Still on the menu

The renminbi bond market is offering a bewildering array of choices, with more onshore options coming online. The oft-predicted demise of Dim Sum, however, remains a long way away.

Predictions that China’s moves to open up the onshore bond market and promote Panda issuance would spell the end of the offshore Dim Sum market have so far proved wide of the mark.

While Dim Sum issuance is down on a year ago, with new issues of Rmb67.5bn (US$10.1bn) at July 15 lagging behind the pace of 2015’s full-year total of Rmb163bn, according to Thomson Reuters data, market participants expect that the offshore renminbi market will continue to fulfil a need for issuers and investors alike. As things stand, it is far easier and quicker for foreign issuers to sell Dim Sum bonds than it is to navigate the procedures required to access the onshore market.

“The Dim Sum market will always maintain its unique identity through ease of access and offering the option to issuers to raise RMB via drawdown off existing debt issuance programmes,” said Tim Yip, head of cross-border renminbi, debt capital markets, at HSBC.

“This differs from the Chinese domestic market where the working language would be Chinese and bond documentation be under Chinese law, for example. There is also no need to secure approvals in advance to issue Dim Sum.”

“The Dim Sum market will always maintain its unique identity through ease of access and offering the option to issuers to raise RMB via drawdown off existing debt issuance programmes.”

That convenience comes at the cost of higher yields, however. At the one-year mark, offshore Chinese government yields were 70bp higher than onshore, based on the curve on July 19. Mainland Chinese investors now provide a major part of the demand for Dim Sum bonds, attracted by yields that more than make up for transaction costs associated with moving money overseas, while expectations that the renminbi will continue to fall against the US dollar are keeping global funds away.

While offshore pools of renminbi are still growing, the liquidity will never be able to compete with what is available onshore. That will make the Panda market the preferred choice for foreign issuers once it becomes easier to sell bonds there.

“People have been wanting to issue in the Panda market for a long time, but there are still no set regulations for Pandas, especially for corporate issuers,” said David Yim, head of Greater China DCM at Standard Chartered.

“We’ve seen sovereigns, financials and certain offshore incorporated PRC companies, but for it to really take off and give confidence to multinational companies, it needs to be more transparent.”

China announced in August 2015 that it would consult on regulations for the Panda market, but so far issuers have gone ahead without knowing the complete set of guidelines. Market participants believe that China has given approvals for issuance selectively – to sovereigns, financial institutions and Hong Kong-incorporated entities of good-quality Chinese firms – to ensure that the first Panda offerings go smoothly, while a broader range of corporate and financial borrowers will come to market once firm rules are put in place.

The arrival of foreign investors is also likely to be another driver for cross-border issuance. China has removed individual onshore investment quotas for qualified foreign institutions, and the application process to buy onshore bonds has been streamlined. However, foreign investors still have concerns that they may not be able to divest their onshore renminbi holdings in times of trouble. Currency movements fall under the auspices of the State Administration of Foreign Exchange, and there are concerns that the freedom of movement of capital might be restricted to avoid sudden large outflows during a downturn, just as China froze trading in certain stocks during a sell-off in July last year.

“Investors remain keen to have exposure to China; at the same time, a key consideration would be the mechanics of cross-border fund flows when an investor conducts its asset reallocations,” said HSBC’s Yip.

Assuming matters like the cross-border movement of currencies are resolved, that still leaves China with several different markets for renminbi bonds, each with slightly different rules. The deepest onshore market, for interbank bonds, should by rights be the focus of most activity, but the exchange market, in which banks are not allowed to act as underwriters, has gained ground in recent years. The exchange market used to have a reputation for a slow approval process and wider pricing than the interbank market, but now its registration process looks to be on par with, if not faster, than its rival, and recent bond pricings have been extremely competitive.

In addition, the Shanghai Free Trade Zone has talked about introducing its own bond market, which would make it easier for foreign investors to clear and settle renminbi bonds using an international central securities depositary account.

Bankers are divided on what form the new Shanghai bond market will take.

