner at Clifford Chance in Hong Kong, worked on the first Panda bond issue and has also been involved with a number of Dim Sum deals. As she sees it, capital controls are a huge sticking point and, even if the free-trade zones help to alleviate some of those problems, the market remains very immature.

“Recently, more issuers have been considering Panda bonds,” she said. “However, there are still some obstacles for issuers to move the bond proceeds out of China. Therefore, the types of issuers are likely to be those who have capital needs in China. In theory, capital controls have been relaxed in the Shanghai and Qianhai free-trade zones, but that hasn’t really been tested yet.”

To set up a business in a free-trade zone can take over a year, a period of time when an issuer’s circumstances, not to mention market and regulatory conditions, may change dramatically. For now, companies wanting exposure and access to China’s currency find it a lot easier to issue offshore, even if it is more expensive.

However, bankers are not giving up on the market. If yields on Dim Sum bonds remain higher than onshore paper, some warn that more liberal Chinese regulations could make a serious dent in the offshore market’s viability.

“I think we’re a long way away from Pandas catching up to Dim Sum bonds, but it’s clear that the onshore market will gradually become more liberalised,” said a Hong Kong-based syndication banker.

”If it becomes fully liberalised, particularly without the capital controls, it will easily dwarf the Dim Sum market and Dim Sum bonds will really struggle to justify themselves.”