“For bond issues in the Shanghai Free Trade Zone, we expect approvals and documentation to be more closely aligned to the domestic market,” said HSBC’s Yip.

There are questions over whether this scheme will come to pass, given that foreign issuers are still waiting for the much-heralded Shanghai board for listing foreign companies, and also over whether there is even a need for one more bond market in China.

“With Shanghai Free Trade Zone bonds, it is almost like a Dim Sum market onshore,” said StanChart’s Yim. “If Pandas take off and the outstanding technical issues are resolved, it (the Panda market) should become the market for everything RMB-denominated.”

Having several different kinds of bonds risks fragmenting liquidity, though some bankers point out that it is no different from the broad array of bond offerings in the US dollar market, under Reg S, rule 144A, SEC registration or in the Formosa market, for example. Each is limited to a certain pool of investors, but it does not prevent them from being viable formats in their own right, and in fact they are tailored to suit the needs of market participants in particular jurisdictions.

All the same, the differences between China’s various onshore bond markets make things more complicated for foreigners.

“We think it does make investing in China more complex and troublesome, operationally, but essentially once investors work out the issue of getting access to these markets (China interbank and exchange markets), it falls back to expected returns from the bond market (yield, potential capital gains), cost of investing, liquidity and easiness to repatriate profit/capital,” said Edmund Goh, fixed income (Asia) investment manager at Aberdeen Asset Management.

Another problem for foreign investors is that domestic rating agencies do not differentiate much between issuers. It is rare to see a local rating lower than AA, which has led to investors taking their own approaches in selecting credits: for instance, avoiding bonds from the steel sector, where overcapacity has made it difficult for some companies to cover their interest payments, sending yields higher than like-rated credits from other sectors. Issuers often neglect investor relations, meaning that investors have to put in a lot of work to separate facts from rumours.

“The difficulty with investing in onshore bonds is that most issuers are rated AAA, so the rating doesn’t give you much indication of the credit quality,” said StanChart’s Yim. “If you’re a fund manager from the US or Europe, it is very difficult to buy something in the PRC. If you do not know the companies well, you will hear all the news last, and you cannot rely on the rating.”

Such concerns, in addition to the low yields onshore, mean that many foreign investors still prefer to gain access to renminbi bonds through the Dim Sum market. Some investors are still buying without hedging, making some wonder whether the Chinese bond market has moved beyond being simply a punt on renminbi appreciation.

Certainly, five or six years ago, the white-hot Dim Sum market was made more attractive by the near-certainty of renminbi appreciation each year, as the currency was widely considered to be held artificially low to support Chinese exports. That one-way street came to an abrupt end in August last year when the People’s Bank of China allowed the renminbi to drop nearly 4% against the dollar in two days. As a result, bond investors cannot bank on currency gains to supplement their yields, suggesting that credit investors no longer view renminbi bonds as a pure forex play.

“We think it is still beyond that,” said Goh of Aberdeen. “Although FX has been more volatile since August last year after the FX regime was changed and that has resulted in FX being a bigger driver of CNY bond returns, we still think over the long run, changes in the onshore risk-free rate and changes in credit risk premium (which is still in its early stage of discovery) could have a pretty sizable impact on returns, especially on longer duration bonds.”

As barriers to onshore issuance and investing come down, and wider use of the renminbi globally makes currency risk less of a concern, Dim Sum bonds are expected to lose more ground to Pandas. The amount of Dim Sum bonds outstanding actually shrank by 17% between the end of 2015 and the end of June 2016, due to redemptions, according to Standard Chartered research.

“As the Chinese interbank bond market allows greater access for foreign investors and issuers, the role of the offshore RMB bond market might fade and more offshore RMB bond issuance will be diverted to the onshore bond market,” said Ivan Chung, an associate managing director at Moody’s.

However, for now, Chung expects most foreign investors will stick to government and quasi-government credits in the interbank market, until investor protection mechanisms catch up with global standards. Increased onshore default rates could also serve to deter foreign investors from venturing onshore. At least for the near future, Dim Sum remains a tasty alternative.